How Schonfeld fell into Millennium’s arms

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Last week my New York-based colleague Ortenca Aliaj and I revealed that Izzy Englander’s Millennium Management is in advanced talks to put billions of dollars to work with smaller rival Schonfeld Strategic Advisors. Such a partnership deal would mark the largest of its kind in the $4tn global hedge fund industry. 

We followed up with this deep dive, in which we explained the rationale behind a transaction — and how this is not the first time that the two groups have considered teaming up. 

Notably, they held informal discussions during March 2020 when the early stages of the pandemic unleashed turmoil on the markets. That month Schonfeld’s flagship hedge fund was down about 16 per cent and its prime brokers were asking it to put up more collateral, in response to a routine margin call as markets moved against it. One idea put on the table was for Millennium to provide some capital. In the end, talks never came to fruition and Schonfeld managed to shore up its position. 

Fast forward three and a half years and Schonfeld’s capitulation to Millennium reflects the changing fortunes of a hedge fund manager that has struggled to keep up with large rivals. Despite its strong long-term record, neither of Schonfeld’s two funds have made money this year, adding to an underwhelming 2022 in which the firm lagged far behind the likes of Ken Griffin’s Citadel and Millennium.

It also illustrates a key dynamic of the “pass-through” expenses model that is a defining characteristic of the multi-manager platforms. Instead of an annual management fee, the manager passes on all costs to their end investors. The idea is that managers can invest heavily in areas such as staff and technology, with the cost more than offset by the resulting performance improvements. 

The multi-manager model is significantly more headcount-intensive than traditional hedge funds, and appears to have less operating leverage as firms grow bigger. “As assets scale, headcount (and with it their cost base) tends to grow on a linear basis,” said a report last year by Goldman Sachs prime brokerage. 

But crucially, if the amount of money a firm manages declines, costs do not fall in line with the decrease because it is hard for managers to cut spending at the same pace. That means fewer investors end up footing a larger bill that eats into returns, which could trigger more cash being pulled out. 

A prime broker explains it like this: 

“If assets start getting redeemed, the investors that are left behind get left with the brunt of the costs. Clients are going to want to redeem quickly and not get stuck. You don’t want to be the last person left holding the bag.” 

Looking at Schonfeld, its assets have doubled in the past two years, from about $6bn to $12bn. And its headcount has grown from about 600 to more than 1,000. The issue for Schonfeld is that while its assets and cost base have surged, it hasn’t put up the performance figures to match. 

Read the full story here. And it might be worth reminding yourself of our Big Read from August, in which we explore whether multi-manager funds are becoming a victim of their own success.

ESG ratings: whose interests do they serve?

As demand for ESG risk data has ballooned in size over the past decade, the likes of MSCI, Morningstar and S&P have acquired considerable power to influence and in some cases dictate which stocks and bonds end up in the $2.8tn or so of investment funds that are marketed as sustainable.

But it turns out that a product meant to make investors’ lives easier has in fact left them frustrated with the level of chaos and confusion it creates, writes my London-based colleague Kenza Bryan in this must-read Big Read.

A lack of regulation around the quality of these scores has led a variety of problems to set in, namely around accuracy, transparency and conflicts of interest. The European Commission, for example, thinks that ESG scores are plagued by conflicts of interest. There’s the sale of ratings, data and indices to the same investor clients, as well as the sale of consultancy services to help companies improve their ratings, and the practice of charging companies to display their own rating on financial products.  

As Kenza explains, scores are mostly paid for by investors, not issuers. But consultancy services to help companies improve their ratings are still widespread. 

Daniel Cash, a credit ratings specialist at Hong Kong law firm Ben McQuhae, compares this situation to how credit rating agencies operated before the 2008 financial crisis, which drew the attention of regulators to the potential for ratings to be skewed towards paying clients. “They were using consultancy services as cash cows and essentially the rating agencies are doing the same thing,” he says.

A further potential problem for the industry is the gap between the perception of what ESG ratings assess and what they actually demonstrate.

“There is disillusion and confusion when people realise the labels mean very little or do not measure what they want them to measure,” says Fabiola Schneider, an assistant finance professor at Dublin City University. “And you have investors trying to exploit that confusion and attract capital by appearing greener than everyone else.”

Data providers insist they are neutral conduits for information — not standard-setters. Read the full story here and see if you agree . . . 

Chart of the week

Line chart of amount ($bn) in the Federal Reserve's overnight reverse repo facility showing use of Fed's excess cash facility drops sharply

Use of a Federal Reserve facility for storing cash has halved from its peak as money market funds plough their excess funds into US government debt instead, writes Jennifer Hughes in New York.

Investors on Friday put $1.28tn into the Fed’s overnight reverse repo facility (RRP), where cash is stored risk-free for a short period for a generous return. The total was close to the lowest level in two years, half of its $2.6tn peak and a drop of more than 40 per cent since May.

Until this year the record daily inflows of more than $2tn into the RRP were considered a sign of market uncertainty, implying that US money market funds that invest in government debt preferred the safety of the Fed over the volatility of bonds.

The facility was established permanently in 2014, and is designed to suck up excess cash in the financial system.

However, the incentives for investors have flipped in recent months, driven by data that point to a resilient US economy. That has forced traders to rethink their views on how long the Fed will keep interest rates elevated to curb inflation.

As a result last week tumbling bond prices pushed yields on benchmark 10-year Treasuries to a 16-year high of nearly 5 per cent.

Higher yields have increased the attractiveness to investors of money market mutual funds, particularly as rates from competing products such as bank deposits have failed to keep pace with interest rate moves.

A record $5.7tn currently sits in US money market funds and the vast bulk of the inflows, worth $64bn, flowed into government funds, according to weekly data released on Thursday.

Five unmissable stories this week

Japan’s prime minister Fumio Kishida has appealed to BlackRock founder Larry Fink and others controlling $18tn of assets to invest in Japan’s future, wrapping up a charm offensive to lure capital into the country. Top managers from the likes of KKR, Blackstone, GIC, Norges Bank and Temasek were hosted last week by Kishida during a “Japan Weeks” government campaign. The message was that global investors should finally turn bullish on the world’s third-largest economy.

A sell-off in global bond markets has pushed borrowing costs to their highest levels in a decade or more. That means potentially heavy losses for banks, insurers, pension funds and asset managers that own trillions of dollars of sovereign and corporate debt after loading up in recent years. Don’t miss our deep dive on the parts of the financial system that could come under strain. 

US tech investor General Atlantic and French asset manager Carmignac are backing a London investment manager that is buying out stakes in private equity funds, as they seek to diversify into this fast-growing strategy. The pair have bought minority holdings in Clipway, a firm set up by former Ardian senior investor Vincent Gombault.

The family office of secretive billionaire Harald McPike has accused US gaming investor Jason Ader of fraudulently inducing it into backing his special purpose acquisition company because he was under pressure to return $16mn to his mother. 

Vontobel has named two internal candidates to jointly lead the group when current chief executive Zeno Staub steps down in April. Georg Schubiger, head of wealth management, and Christel Rendu de Lint, head of investments, will become co-CEO of the Swiss investment manager from January.

And finally

Morris’s bespoke armchairs in front of the early 19th century hand-painted Chinese wallpaper that was painstakingly restored a few years ago. Shown as part of Idris Khan & Annie Morris: When Loss Makes Melodies © Pitzhanger Manor & Gallery. Photograph by Andy Stagg

In the early 19th century renowned British architect Sir John Soane designed and built Pitzhanger Manor as his dream country retreat in then-rural Ealing. Well Ealing is no longer rural, but the neoclassical house remains as striking now as it must have done back then. Pitzhanger Manor and its accompanying gallery have just unveiled an emotionally charged new exhibition fearing the work of British contemporary artists Idris Khan and Annie Morris. Across the two spaces over 30 works of sculpture, photography, painting and embroidery are beautifully juxtaposed with Soane’s domestic spaces. Curated by Maya Binkin. On until January 7.

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