Traditional stock-pickers in the hedge fund world have been struggling to justify their expenses and weak returns in recent years, as low-cost algorithmic funds have done better. Now, human managers are starting to embrace the technologies employed by their robot rivals to improve results.
Prominent hedge fund managers, investors and consultants gathered at the Milken Global Conference in Beverly Hills this week said the industry is increasingly turning to big-data analysis, machine learning and other types of artificial intelligence to research investments or build on ideas. They insisted it is not a cost-cutting strategy to replace human managers. Rather, they are trying to improve performance with the help of technology.
"There is still a role for humans to figure out regime change and to figure out disruption, but those humans tend to do better when they are aided by quantitative tools," said John McCormick, chief executive officer of Blackstone Group LP's alternative asset management business. Blackstone, the world's biggest investor in the $3.3 trillion hedge fund industry, has found that the most successful ones within the analog realm are those that compliment human talent with sophisticated technology, McCormick said.
That evolution was a key focus of hedge fund panels and a hot topic on the sidelines at the Milken event. Managers at firms including D.E. Shaw & Co and Citadel, plus big US and global pension funds, said it is a watershed moment for the industry, driven by market trends that have put enormous pressure on active fund managers. The number of publicly traded companies has declined to about 3,500 - roughly half the number from two decades ago - offering managers fewer options to find outsize returns.
Meanwhile, investors are balking at the high cost structures of hedge funds, which often charge a 2 percent fee plus 20 percent or more of gains, especially as low-cost, passive investments like index funds have produced better results. The mood worsened last year, as stock-oriented hedge funds lost about 7 percent, compared with a 4 percent decline in the Standard & Poor's 500 Index.
"There are fewer tradable opportunities," said Eddie Fishman, chief operating officer at D.E. Shaw Group, a $50 billion hedge fund firm. "People are not looking to add to long risky assets and there is such a pressure for uncorrelated returns." It is a much different dynamic than the run-up to the 2007-2009 financial crisis, when investors were clamoring for access to exclusive funds. A host of once-prominent hedge fund firms including Eric Mindich's Eton Park and Richard Perry's Perry Capital are now calling it quits.
People are "looking at the hedge fund industry as a giant poker table and asking themselves who is going to lose," said Ilana Weinstein, chief executive of the IDW Group which recruits employees for Wall Street's top hedge funds. Other funds that focus on picking stocks, including Daniel Loeb's Third Point, are hoping that quantitative science can help improve performance.
But even as firms embrace new technologies, managers and investors said attracting and retaining top talent is still crucial. While compensation is a key motivator, is it no longer the only one. Younger recruits especially want to feel that they have a real career path with meaningful challenges, Milken attendees said. The "way to reduce the risk of firm failure is to attract other people," said Blackstone's McCormick, "because no one has a monopoly on the right way to invest."