Global Investment Report’s survey of the Top 50 hedge funds is unique industry research. This year is the 20th edition of the survey, which previously has been featured in The Wall Street Journal, Barron’s, FinancialTimes, and Institutional Investor.
We had the opportunity to sit down with the survey’s manager Eric Uhlfelder and quiz him about his findings and how he devises his ranking of the industry’s most consistently performing hedge funds. If you want to skip the fireside chat I had with Eric, please feel free to jump directly to a copy of his report at Global Investment Report.
Eric follows a broader range of strategies than what we do, and the perspective of the larger funds is inspiring and adds context to an industry that struggles with performance and perception. The 20th edition of the report spans a large number of topics, ranging from the expected (the survey of the 50 most consistently performing funds) to the unexpected (an interview with the former US Ambassador to Russia).
Can you describe your scoring methodology and the requirements to qualify for your list? How persistent are the persistent funds and how much do they change from year to year?
- There are several minimum thresholds that funds must meet to be considered. Now that I’ve applied these standards for five consecutive years, this approach is revealing the most consistently performing managers. That’s further borne out with more than two-thirds of the Top 50 funds regularly qualifying for the subsequent year’s survey. Here are the basic minimum requirements.
5 years. That’s actually longer than the average life expectancy of the average hedge fund. Funds that reach that age likely have been buffeted by various edges of the market cycle, which can tell us something about their investment and management skills.
Minimum performance hurdles:
Funds need to have delivered minimum absolute returns over each of the past five years. That hurdle started at +5% in 2018 (when I prepared the survey for The Wall Street Journal), then it fell to +4.5% along with the risk-free rate.
Because 2022 was an awful year for most strategies as interest rates soared, that number turned negative to -5%. Still, 44 of this year’s Top 50 funds made money last year and 3 additional funds lost less than 2%.
Minimum Assets under management (fund or strategy):
Fund or strategy aum of at least $300 million. This helps ensure management can afford top-tier service providers, which helps ensure sound management practices and reporting accuracy.
Only broad-strategy funds:
Avoiding narrowly focused funds means performance more accurately reflects management decision making, not a good industry tailwind or a nasty headwind which managers can’t do too much about.
There are many multi-strategy funds on your lists. These are managers that have enjoyed tremendous success lately. How do you view such funds compared to single PM/focused hedge funds? Will they persist or perish? And will investors stomach the pass-throughs?
- The idea of flexible multistrategy funds seems to be an interesting all-weather investment solution. But on average, they aren’t doing particularly well. According to BarclayHedge, the average multistrategy fund lost 3% last year and over the trailing 5 years through 2022, returned only 2.2%. So all the rage about the strategy really involves a select group of outliers, like Citadel Wellington (ranked No. 3) and D. E. Shaw Composite (No. 14).
- Both did very well last year and delivered 5-year trailing annualized returns of 23% and 15.4%, respectively. Their underlying success is based on their manager and strategy selection and weighting. These folks are certainly proving more successful than the fund-of-funds model. That said, a single strategy manager is much easier to break down and discern what’s driving exposure, risk, and returns. That transparency is always helpful, especially if you’re doing your own homework.
- Your question about sustainability, especially with the most successful funds, is on everyone’s mind. The concerns I hear from large allocators: they’re increasingly worried about growing use of leverage, rising fees and pass-through expenses, and internal opacity. I’m worried about managements’ belief in limitless capacity. That’s counter-intuitive to what my research has found over the years. The larger a fund gets, the more limited are its investment opportunities, and then this can lead to more risky decision making to find a new edge.
- Searching for great returns certainly might explain growing use of leverage. But that’s conjecture. It’s also hard to identify performance drivers of such complex portfolios. Then, with internal manager compensation often linked to how much of the pie a manager is running, then there’s the issue of keeping all of the team happy, something maybe akin to herding cats. But my largest concern about the very biggest funds that are delivering extraordinary returns year after year, it feels like musical chairs. Regardless of whatever assurance management provides, the music always stops. And no one can predict when that will happen.
You do a remarkable job of providing transparent and accessible coverage of complex strategies, and activities related to these funds. How do you tease out relevant details for each fund?
- Thanks. I guess perseverance is key. The longer you research an industry, the more you learn, and the more key industry figures begin to trust and open up to you. Like fund management itself, it’s all about sticking to a process. But then something else happens . . . you start to see links between manager, strategy, and performance . . . and when you see deviations that don’t make sense, you know the questions that really need to be answered to help understand what’s going on.
- But I’ll be the first to say, I still feel like I’m often just scratching the surface. I can combine facts and reverse engineer an ostensible explanation of what I’m seeing. But it’s not the same as being in the engine room and seeing firsthand what’s driving behavior and performance. And there’s the rub. There will always be uncertainty when investing in hedge funds along with most other alternative vehicles.
What are some common challenges that you and other journalists face when attempting to interview publicity-shy funds or obtain performance information from them? Some of them are hellbent to stay out of the public domain and they are very reluctant to provide return transparency.
- The biggest challenge: most journalists write negatively about the industry. There’s an abundance of schadenfreude going on. A key reason for it: the majority of hedge funds are not particularly good investments and the industry is hard to truly understand. Even when journalists approach hedge funds on a benign subject, that kind of story can still come with a dig.
- I can’t blame good managers from being reticent. It takes time to get stories and details precisely right, and most journalists are working under strict deadlines. One off-handed statement or poor reference in an article can prove very costly to a manager. So why take the chance? It helps when an analyst or journalist understands this, because it’s expensive and hard to start a hedge fund and most press exposure is likely not worth the risk.
- That said, last year’s survey included six fund profiles, most of whom had never been interviewed before. They ranged from a small US hedged equity shop, a merger arbitrage manager who was part of a multi-billion-dollar firm, to a Middle East/North African equity fund and a manager investing in frontier African sovereign debt.
- Managers see that for two decades my goal has been to focus on the handful of shops that are actually delivering on the promise of independent asset management. Since I’m interviewing managers who have a solid long-term track record, they know I’m looking to explain their success.
- But at the same time, I make it clear that there’s also a lot to learn from missteps. I want to write about when a manager stumbles. They all do at one time or another. There’s no embarrassment there. Recovering from problems reveal character and commitment to their investors. Moreover, there’s often a really good lesson in explaining why an ostensibly sound investment turns bad.
- Sometimes it’s timing, sometimes it’s not having seen all the risks, sometimes, it can be triggered by an event that comes out of left field (US baseball parlance, i.e., coming out of nowhere). To me, a manager that is candid in explaining failure is more likely to be a straight-forward type of person, and that quality, along with proven competence, is what allocators should be looking for.
You have maintained this remarkable survey for 20 years. How long do you intend to continue and what is in store for the next 20 years?
- I’m motivated to sustain this survey because none of the publications that used to support such efforts (which I managed) are producing this time-consuming research. You’ll more readily find articles on the wealthiest funds and managers than any kind of in-depth look at performance. I like having cornered this small piece of the market.
- Something quite different from any other survey I’ve seen or managed: I produce quarterly reports that track the subsequent performance of the Top 50 funds for the entire year following their selection. This review tests the merits of my survey. Last year’s Top 50 funds, selected based on 5-year trailing returns through 2021, proceeded to outperform the S&P 500 by nearly 24 percentage points in 2022.
- I like seeing what each year brings, new allocators and managers that come my way. It’s a remarkable learning experience. And the survey is a compelling forum in which I can dive into contemporary issues and finance. I’m always wondering around what theme I should build the survey. And my work always leads to new unexpected opportunities, like meeting up with the head of NilssonHedge. Who’d have thought?
More of Eric’s work can be found here The Global Investment Report.