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Pivotal Perspectives: Decoding the Modern Hedge Fund Landscape with Jon Caplis
In this episode of The Derivative, Jeff Malec sits down with Jon Caplis ( @JCaplis ), CEO of Pivotal Path, to dive deep into the world of hedge funds. They explore current performance trends across strategies like equity quant, global macro, and multi-strategy funds, unpack the challenges of hedge fund data collection, and discuss how sophisticated investors are approaching alternative investments. Caplis shares insights from tracking over 3,000 hedge funds representing $3 trillion in capital, revealing surprising trends in performance, investor interest, and the evolving landscape of hedge funds. Plus a look at talent, capacity, and changing dynamics in multi-strat funds .. SEND IT!
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From the episode:
Check out the complete Transcript from this week’s podcast below:
Pivotal Perspectives: Decoding the Modern Hedge Fund Landscape with Jon Caplis
Jon Caplis 00:07
We track about 3000 hedge funds, which collectively represents over 3 trillion in hedge fund capital. Just to give you an idea of how these numbers can be all over the place, if you look at pre Quinn’s data, they’ll tell you there are 30,000 hedge funds. We would argue that’s off by an order of magnitude.
Jeff Malec 00:27
Welcome to the derivative by our same alternatives send it.
Jon Caplis 00:31
I’m Jon Caplis, CEO of PivotalPath, and I’m here to talk hedge fund data and investor interest on the derivative. We’re you.
Jeff Malec 00:48
Jon, how are you?
Jon Caplis 00:49
I am good. Jeff, nice to see you.
Jeff Malec 00:52
You too. A little bit of a allergy Cubs game yesterday induced cold. So bear with me, but the show must go on. But we’ve bumped into each other a few different panels over the last few months, and enjoyed everything you’ve had to say. So wanted to have you on and talk through kind of the overall hedge fund picture, if you will, and get into kind of some of the trends you’re seeing in performance and investor interest. But yeah, let’s start with kind of your background and and why anyone should care to listen what you’re going to talk about,
Jon Caplis 01:24
sure. Well, I’ll let them decide if they care. But I founded a pivotal path back in 2013 so just to give little overview, we’re coming up on our 12 year anniversary. Pivotal path is a hedge fund research firm that has grown to what our clients call us, which is a trusted hedge fund industry expert. So we are neither a consultant nor a database, and our clients which are exclusively allocators, they range from groups like Goldman Sachs and JP Morgan Blackstone to sovereign wealth funds and public pension plans and global family offices across the world. They collectively invest about $500 billion in hedge funds, and just at a high level, that even though they’re all unique, three kind of key reasons or themes that they all work with us. The first part is that we’ve built out the most complete set of hedge fund information that goes far beyond returns. The second part is that we produce unbiased research. We have raw data, information and the tools to analyze strategies and funds and scale and then, thirdly, our indices, which are really starting to gain traction as most accurate and reflective benchmarks in the hedge fund space. And prior to founding pivotal path, just very briefly, I worked for three different hedge funds, most recently, where I was at Campbell, which is a large CTA, and I co ran the risk team there was also on their investment committee. And so I’ve been able to really see, kind of both from a fun side and an allocator side, how these groups interact with each other. And pivotal path is really there to help create a bridge between those two and increase productivity.
Jeff Malec 03:03
Alright, we had a Joe Kelly’s been on the on the podcast from Campbell. So did you, did you mean to end up where you are instead of a database or a consultant? Or did it kind of happen that way?
Jon Caplis 03:17
No, it was actually pretty intentional. We saw kind of a couple of issues, and this was wearing a hat that I wore, both at Campbell, but also with philanthropic endowments, where I sat on investment committees. And, you know, I saw that on one side, you had the consultants, and the consultants certainly have good businesses, but their business is really about creating scale and having approved list of managers that can scale across their client base, and not
Jeff Malec 03:48
necessarily menu model,
Jon Caplis 03:51
correct, correct. Yeah, and nothing wrong with that. But for those that have their own investment teams, sometimes you want to dig down a little deeper and and understand well, how did you come to the this approved list? And if you’re recommending three managers in the multi strat space, you know, what about the other 75 managers? And so, you know, we saw that, not only did you have consultants which would give a little bit of information and really sell you their advice. And again, that’s a perfectly good business model, but the flip side of that coin were the databases themselves, where they were all trying, and laudably trying, to create transparency and organization in a relatively opaque space. But unlike the consultants, they didn’t really have access to quality data. And so what I mean by that is a lot of hedge funds historically and then the problem has actually gotten worse. They just chose not to provide their data because there was very little incentive to do so, and they also knew that if they did so, it would essentially be public. And so that means that everybody, including their competitors, including media and anyone else, could see their data and maybe lose control of the narrative. So you had these two bookends in the industry, where we’re both were providing information, but no one was doing it for the allocators, where they were fully transparent and a fully complete way as well, to give them, again, the tools and the data to analyze for themselves. Neither
Jeff Malec 05:17
had the full picture, basically, but from two different reasons why
Jon Caplis 05:20
exactly that’s exactly right. Love it so
Jeff Malec 05:24
with Pivotal path and having this more complete picture, would you go so far to say you have the full picture? Is that the ideal golden goose you’ll never quite get to?
Jon Caplis 05:35
Yeah, I’d say that we have as close to the full picture as you can possibly get. There’s always going to be a few relatively let’s call them difficult, or just funds that are hard closed, extremely hard closed, and really have no interest in sharing information at all. That being said, you get to 99.9% of the funds that are out there, and all of them, whether they are actively raising capital, replacing redemptions, or considering raising capital in the future. They also all have clients, and to the extent that many of them are also our clients, we knew that it would always as long as we protected that data and knew that we were only representing the allocators themselves, we would be able to build really strong direct relationships with those managers and the trust of them, and that’s what we’ve been doing over the last 12 years.
Jeff Malec 06:24
I love that could be a whole podcast on itself. Of the closed, hard, closed, extremely hard, close. We’re close. Yeah, you sure here’s a check? No, we’re hard. We’re hard. Closed, are you sure here’s a bigger check? We’re extremely hard. Close. Tell us a little bit of what you’re seeing in terms of the data and your research, of kind of trends in performance in the different hedge fund categories. We could dip into a little bit of like whether you where you kind of land on hedge fund categorization. Do you guys come up with your own or you stick with what metrics you stick with there? But yeah, assuming we answer the categorization problem, where, where are you seeing trends and performance there over the last kind of 24 compared with q1
Jon Caplis 07:14
Yeah. I mean, so even there, I’ll just start very high level. Let’s talk about define hedge funds for a second. So these are managers that can accept institutional capital. This is, this is how we’re defining them, and very likely they have a fund structure in which they’re charging management fees and performance fees. So it’s a very simple definition that being said. Just to give you a sense of the size of it, we track about 3000 hedge funds, which collectively represents over 3 trillion in hedge fund capital. Just to give you an idea of how these numbers can be all over the place, if you look at pre quince data, they’ll tell you there are 30,000 hedge funds. We would argue that’s off by an order of magnitude. And you know, the reasons why even simple things such as the total number of funds are up for debate, to some extent, is the fact that a lot of the managers out there, it’s very easy to kind of tick a box in SEC filing and say you’re a hedge fund. That being said, that’s how the databases kind of work backwards. They start with, typically, what might be publicly filed, and then you know what they’re going to do is they end up kind of, you know, double crowning, triple counting in a number of different ways, because a fund might might be a hedge fund, but they might also have private credit or funds of one or offerings that are different share classes, and so by the time you get through all of that, you can end up with a what seems to be an overwhelmingly daunting set of funds, when in reality it gets it’s really closer to 3000 funds. So let’s just start there. Yeah,
Jeff Malec 08:55
there’s some semantics in there, right? Because take one, take Campbell probably has whatever, 25 different share classes or actual structures. So is that one hedge fund or 25 funds, 25 different so I can see both sides of the coin there, right? I’m like, well, there are 25 different structures and classes. So you’re part of like, if I’m looking at performance and whatnot. It’s going to be the same performance.
Jon Caplis 09:22
They’re either going to be parisu or very close to it, or they’re not going to be open for investment, right? It may be, again, a fund of one that was created specifically for a very large pension fund that is not going to allow another investor in. It could be a strategy. Why do we care? Is the firm’s incubating, and maybe they’re incubating a number of different strategies to see which one ends up, you know, being marketable. Those strategies themselves are not open for public investment. It also ends up counting a lot of long only vehicles. It counts, you know, funds that are private credit, that might just kind of have that, you know, rough label of ahead. Hedge Fund, because they they check off a lot of different boxes. So or it could be funds that are extremely small that no institutional investor and even most family offices wouldn’t consider a fund, but they might show up on a database. So there’s lots of different ways to cut it, but the point is, at least the way that we view it is, we want to count the number of strategy offerings that institutional investors are either invested in or can invest in themselves.
Jeff Malec 10:29
So tell us what you’re saying in terms of categories there, what, what the most popular are, or I was starting with performance first. So yeah, what, what you seen trends in performance? Who did well 24 What 25 is looking like so far?
Jon Caplis 10:42
Yeah. So you know, if we now that we’ve defined what hedge funds are, we have our hedge fund composite index. So that’s the broadest measurement of all the strategies that we cover that so far through April is up about 1.1% so let’s call it flat on the year. That’s not to say that there hasn’t been a lot of volatility, as you can imagine. Underneath the hood, we track about 40 different strategies that roll up into that composite. So we’re looking at a very similar breakdown to how probably most investors think about it. We have credit strategies that break down into six sub credit strategies. Won’t go through all of them, but we have equity Long, short strategies that break down globally and also are differentiated between what’s quantitative and and discretionary or fundamental. We have equity quant strategies, and then equity sector strategies as well. Which are those that focus on, obviously, sectors within like like healthcare or TMT or financials. And then from there, more of the broader kind of macro strategies. Within global macro, we have a number of different sub strategies, from those focused on commodities to those that are more multi manager approach to manage futures, which is a separate strategy, and then multi strat, volatility strategies, as well as the event driven space. So sorry to kind of a lot of strategies, but wanted to just give you kind of an idea of how we break those down. And
Jeff Malec 12:14
who would you say, is that your main competitor on that overall index, the HFR hedge fund index, or is like outside of yours, what is a good benchmark, or is there none, I mean, or what has the industry used historically?
Jon Caplis 12:28
Yeah, so look, HFR is certainly, you know, probably the well known name in the space. They’ve been around for a long time. And whether it’s HFR, Eureka hedge or Barkley hedge, or even Morningstar and Bloomberg. A number of them have their own indices. The problem with all of them, and it’s really not to pick on, one of them, comes back to do the key contributors? Do the key performing funds actually provide their data to these databases? And while the answer historically was not really the answer is actually becoming more of an emphatic no. And what’s happening is, not only do you see hedge fund indices that have different performance, so even if you look at the composite level, and you look at again an HFR composite, and they have a number of them, you’re going to see that our indices tend to systematically outperform, and systematically outperform by anywhere from two to 300 basis points per annum. You’re also going to see that almost all of that is going to come in the form of alpha, especially if you’re looking at it relative to something like equities like the SP 500 or, you know, a Barclays high yield or a 6040, portfolio. And so what that means is a lot of funds that are really the high quality names, the institutional names and the key performers, they’re not part of these indices, which skews the performance lower. And while that may seem like a good thing for an individual manager saying, well, we beat all of these indices handily, and you very rarely meet a manager whose fund isn’t outperforming the benchmark, which is quite difficult. Not everyone can outperform the average. But what on the flip side of that, a lot of investors are using these indices, or at least the underlying data, as inputs into their asset allocation models. So especially if they’re multi asset portfolios, they are using the expected returns and expected volatility and and all of the other characteristics like alpha and correlation statistics and things like that, to determine, number one, whether they invest in hedge funds or that hedge fund strategy at all. And number two, how much. And so those are the areas where you know, again, I wouldn’t want to pick on any one of them individually, but there are systemic biases toward the downside, which have negatively affected the industry for many years. From that allocation perspective, just being lower due to which
Jeff Malec 14:50
is a bit of a hot take, maybe not, because the research is always right, that there’s survivorship bias, that there’s all this stuff that over inflates. Performance of the index, right? So you’re saying instead, no, it’s survivors, it’s whatever the term is, it’s
Jon Caplis 15:06
exclusive selection bias. Yeah, selection bias is actually the
Jeff Malec 15:11
like, self enforced selection bias. Yeah,
Jon Caplis 15:13
yeah. I mean, just to give you an idea, I mean, 300 of the largest hedge funds are over that do not report to any databases, and we cover all of them, and they’re going to, you know, each one of them is above a billion dollars, and most of them significantly more than that. So it ends up being over half a trillion dollars in hedge fund capital that databases just don’t cover. And it turns out that those performers, just over the last 10 years actually have about double the performance of the average fund, and almost all of that in the form of alpha. And these come particularly from the multi strat space, from the global macro space, and then the equity quant space. Those are three areas where typically, managers play a little bit closer to the vest, and they do not publicly report for numerous reasons that I mentioned before, just kind of the fact that many of the fact that many of their competitors are probably looking at that data as well, and so those are the ones that are missing. And so that’s the biggest bias. And that overwhelms to your point, all the other things you mentioned are correct. Many of these databases also have survivorship bias, meaning that funds that they actually have on their platform, they may backfill. So survivorship bias and backfilling BIAs are very much related. But just to give a very simple example, let’s say there’s a, you know, multi billion dollar fund that decides today to start reporting to any database they could. Take that data and just, you know, it has a 20 year track record fill all the way back in time change all of the performance, because technically, that fund was around, or that that manager was around, that being said, they didn’t have access to that data. And you’re not going to certainly find there’s no fund that that went out of business three years ago that’s going to say, Hey, by the way, you should now add my data back in. Yeah, you know, from 2021 going back. So that happens as well. And what ends up happening? It’s not just that the performance is lower, but it’s that the indices are not representative, and they can often be misleading. So even trying just to determine that as an allocator, what a strategy is supposed to do, what environments it might thrive, you know, is it going to do? Well, if inflation is rising or steady, or interest rates are going to remain above 4% those are questions that investors are asking and utilizing, often, these indices to help make those decisions. And unfortunately, all of these index providers have really had misleading indices at best over the years that’s always haven’t gotten to the trends yet of what? Yeah, no worries. Give it the background. But that’s
Jeff Malec 17:45
always a weird thing to me, of you’re using the index to decide on a manager, and then the manager is going to have, by definition, it’s not going to match the index, right? It’s going to have variance around that index. So at some point, to me, the investor should switch to using the manager data in those models instead of using the the allocation or the index? Well,
Jon Caplis 18:08
that’s, it’s a really good point, and it’s kind of a subtle one, and this is also just depends on your philosophy. But a lot of the sophisticated investors that we work with, they will start with a strategy, and so they’re, they’re starting with asset allocation. They’re determining, do we want to be in global macro discretionary, you know, as an allocation and they might use, depending on how they do it, they could sample a group of managers. They could use our index which would, which would get around survivorship bias and the other biases as well. But to your point, once they do that, that’s just to kind of at a baseline, say, Do I want exposure to this strategy? And then the step beyond that, then comes the manager selection. And so oftentimes the question is, look, I know I can’t pick the best manager every single year in that strategy, but what I think I can do as a as a sophisticated allocator, is I can, I can select the manager or group of managers that essentially best affect that strategy, that I like the characteristics of, and execute that strategy. And so it’s not necessarily, especially if you’re working with high quality data, you don’t have to outperform the index by three, four or 500 basis points per annum for it to be compelling. You actually just need to be in the top half, and even if you kind of hit that at average, it’s still going to be compelling when you’re using a complete set of data. But
Jeff Malec 19:30
it to me, it’s a weird thing, like leads to the managers trying to not be as diverse as the index, and getting right kind of leads to lowering their vol and matching the index and then also leads to replication of the index, right? Someone eventually goes, Wait, why am I trying to pick this these managers do and whether to outperform the index or not, just to be around the index with the risk of them massively underperforming it? Why don’t I do this model that replicates the index? So we’re way off the script here. But. Yeah,
Jon Caplis 20:01
we could also what we do for a long time, but no, I think it’s an excellent point. What I would say is many, not all, but many of these hedge fund strategies are not easily replicable, or certainly not replicable in a very liquid fashion. And so you know, when you’re talking about multi strats and the infrastructure that’s required not only to to bring in a large number of highly talented portfolio managers, but also size those managers provide, you know, funding to those managers, the risk management around I mean, significant investment in infrastructure is required to to do well in that space. And in fact, you can see it in the numbers, where, in that strategy alone, the larger managers tend to outperform the kind of mid size and smaller managers significantly. Not every strategy is like that. But I think your point is a good one, that look, you still need to be able to select the managers, and so you need to at least have the menu with a complete set of managers to know, am I even making a good decision? How can I do that if I don’t even have all the options? Right? So you got to start with a complete data set, and then every, every investor is going to have a slightly different perspective on how they decide how much capital and where to allocate it within that strategy.
Jeff Malec 21:15
And I haven’t seen it yet, but I guarantee, here you go on the podcast here, guarantee someone’s going to come up with a ETF, like, a multi strat replication. ETF, oh, and, right. They’re not going to spend all that money. They’re gonna be like, Oh, we can replicate this if we sell Euro dollar calls or something, right? They’ll just come up with some strategy that will, you run it backwards, and it’s point nine, correlated with the multi strat index and, and this is what we’re going to do. Last
Jon Caplis 21:41
thing I say on that is, oftentimes, especially in replication, it’s somewhat easier to replicate the beta or have a high correlation. The hardest part is replicating that alpha. Yeah, right. And so, and if that’s, you know, coming in the form of 345, 100 basis points per annum, which a lot of these strategies, it is, that’s the part where it usually doesn’t, doesn’t work out so well in a replication strategy,
Jeff Malec 22:03
agree, but they’ll be like, well, if I can, if the alpha was equal to just selling those call or doing whatever strategy right for that period, next time, it might be something different, but for that period, I’m just going to do that through all those categories where, what, what stood out to you from, like, both a good perspective and a bad perspective of life over Yeah, it’s been a pretty crazy two years, with bonds being crazy and the volatility in April
Jon Caplis 22:36
it has been, there’s really Two key areas that have been, I wouldn’t say, unbelievably consistent, although maybe one of them has been that has garnered the attention of a lot of our investor clients. So So equity quant, typically, these are market neutral. They don’t have to be, and historically, they’ve had a little bit of of positive beta. But one thing that we’re seeing, and you mentioned the volatility. So, you know, you could argue that technology has certainly improved, and we’ve seen, you know, the oncoming of AI, but a lot of these managers have been running machine learning strategies, you know, going back to kind of the 2015 and before that. And so, you know what, what we’re seeing is these equity quant managers, they’ve been able to take advantage of a lot of the volatility, even in the underlying factor space. So, you know, it’s not just that value came back versus growth, which we saw, you know, during the COVID time period, where value had been kind of dead for dormant for a long period of time, but you’ve seen a tremendous amount of volatility in value growth momentum has been something that has, you know, been really strong for the last couple of years, up until, you know, the beginning of this year, and now you’re starting to see it come back in vogue. But it’s been in that factor space that they’ve really been able to kind of systematically find value or generate returns where many other, you know, many other strategies didn’t work quite as well, even in years like 2022 where almost every strategy outside of CTAs and global macro, we’re losing money, these strategies were hanging in, as I mentioned.
Jeff Malec 24:12
And is it, can you see on the platform? Or do you have insight into Are they just long Nvidia basically on that whole time? Or they’re actually doing right? The the alpha is in the actual trading back and forth and inside and out of
Jon Caplis 24:27
these, yeah, I mean that, that’s the key thing. So No, when we track over 300 global risk factors, we’re always looking to see, you know, it’s something that looks like alpha, really, just in the way you said it, just unspecified beta, like you just didn’t realize, Oh, they’re really just investing in Nvidia. And happens to be different than the mag seven, which is different than the NASDAQ, and so you don’t really see it. We track a lot of different risk factors. And in fact, for the most part, although I will say to your point, that has picked up a little bit on the positive side in the last in the last six months or so, but it’s been. Almost not neutral, but very low and statistically insignificant exposure to almost every global risk factor that we cover. And so that’s been the case for equity quant. That’s been the case for multi strats as well, which we can talk about a little bit more that we always say internally, they correlate to almost nothing except each other. And then that’s also been, you know, global macro, which is interesting, because typically discretionary macro and managed futures, which is, we always think of them as almost first cousins, as a space, you know, extremely well. You know, they tend to have higher correlation with each other, and that’s really diverged dramatically where, you know, trend followers, especially in that medium long term space, had that had done extremely well through in 2022 have really given back ever since, and have been struggling, especially in 24 and and year to date, and one of their worst drawdowns in history. So Well,
Jeff Malec 25:57
we just talked through that on the on the last pod. Yeah. So dig into that a little bit if you have Why do you think that is why and macro? You’re saying discretionary global macro, or does that include systematic
Jon Caplis 26:10
so just to give you an idea, I mean, year to date, global macro in general is up 2.7% if you look at all of our global macro strategies. So yeah, global macro in general, 2.7% the only one that’s down are actually the commodity managers, and that’s their April they’re down 2.6% global macro discretionary is leading the way up 6.9% and so that’s really the biggest component of global macro. They’ve definitely been able to be much more nimble around huge moves and kind of sudden changes in both the dollar but also interest rates. And so when we’re talking about trends that have been so long in the tooth that a lot of these trend followers would have been very heavily one sided. It takes a long time for those kind of, those Titanic ships to turn around, and so obviously, a very choppy environment where there’s significant volatility on both sides, and then ends up kind of with not much. Just take the s, p5, 100 as an example. That has been almost, you know, down almost 20% year to date, and then, you know, back to up five and now, and change and now kind of flattish, if you will, that type of volatility that whip selling volatility tends to be really difficult for that medium to long term trend follower. And it doesn’t mean that global macro discretionary managers will always get it right, but at least they have much more of a nimble opportunity to do so, and they’ve done extremely well both, like I mentioned, in the dollar and rates
Jeff Malec 27:40
and gold, I would assume Tim
Jon Caplis 27:44
has been that’s been a part of it, although you would think that the the managers focused on commodities would have done a little bit better, you know, based on that move in gold, I’m sure they’ve gotten that right. But I think, you know, some of the other just as liquid in the energy space as well have been pretty difficult. The
Jeff Malec 28:03
I’ve been saying for a long time, you had macro and trend were kind of converging, or macro and managed futures were converging. Mm, hmm, right? Of like, macro is getting a lot more systematic, trend was adding some more stuff, like carry and whatnot. So it was kind of converging. So it’s interesting, yeah, that they’ve now diverged in specifically this period. I’ll
Jon Caplis 28:26
give you a really interesting stat. So right now, over the last 12 month periods, over the last year, our Managed futures index is down 14.8% and again, that’s one of the largest drawdowns that we’ve seen in history. And then you compare that to global macro discretionary over that same time period, it’s up 11 and a half percent. So that divergence of over 25% and we’re talking about two sides of essentially the same trade is take a look at the data itself, but it’s almost unheard of in history. Yeah.
Jeff Malec 28:58
The question is, what? Yeah, my brain will go to, what are they giving up in order to to get that out performance in terms of another 22 or extended drawdown? Do they somehow add some trades there? Because it worked this time, that don’t work the next time. But so given that Where are you seeing the investor interest? Is it flowing lots of flows into equity quant, lots of flows into macro, or just clock flows overall, and where are we at in the whole hedge fund space? Yeah,
Jon Caplis 29:33
so I’d say that this is a time and maybe not too different than than history, but I’d say it’s pretty pronounced right now, where the interest has been, I’d say, very sincere and very strong from most of our clients, you know, for the last year and change. And so we’re seeing a lot of work in macro space. Yes, we’re seeing definitely work in the equity quant space. We’re seeing a lot. Lot of meeting takes place in credit, for sure, what I will say is there, there’s kind of this other kind of elephant in the room that I’m sure you’ve talked about, probably on previous podcasts. And I’m certainly not an expert in private equity, but the liquidity, kind of the expected distributions that have come historically, obviously, just haven’t been coming. And maybe, maybe that’s improving a little bit, but that’s the type of liquidity that a lot of these investors expected to have to then redeploy back into more liquid strategies in the hedge fund space. And so we’re definitely seeing, we’re seeing interest. We’re seeing some managers get flows. It’s still a lot of them are the larger managers, but it’s really managers that are uncorrelated to the equity markets. I mean, there’s been a feeling for at least the last year or so that not necessarily that, you know, nobody knew necessarily that tariffs were to come and create this tremendous volatility. But there was concern that markets were, you know, at least unsustainable. And so there was, you know, the concept where they wanted to diversify away. Credit has actually been doing extremely well, where, for the first time in the last probably six or seven years, really, since private credit, kind of, you know, became a popular investment, you’re finally seeing hedge fund credit hedge funds are actually slightly more popular as these types of surveys from prime brokers. We’ve seen that numerous times. We also poll our clients, and we see a very similar trend where the returns in the more liquid credit hedge funds have been as good, if not better, than what we’ve been seeing in the private credit space. And so the pendulum is definitely starting to swing back to again, a significant amount of work in the space, some flows. But right now I still think, unfortunately, we’re in a wait and see mode, until you see kind of a huge number, a huge amount of capital flow into the hedge fund space, which
Jeff Malec 31:57
you think will be based on private equity distributions and or redemptions, but they’re locked up. So, yeah, that’s a morass, right? That’s a the the big problem we all have of, Okay, you guys all went huge into private equity. What does that look like over the next 510, years?
Jon Caplis 32:14
Exactly, right? I mean, you know, we don’t need to see huge redemptions from or even a huge change in asset allocation. To see significant inflows into hedge funds, you just need to see kind of the normal distributions, just cash, basic cash and so, and I’m talking purely about the institutional investors, right? So it’s a lot of pension funds that have been very heavy into private equity, in particular, some private credit as well. They’re the ones that, in general, are really looking to allocate more to the liquid hedge fund space, and have just been unable to do in scale. And then, you know, another side of the coin is family offices, some of the retail side, that’s where you are seeing flows into, certainly, liquid alts and into some of the hedge fund space as well. But you know, you’re not going to see the needle really move until you see those institutional investors have the liquidity to do so, which
Jeff Malec 33:11
begs the question, what will be the catalyst that makes that happen? Right? Is they need more IPOs, but people aren’t ipoing anymore. They just need those businesses to throw off free cash flow, but maybe they paid too much for and they can’t overcome what they paid to generate that cash flow. Yeah, cast, but a lot of different
Jon Caplis 33:29
podcasts, but a lot of questions. I think all of those things are extremely relevant and probably are contributing, unfortunately, to the lack of flows right now. And
Jeff Malec 33:41
what do you see in your data when you’re looking at the these different categories and the correlations and kind of, how do investors typically that you see what look back? Are they using? How aware are they that these things change over time? Like, what’s your view on that space, on that piece of the puzzle? Yeah, I
Jon Caplis 34:01
mean, it’s a great question. It’s something that definitely is going to change from investor to investor. But I think there are a couple of things that are kind of basic truths, or at least pitfalls, that can happen, and investors need to be wary of these, and especially when they’re thinking about asset allocation. So I’ll give you a couple of examples. If you look at our hedge fund composite index, and like I said, it’s been generating three and a half percent to 4% Alpha per annum for the last five years and 10 year periods. It’s been actually unbelievably consistent over the last 20 years. I mean, people kind of think of the, you know, early 2000 late 90s to 2000 and through 2007 as the heyday for hedge funds. And there’s some validity to that. But interestingly enough, on a risk adjusted basis, when looking at excess returns beyond the risk free rate, hedge funds have actually continued to do pretty well. And. And performed pretty consistently in kind of the pre financial crisis and the post financial crisis periods, although the overall absolute basis has been lower, just because the risk free rate has been closer to zero over much of that time. But that aside, if you look at correlations of our composite index, while the exposure might be low, meaning the beta. Typically, it’s been, you know, below point two, the correlations are still reasonably high. I mean, over the last 12 months, our composite index is close to point eight. Two. If you look at over the last 10 years, it’s
Jeff Malec 35:34
S P, or what are we talking to the S P, I’m sorry, 500
Jon Caplis 35:38
over the last 10 years, it’s been point seven, seven, right? So these are not, you know, trivial correlations. They’re pretty high. In addition to that, if you look at equity strategies as you might expect, you’re seeing just overall Long, short equity strategies that we cover correlate point eight, six, and that compares to a 10 year average of point eight, eight, right? So very high. And then you can look at the flip side, where you can look at strategies like volatility trading, where you’ve had a negative correlation to the S and P over a long period of time of negative point three over the last year, negative point four over sorry, negative point four, three over the last year, negative point four over the last 10 years. So what’s interesting is, when you look at just a correlation matrix over very, you know, 135, 10 year periods, the correlations of these strategies to the S and P, higher low they look to be consistent. And that in is where it kind of lies. A pitfall is that, you know, just because things have a high correlation to something over time, or even a low correlation doesn’t mean that that’s always the case, right? So if you actually plot a rolling one year period or rolling two year period of returns or and look at correlations through times, you know, take something like managed futures, where, again, you know the space really well. They may average a correlation of zero over a market cycle, or five year, 10 year, 20 year period. But that typically comes with, you know, huge positive exposure offset by huge negative exposure. And so these are directional strategies, at least in managed futures for the most part, where, you know, just thinking about a zero correlation, you have to really understand kind of what you’re going to live through over the period of any given year two, year three year period, and that can again range from positive point eight to negative point eight and everywhere in between. So it’s really important to you. Go ahead, I
Jeff Malec 37:37
was just kind of, we have a you’ve nailed it. We have a good blog post we’ll put in the show notes. Of negative correlation does not equal non correlation, right? So investors tend to think of non correlation as negative when they want it. But I tell people, yeah, like, okay, managed futures at zero, like you said, that means it was point seven, five for five years, and negative point seven, five for five years, and average to zero, right?
Jon Caplis 38:00
Exactly, right. So that’s a really important distinction to make. You have to look kind of peel back the onion a little bit and get a little bit more granular. The second thing is, a lot of our clients, and we talk to them about this, is thinking about, what are correlations that are structural versus non structural, right? So what do I mean by that? Let’s take something in the energy complex. Take crude oil and gasoline, right? Crude oil has to be refined to create gasoline. Now, those correlations can break down over time, but there is a structural relationship that will always match both of those different, both of those different raw materials together, right? Yeah. And so it’s never going to have a negative correlation. In perpetuity. It can’t happen these things are related. They’ll just stop refining crude oil, if that, if that happens for long enough. And so you see kind of, you know, take the opposite side of that, where you have things like gold, which at times can have significantly positive correlation with equity markets, with the dollar, it can go completely the opposite way. And so those are more relational, and they can trend for many periods of time, but there’s nothing structurally holding gold, you know, to the dollar, or negative to the dollar, or any of the other asset classes. And so it’s very similar in right? And it’s very similar, right? Maybe when it was pegged, but, yeah, it’s very similar in during the gold standard. It’s very similar when you look at something like volatility trading. So volatility trading, for the most part, these strategies are going to be long volatility, and it’s very difficult to have huge drawdowns, at least sudden draw downs in any market, but equity markets in particular, without volatility spiking. And so there is this negative structural relationship between volatility and equity returns. And so it’s understandable that you would have, not only, you know, a negative correlation over a long period of time, but even at most periods. Periods within you’re going to see that relationship hold. You take something like multi strats, where there are plenty of times where there’s maybe zero correlation, and they they’re going to be much different than managed futures, where it’s a lot of positive offset by a lot of negative, because these are not directional strategies. They’re often very closely hedged and managed to beta neutral, and, you know, dollar neutral, all of those things. But what’s interesting is those correlations, if you’re not looking, can also creep up in a, you know, on a regular basis. So let’s take just our multi strat index right now. If you look over the last 12 months, and that’s, that’s only 12 data points, so let’s, you know, be careful about that. But it’s at point six, nine. Correlation to the s and p, right? So that compares, if you look over the last three years rolling, it was point two, six. If you look at the last five years rolling, it was point three, one. But interestingly, if you look at the last 10 years, it’s point five, right? So part of this is that used to be, you know, in the just after the financial crisis, into the early 2000 10s, these multi strats were not nearly managed as tightly, and they tended to have more positive correlation. It’s really only been since kind of the late 2000 late teens into in the more recent period, where these strategies have been virtually, at least, thought of as market neutral. But again, even that’s not always the case, and it’s important, and our clients, you know, are looking at these things to understand what is the structural relationship where I know I have a certain amount of exposure to the s, p, I want to have strategies and managers within those strategies that are going to not only generate alpha bird are going to have exposures that are going to either offset, depending on what my objective is, or are going to minimize or mitigate drawdowns in my portfolio. So those are the characteristics that our clients are analyzing when they’re looking at the history of these strategies. And again, it’s really important to differentiate those structurally related ones. And again, on the other side, equity long short for the most part, unless you’re looking at market neutral equity strategies or low net strategies, predominantly, they are going to have a significant long bias. They’re going to have a beta of anywhere from point four to point six. So it’s important that you understand, if the equity markets sell off significantly, that part of your portfolio, even with alpha, even with stock selection and risk management, is still probably going to be down. So that’s how our clients are thinking about
Jeff Malec 42:29
Yeah, and you’d say they generally understand that. I believe, right? A lot of the allocations come from their former equity allocation, right? Yes, they’re not taking it. I mean, some are out of bonds went up, but essentially, like, Hey, this is a smarter way to do equities. It’s a less volatile, better risk adjusted return way to do equities. We get that there’s that correlation there. Let’s plug it into that side of the equation.
Jon Caplis 42:50
Absolutely, absolutely.
Jeff Malec 42:58
So we mentioned multi strats there. Let’s dig in on those for a little bit first, maybe just some definitions. Do you define, or should we define multi strat versus pod shop?
Jon Caplis 43:12
So it’s a good question. We cover multi strats a little bit more broadly than just the pod shop. So our multi strat index has about 80 funds, or 81 funds, about little shy of $400 billion it’s almost everyone you could possibly think of when you think multi strat, from the big names and the most well known names down to some of the smaller strategies that you have to be in the industry. Probably to know about that being said, No, we don’t limit it to just purely the pod shops. And the reason is, is that whether you’re a pod shop or not, while there certainly is going to be differences in risk management, and you know, month to month, the return characteristics are still going to be relatively similar if you’re diverse enough. And so we do incorporate all those now what I’ll say to that is pretty interesting, even when you ask about, you know what? What’s multi strap doing? And this gets back to the indices that we were talking about earlier in the construction of those indices. So if you take hfri pod shop index, which, again, highly correlated to what we have in a year like 2024 their index was up 6.8% okay, beat the risk free rate. Not bad, but our index was up 11% and you know, when you’re talking about a difference of over 400 basis points in a given year, and again, that’s not an anomaly. That’s the rule we typically see, especially in strategies like multi strat, where a lot of them just aren’t reporting to the databases. We see anywhere from 234, 500 basis points difference per annum. And so you know that can be the difference between allocating, even finding multi strats compelling at all, to saying, You know what? You know the risk free rates, not too far off. There’s, it’s fully liquid. There’s, obviously, there’s no risk, and a risk free rate. And. So you know, how much, if at any you know, should we be locking up capital and really losing a lot of that transparency in the multi strats? And so it depends what benchmark you use, and if you use a complete set of data, the multi strats have really been almost printing money for, you know, the last 10 years. But I’d say, certainly over the last five years where we’ve been through feels like, you know, 100 years worth of market cycles condensed into one and the multi stress, no matter what you’ve thrown at them, they’ve really been able to mitigate losses and sudden reversals as well as perform well. And you know, years like 2020 and years like 2022 where they were roughly flat, to years like 2024 where they were up 11 and just continue to generate not fully uncorrelated returns, but a lot of alpha relative to the s, p and other asset classes.
Jeff Malec 45:49
And do you think that’s because of their style, because of the diversification, or because of the center book, or what? What’s your multi stress pitch, if you will. It’s why the investors love them so much. There was just an odd lots podcast last week or two weeks ago, why investors love multi strats. But to me, to me, it’s the performance. Performance driven. They’re chasing the performance.
Jon Caplis 46:16
Look, I think at the end of the day, it always comes down to performance and the multi strats, but but also think about replication. It’s kind of what we talked about before. It is a place that is very difficult to replicate. You certainly can’t do it cheaply. And so when you have something that generates performance that is difficult to replicate, and that performance is highly coveted because it’s really unique alpha and it comes at times of market strife, and really all weather people are going to be willing to pay for that. And then you throw on top of that, that the larger managers, and kind of the top tier, the top three, the top five. We won’t name names. We probably know who they are. For the most part, they’re they’re either closed, they’re either hard closed, they’re extremely hard closed, right? But they’re very particular about who they let in. And I think that, in itself, also creates additional demand for it, because people want to be part of that club. It’s kind of the one remaining, you know, space that’s really difficult to get into, at
Jeff Malec 47:15
least exclusivity, back into hedge funds, if you will, to some extent.
Jon Caplis 47:19
I mean, I’d say that’s mostly gone away, but it is there in the top few, for sure, in the multi strat space. So access is something that, you know, is really important. But, you know, look, I don’t know, I can’t say that there is a secret sauce, but I can tell you that there are certainly some consistencies in the ones that are the best. And it really comes down to, it’s not just, oh, it’s a war on talent. And they can throw money at talent, that can happen. And you’ve seen a lot of big players with a lot of resources throw money at talent and try and solve the problem that way. It doesn’t always work out, you know, as you expect. So it’s much more about its experience. Number one, it’s risk management. Number two, it’s portfolio construction, that center book is extremely important. And just how you know those center books are run at the biggest shops, I don’t think anybody knows exactly, other than the fact that those center books tend to always be on the right side of huge market moves, or at least, you know, not getting hurt from them. So there is a real there’s always going to be demand to pay for a stream of returns that you can’t generate on your own or cheaply. And I think we’re seeing that in the multi strat space, and it’s just going to continue until there really is a return event that is extremely negative we haven’t seen. And
Jeff Malec 48:37
multi strat versus pod shop, we’re just talking about the multi strats netting the fees, and the pod shop isn’t that you’re paying each manager depending on their performance. Yeah. I
Jon Caplis 48:48
mean, I’ll tell you why this is such a hard distinction. It’s even harder distinction to make today than it was five years ago, because take any shop that you would call a pod shop, even kind of the quintessential pod shop, and they are also investing in external managers. And so there’s been an evolution in the space where you’ve actually seen fund to funds, kind of historically, some of those fund to funds have become much more like the multi strat pod shops and the multi strat pot shops, to some extent, have become more like fund to funds in the last couple of years. And part of that is there they’ve been we’ve talked about this on a number of podcasts, but kind of coined the term with others. I wouldn’t take full credit for. They’ve been a victim of their own success, where these multi strats have done so well, and the PMs inside of them have done so well that they have been able to actually spin out and start their own funds and have the working capital to do so. And because of that, you know, the multi strats themselves have had to make a decision. Do we want to just say, All right, well, we’ll just continue to have this war on talent and bring everybody in house? Or might there be a benefit to not only be okay and maybe bless that that portfolio? 100 for spinning out, but actually seed them and look at the right now, so stay invested in them. Still have the upside. In fact, your costs and overhead are going down because you don’t have to pay those significant signing and retention bonuses that are associated inside of the pod shops. And so these multi strats have actually been the largest source of new capital, of capital for new launches over the last 12 to 18 months, which is something that would have been unheard of three years ago, especially five years plus. So that’s why building
Jeff Malec 50:33
their own building here in Chicago, because one of their guys got poached in the elevator at the UBS tower. He’s like, I don’t want anyone else in our elevators,
Jon Caplis 50:40
right? And you think, you know, it used to hear tiger cubs. You now hear Citadel cubs and Millennium cubs and de Shaw cubs, and you’re seeing all of these really smart PMS that now have the wherewithal to launch and know that they might even have the work that capital behind them from the multi strats themselves. But, you know, more constraints are kind of off.
Jeff Malec 51:00
Yeah, it’s so weird, right? Then it just comes back into the old model. Like, now these guys are all their standalone funds. We want to access them. It’s a fun to fund. Like, no, we don’t like fun to funds. We want to Pacha, okay, I’ll call it a pod, right? Yeah.
Jon Caplis 51:13
So some of it’s, it’s a lot more semantics than you think. So to make that distinction in an index, yeah, it doesn’t make any sense, right? Because
Jeff Malec 51:20
I think myself and listener, I’m envisioning a pod shop of like, okay, there’s some big, fancy building here in Chicago, and there’s a p6 PMs on each floor of three floors, and they’ve got teams and one center book managing it all. But there, everyone’s in house there and getting paid. What they get paid? Yeah. So that is an interesting distinction. And you, I heard you, I think that was in Chicago, maybe almost a year ago, but you were talking about a future where maybe, and maybe these are funds, or maybe even the individual managers are on platforms, and you could kind of mix and match from all these different places, each of those managers and kind of build your own pod show.
Jon Caplis 51:59
Yeah. I mean, I think the trend that you’re hitting on is something that we’re seeing kind of everywhere. And there is, there’s a couple of things happening at the same time, you know. One of them is that the investors, the allocators themselves, have just gotten so much more sophisticated over the last, you know, let’s call it decade, but certainly in the last five years of you know exactly what they want, right kind of separating beta from alpha, and we can get into portable alpha and what role that plays in this, but it’s all you know. Basically boils down to investors. They’re very specific about what they want in their portfolio. They’re very specific about what they’re willing to pay for, and that really is alpha for whatever their portfolio is, not necessarily Alpha against any individual risk factor. They can kind of define it themselves. And so what we’re seeing is a couple of things. One is the hedge fund industry itself is becoming much more of a solution provider. Right? Managers are now sitting on the same side of the table as allocators and saying, all right, you tell me what you need, and we’ll figure out a way to provide and oftentimes, this is now done via separate accounts. It could be funds of one, but it’s usually more often via separate accounts, which gives full control to the end allocator, full transparency, but also a really healthy relationship that can, not only, you know, be a large dollar amount, but can scale, because now they know this manager can provide a number of different solutions, you know, as we continue to evolve, and so we’re seeing a lot of separate accounts. We’re seeing a lot of portable Alpha kind of making its way back in. And you know, the term, while maybe not the best term, because it had a lot of negative connotations around the global financial crisis, you can call it stacked returns. You can call it a number of different things, kind of getting back to semantics. But the point is, again, sophisticated allocators now have the ability to say, we don’t want to pay for the beta. We can get our own SP exposure at, you know, almost for free. What we are willing to pay for is maybe the stock selection or credit strategy, or whatever the strategy is, if it generates uncorrelated returns, we’re willing to pay for that. And managers who years ago, in just a few historically, might have said, look, it’s either you invest in the commingled fund or not. It’s a binary decision right now are saying, let’s figure this out. And so I think the world that you’re mentioning, I mean, the individual PMS also can, can have much more flexibility, because they can take capital from the managers, which also realize that it’s no longer exclusive capital, even when, when pm spun out before it might be, might be very restricted to just the multi strat investing in you now, it’s not exclusive anymore. And so you know, following up on that, could we see a world where you could be part of a number of different multi strats, absolutely, especially if you think about kind of the multi strats that are now being built, really at the allocator level, where you’re seeing kind of allocators get into this game, the larger ones, but with the help of of separately managed account platforms, where they’re starting to kind of put together their own. A multi strat, if you will. And so that’s exactly how they’re thinking of it, is finding these different PMS and also being the portfolio construction and the center book and all of those other things that you know the multi strats are well known for. And
Jeff Malec 55:14
what is there a feeling out there that will run out of talent eventually or no? Like to me, to me, there’s a Race to Zero, like everyone’s poaching from each other’s multi strats, or they’re going out on their own, but there might only be X number of of actual good talent out there.
Jon Caplis 55:32
Yeah, I think that’s a good point. I do think that, you know, there is some finite limit on talent that, being said, the limit may be much larger than we than we thought. And think about it this way. You know, for how many years did we hear, almost every single time where a large multi strat went from 5 billion to 10 billion? You know, they have capped out, and they’re not going to be able to if they hit 15 or 20 billion, you’re going to see, you know, the industry is going to implode. And then it was 25 and then it was 30. And now we see some of the funds are at 70 billion plus. And I’m not saying that there isn’t a limit, but the limit is certainly well beyond what we had thought. And then secondly, the multi straps themselves, as they were, kind of vacuuming up all of these different PMS, which would have gone out on their own at a different point in time. Now, the economics were so good to go in house under a large multi strat, where they could get their signing bonuses and they didn’t have to raise capital, and they could really just focus on the portfolio where, you know, they definitely, you saw a lot fewer launches over a period of, you know, five years and and you thought, Oh, well, maybe the talent pool has dried up. Well, really, it was probably just that it was being consolidated. And you didn’t really see it, because it wasn’t happening above water. It was happening, you know, below the surface. Now all of a sudden, you know, we’re seeing a lot of these PMS again, kind of spin out, and capacity may be quite different on an individual level than it is as part of an individual firm, where they can only have so much leverage. So you’re seeing the constraints come off again. I just think it’s a different formation of the industry. And again, we’re still not that far from $3 trillion and when you compare that to some of the other asset classes and a lot of the deep markets that a lot of these managers, they’re not really trading the small cap names like they used to. They really are in kind of the large cap and mega cap. There may be a, you know, significant amount of capacity that is still yet to be tapped. So I’d say capacity is there manager talent, the talent will find that capacity and or
Jeff Malec 57:43
I was gonna tell, I was gonna say, or they’ll go more multi, for lack of a better term, right? Of like, we’ll do more strategies and more markets, and we’re gonna go into India, we’re gonna trade commodities. We’re gonna do right? Like, if they do, would you agree that it’s mainly centered the multi stretch in equities right now,
Jon Caplis 58:03
I say that that has been a five years ago, 100% over the last at least three years, and more recently, all the things you said have been happening inside of all the firms. And it’s also more transparency. So a number of the larger firms have been maybe more in commodities than they let on for a while. You know, certainly some of them have been more in credit but you are seeing different types of multi strats that are forming that you know, may specialize in a certain region, or may specialize in a different asset class, from enter from equity markets. And you’re seeing it in the commodity space. You’re seeing in the credit space. So even kind of what you think of as defining what a multi strat is that’s evolving too, and it’s evolving all over the globe. So, yeah, I think we’ll continue to see them, you know, emerge all over the place, in all different strategies and asset classes.
Jeff Malec 59:00
I’ll ask you our fun segment of okay, what sort of you’ve been down any crazy rabbit holes recently, like going back to old 80s videos or sports stats or something non work related?
Jon Caplis 59:17
It’s been a lot of work lately trying to think about what I’ve been down. Been watching some documentaries lately, kind of going back to just watch the one on bin Laden and how they caught him, which, you know, we all lived through it and we lived through 911 but
Jeff Malec 59:42
they’re better than Zero Dark 30 movie.
Jon Caplis 59:45
Yes, I mean, this is it’s not as stylized, it’s grittier. But, you know, just talks about a lot of the decisions that were made with not as much conviction as you might have thought. I’m even. Kind of getting bin Laden and imperfect information Exactly, exactly, I’ll tell you one of the one of the takeaways, or one of the interesting things from it was, I can’t remember who brought it to him, but it was maybe Ben Rhodes. But they said to Obama that, you know, going in and capturing or killing Bin Laden, we have much less confidence than we did for weapons of mass destruction, oh no during that era. So just to give you kind of the confidence level was quite low relative to other things that we’ve gotten wrong. So we’re
Jeff Malec 1:00:34
sending in two helicopters instead of two battalions. So that might have helped with the math. There Correct, correct.
Jon Caplis 1:00:41
But that’s, you know, always about, kind of taking more of a quantitative view of things that you know had been much more qualitative historically, is always interesting. Like, you know, all the Michael Lewis books, they’re fascinating.
Jeff Malec 1:00:56
Yeah, I hear you all right, John, thanks so much. We’ll leave it here tell people where to find you pivotal path.com.
Jon Caplis 1:01:04
Absolutely, absolutely. And Jeff, you know, really appreciate the conversation and enjoy working with you and speaking to you. And RCM so you know, thank you so much, and hopefully this will be of interest to you guys and your and your listeners.
Jeff Malec 1:01:17
Love it. We’ll see you soon. All right, Jeff, All right, thanks, Jon.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
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