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Impact Investing

IPE special report May 2018

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The lure of greater freedom and flexibility is enticing successful fund managers to leave the security of traditional, large investment firms to try their luck in smaller, more nimble and adventurous hedge fund start-ups. Once out, they are finding that they relish the challenge and excitement. And many of those who have made the change believe that there are lessons for large firms to learn in order to survive and succeed in today's investment climate.
After talking to numerous senior fund managers who have have started up their own hedge finds, IPE could not find one who regretted his move – nor any who would consider going back.
There tension between the culture of a large firm and the personality of a successful money manager is one factor that encourages some managers to make the change. Many of the best asset managers have a strong entrepreneurial streak; they are risk-takers, and so bridled under the constraints of working in larger, bureaucratically run organisations.
Working in a small firm, it is agreed, offers more challenge and excitement. As Stephen Thompson explains, he left Merrill Lynch for NewSmith Capital because of “a desire to move into a smaller company, which can be more dynamic and exciting. And it is very exciting, because everything that you do has a real impact on the company”.
Another hedge fund start-up says: “Entrepreneurial types like to run the business. There is some scope in a large firm by climbing the greasy pole, but it's not the same thing.” As another fund manager, who left a big house to set up a hedge fund, puts it, “the idea of running your own business is attractive to most people who are risk-takers. Most fund managers would like to run their own business.”
Another difficulty is the need to invest according to house styles and predetermined strategies. “There are certain mistakes that some companies have made,” said Philip Hardy, formerly of Schroders, today at Polar Capital. “They are too wedded to one style and try to stamp that style on all managers. But fund managers are all different and you can't make us all the same.” At Polar Capital, managers meet formally twice a month (and informally whenever they choose), but there is no house view defined at the end of the meeting.
The prospect of an escape from office politics is also a big attraction to those who jump ship. As one asset manager says: “Big firms are big firms, and by default they tend to become more political.” Many hedge fund managers pointed out that they appreciate the more “collegiate” style of working they have found in a small, independent set-up.
Because smaller companies tend to allow their proven managers a great deal more freedom in running the assets under their management, investment managers who make the change are able to rediscover the “intellectual challenge” inherent in what they do, according to one senior investment manager who jumped ship recently. “Here I have the freedom to invest in an unencumbered capacity,” he says.
A colleague in a different firm seconded this: “They the big_firms have taken all the fun and science out of investment. They don't take risks. It's uninspiring and boring.”
And as a third asset manager complains: “They've taken the soul out of stock-picking.”
One fund manager who is at an independent hedge fund points out: “Now I have more tools in my toolbox. The old way, with long-buys and a significant portion in equities, is now a weakness. Here I have a more flexible investment style.”
Hardys says: “You can control the amount of assets you want to manage. Having too much assets reduces liquidity. And as more money is run on shorter-term strategies, having too much assets is a hindrance.”
Hardy says that in a small hedge fund “you have the chance to do something that you passionately believe in, not hindered by liquidity restrictions, by internal politics or the need to conform to a house view”.
Change is afoot: since the end of the tech boom, the stock market cycle has changed radically, meaning that they are facing new investment challenges. And, crucially, as the business environment is changing, too. Hedge-fund start-ups are taking advantage of this, and the larger firms are also finding themselves responding to new conditions.
According to many who have left traditional asset management firms, the long-only world “is in turmoil”, as said one senior investment manager who is now at a hedge fund. “They are competing by fees, and the fees are ridiculous. Intermediaries are encouraging them to beat up on fees.”
Hardy says: “It is clear that the days of investing money long-only with no over-riding downside protection are over, have highlighted the risks of running a lopsided strategy.”
“The industry is continually evolving, and I think that there is a natural change taking place in the big institutions,” says Thompson at NewSmith Capital. “This is evident in the difference between the products that they will be offering in three years time versus what they were offering 10 years ago. It’s all a reflection of client demands.”
Another hedge fund manager seconds this. “The European institutional market is coming back into alternatives, so the big institutions need to be flexible and change. Even in a long-only environment, they have to implement better risk controls and look for new products.”
So as traditional asset managers respond to market conditions and are changing in many ways, there are lessons they can learn by observing the way independent hedge fund managers operate.
One challenge they have to face up to is how to incentivise and retain talent. Creative freedom and intellectual challenge is one issue. As the big firms are being forced to adapt to a changing business environment by reviewing their product ranges, this may offer some scope to fund managers who want to break away from long-only investing without sacrificing the security of working for a big company.
As they look towards new opportunities, traditional asset managers have to reassess the ways in which knowledge is shared. Money managers today are dissuaded from proposing innovations because they are not assured of ownership of their ideas, pointed out one disaffected fund manager.
And when talking of incentives, money is obviously another. As one hedge fund manager pointed out: “Ultimately, everyone's got their price.” The pay potential in a hedge fund company cannot compare to the big firms, even when bonuses are up. “For the same financial reward, I can put in 10 years at a hedge fund versus 30 years in a firm,” said that same fund manager. “Those guys have to do the same amount of work that I do.”
For him, the choice is clear.

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