The Biggest Hedge Funds Take the Lead—and Pocket the Most Investments

Amid an attrition trend and a performance lag, the smaller operators are closing.

Reported by Larry Light

Art by Simone Virgini


A big shift is under way in hedge funds. Fewer have the wherewithal to triumph or even survive.

The change: Large hedge funds are outpacing their smaller competitors, which historically had done better. “The small shops are getting squeezed out,” says Jeff Boyd, CEO of Northern Trust’s hedge fund services.

Time was that smaller funds could easily outmaneuver the big guys. The chief advantage was they were more nimble and could operate undetected. The giant funds’ trades were easy for rivals to pick up.

The small funds also had hunger going for them. Their staffers thought nothing of pulling all-nighters to execute a canny trade. The big funds, the thinking went, were not as ambitious because they already had arrived.

Something has altered this equation lately. Many small funds are finding they cannot keep up, lacking the resources to prevail in a messier investing world. A big reason is that interest rates have catapulted, and that has eradicated the layups that many small funds took for granted.

For the first time since 2018, big funds last year performed better than small ones, those with $3 billion or less. In 2022, the Hedge Fund Research Index Fund Weighted Composite Index, which equally weights funds of all sizes, lost 4.25%. Meanwhile, the HFRI Asset Weighted Composite Index, which gives more magnitude to the larger funds, rose 0.97%.

For sure, regardless of size, hedge fund operators insist that they do not promise to beat the indexes. Rather, they say, their charge is to protect investors on the downside and offer diversification from traditional equities and fixed-income securities. Trouble is, given hedge funds’ lofty fees, many investors are looking for a bounteous performance in return. On average, says HFR, fund management fees last year were 1.35% and incentive fees 16%, which is a generous slice of any results (these fees are down from the traditional 2% and 20%).

Clipping the Hedges

The upshot is the hedge fund industry’s popularity is waning, and that is not good news for the weakest ones. To Karl Scheer, CIO of the University of Cincinnati, hedge funds “are not a great plan to spend our time on.” He intends to cut his hedge fund exposure to 10% of his program’s $1.3 billion portfolio, from 20%. In 2014, the California Public Employees’ Retirement System jettisoned its $4 billion hedge fund portfolio, labeling the asset class too costly and complex. Earlier this year, CalPERS indicated it was looking at possibly returning to hedge funds, but it does not intend to make any major foray into the category.

Recently, new fund launches have shrunk and liquidations have spiked. Last year, 571 funds were shuttered and only 432 new ones were hatched. Consulting firm Agecroft Partners, which tracks hedge funds, forecasts that more funds, the bulk of them on the small side, will close in coming years, hurt by higher expenses and lower revenues. In a report, the consultancy said it “expects the closure rate to continue to rise for small and mid-sized hedge funds.”

The result is that the sizable outfits are the winners. Small wonder there is a tilt of investment dollars toward them. Agecroft projects that 5% of hedge firms, those “with the strongest brands,” will garner 80% to 90% of net inflows in 2023. “Poor performance will accelerate the outflows of capital,” says Don Steinbrugge, Agecroft’s founder and CEO.

The large funds increasingly have the clout to grow even bigger, argues former hedge fund executive Brad Lamensdorf, now principal and portfolio manager at the AdvisorShares Ranger Equity Bear exchange-traded fund. “The smaller managers are struggling to grow,” he says. “If Harvard wants to place $1 billion, then it will want a fund” able to handle such a sum with ease.

The big funds also are better equipped to deal with ever-proliferating regulatory burdens. Since the global financial crisis of 2008 and 2009, Washington has put numerous rules on hedge funds, and the administration of President Joe Biden is pushing for even tighter regs.

Overall, the once-hot hedge fund industry suffered in the 2010s, as the S&P 500 flew higher on the wings of near-zero interest rates. Hedge fund investors wondered why they were paying fat fees for inferior performance, when equity index  mutual funds charged a relative pittance. Hedge fund investment outflows started then. In pandemic-stricken 2020, after federal stimulus juiced the market, hedge funds still trailed: up 9.8%, almost half the broad-market index’s advance.

Only in snake-bitten 2022 did the funds pull ahead, returning slightly less than 1%, as the S&P 500 lost 19.5%. Then in this year’s first quarter, the old pattern reasserted itself: The funds eked out a 0.52% advance, and the S&P 500 increased 7.5%.

Consequently, the fund casualties are mounting. A recent closure announcement came from Graticule Asset Management Asia, a macro fund, meaning it focused on investing in relation to big economic trends. Headed by Adam Levinson, a former Goldman Sachs trader, the one-time $2.8 billion fund ran into trouble last year when it bet the wrong way on interest rates (they went higher than Graticule wagered), according to press reports. The worst blow apparently came in March amid wild swings in bond prices provoked by Silicon Valley Bank’s failure. The fund did not respond to a call for comment.

Some fund closings stem from the cryptocurrency debacle and the bankruptcy of the FTX crypto exchange. Galois Capital, for instance, said in February that it would close and return any money left to investors. The fund once had $200 million in assets. 

To the Mighty Go the Spoils

Agecroft’s Steinbrugge believes that, once the roughly 1,500-member hedge-fund universe has shrunken, better times await. Odds are they will come amid a tumultuous investment climate, which spells opportunity for the survivors. Many strategists predict the stock market will be unsettled for some time, thanks to a slowing economy and a slew of dangerous geopolitical conditions, from the Ukraine war to the serious rifts in the U.S.

“The next two years should be good for hedge funds,” says Steinbrugge. “The market will be choppy,” rife with those lucrative price discrepancies that hedge funds savor.

For a glimpse at how this could play out, look at 2022, when the top decile of the HFR Index catapulted an average of 39.1% percent, and the bottom decile dropped a sickening 33.0%.  In that wide dispersion,  the best players did very well, and the worst, extraordinarily badly.

Right now, plenty of elements are in motion for the sharpest hedge operators to utilize, says Victoria Vodolazschi, head of hedge fund research at consulting and insurance firm WTW. She points to energy transition, fueled by massive federal spending; the dollar’s gyrations; and Federal Reserve interest-rate decisions. “Monetary policy has been the biggest trade,” with the fed funds rate pushed up by five percentage points over the last 14 months, she notes.

The goliaths of the hedge industry have navigated all these currents ably and scored significant increases in 2022. Take Ken Griffin’s Citadel hedge firm (estimated assets: about $54 billion): It bagged $16 billion in profits in 2022, about half of which was shipped back to investors. How did he do it?

Partly through figuring out how far the Fed would go with rates. Griffin’s flagship fund, Wellington, has a wide-ranging purview not confined to one strategy, such as equity long/short or macro. It booked a 38% return last year, per LCH Investments. Citadel, which did not comment for this story, has not detailed its recent strategy in depth. But in October 2022, Griffin told CNBC that the firm eyed rates and employed very active trading in currencies, 10-year Treasury bonds and commodities.

At the D.E. Shaw firm ($60 billion), the chief fund, called Composite, generated a 24.7% performance last year. Composite has a multi-strategy approach, like Wellington. Its companion fund, the macro-oriented Oculus, gained 20%. Shaw is heavily into quantitative trading, a practice it has honed since its 1988 founding.

The ultimate in high-end quant trading houses is Renaissance Technologies ($73 billion), started in 1982 by mathematician James Simons, who had been a Cold War code breaker working for the National Security Agency. When he retired from his company in 2009, he turned the tiller over to a computer scientist. Ren Tech, as it is known, does such things as assess the statistical probability of how far securities will move in a market. The firm’s largest fund, Medallion, clocked a 19% gain last year.

The 2022 performances demonstrated how the largest, and thus most powerful, hedge funds can thrive, despite economic and other problems.  “It’s easy to ride the wave when it is going way up,” says Northern Trust’s Boyd. “But not when it is going down.”

Related Stories:

Agecroft Partners Predicts Top Hedge Fund Industry Trends for 2023

Hedge Funds Continue to Lose Investors

Investors Removed $111 Billion From Hedge Funds During 2022

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Agecroft, Brad Lamensdorf, CalPERS, Don Steinbrugge, fees, Galois Capital, Graticule Asia, Hedge Fund Research, Hedge Funds, Jeff Boyd, Karl Scheer, Northern Trust, University of Cincinnati, Victoria Vodolazschi, WTW,