Hedge fund managers have two “unappetizing” choices in today’s market environment, Dmitry Balyasny, Managing Partner and Chief Investment Officer of the $12.1 billion hedge fund that bears his name wrote in the fund’s first quarter letter to investors reviewed by ValueWalk. They can slim down and focus on a niche strategy or, like Amazon.com, bulk up and build a diverse business. Balyasny Asset Management, from one perspective, appears to have chosen components of both strategies. Balyasny looks to Amazon for the hedge fund future, but will institutional investors give hedge funds the same latitude they have afforded Amazon’s Jeff Bezos?
75% of Balyasny alpha comes from the long end of the Long / Short strategy
Balyasny appears to be growing a large and diversified hedge fund that is comprised of many noncorrelated niche strategies with a prudent if potent dose of long stock selection in his formula. On the quarter Atlas Global was higher by 1.56% while Atlas Enhanced delivered 2.51%.
As if to exemplify the fund’s future, the significant first quarter performance driver, generating 75% of alpha through the Atlas Strategy that built the firm. But 20% of returns were driven by new portfolio managers.
Meanwhile, the fund’s systematic strategy was up “small,” but performance was steady. “Good diversification across regions and frequencies helped performance, and we’re also starting to see the benefits of expanding beyond equities into systematic futures and FX,” Balyasny wrote, pointing to the addition of Dr. Ulrich Brandt-Pollmann, the fund’s new head of Systematic strategies. The Macro and directional strategies were more challenged on the month as the US was the best performing region for the fund in the first quarter, generating 80% of gains.
Dmitry Balyasny building a conglomerate of noncorrelated strategies
One interesting component of Balyasny’s strategy to build a large hedge fund of diversified strategies might be found in the fund’s near non-existent correlation between strategies and the stock market in general.
Although correlations have grown year over year, they remain at generally low levels. The fund’s portfolio managers had a 0.02 correlation to the S&P 500 in 2016, which has moved to 0.10 in 2017. The fund did not publish correlation during crisis statistics, but it famously avoided the August 2015 market crash entirely, a defining moment.
Summing up movements in the hedge fund industry, Balyasny notes the trend for investors to search for real alpha over beta:
Investors are becoming more sophisticated at separating truly uncorrelated alpha from beta (or what looks like alpha on a daily basis but quickly becomes too correlated in any significant market turbulence). This is leading to fee model pressure as investors rightly don’t want to pay hedge fund fees for correlated returns. We are increasingly seeing the de-coupling of these streams with investors getting rid of the jumbled structures and instead selecting real alpha options for their uncorrelated buckets and buying indexes for cheap beta.
This presents both an opportunity and a challenge to the industry as the capacity for true uncorrelated, high Sharpe alpha is very limited with many of the best funds closed. Meanwhile, firms that have historically offered a correlated part-alpha/part-beta model will have to strip the pieces apart and see if there is enough alpha capacity for a viable offering.
Dmitry Balyasny says hedge funds should look more like Amazon, but can they convince institutional investors to ignore gravity as Jeff Bezos has done? Not likely
What the hedge fund industry should do, Balyasny noted, is look more like Amazon. While most “run of the mill, inefficient conglomerates” are typically not worth more than the sum of their parts, Amazon’s founder Jeff Bezos has “crushed the competition” by accomplishing a feat seldom attained by a conglomerate.
Bezo’s first magical accomplishment encouraging institutional investors to ignore gravity. Forget about traditional metrics such as price / earnings ratio – Amazon’s P/E ratio is an astronomic 183.8 – and focus on the “long game.” Many hedge fund managers have unsuccessfully made this argument as their returns have underperformed major stock market benchmarks.
Jeff Bezos is able to levitate above water based on three attributes, Dmitry Balyasny points out:
- Cost of capital. By constantly looking around the corner and convincing their investors to play the long game, Jeff Bezos has, by far, the lowest cost of capital of any of Amazon’s competitors. He is able to reinvest relentlessly in the business. This allows Amazon to attract the best people, invest in technology, drive competitors out with pricing power, and show remarkable growth.
- Amazon’s business units leverage the company’s core competencies and grow into verticals that make sense strategically. The added verticals were mostly built instead of bought.
- There is a culture of innovation, calculated risk taking, and performance.
There is a message for hedge fund managers. “While it is unlikely that any hedge fund is going to compete with Amazon for the title of ‘World’s Most- Valuable Company,’ we can learn a lot from their strategy,” he wrote, pointing to what hedge fund managers have rarely been able to accomplish to date. “It is a great example of the benefits of building a scalable platform that can extend opportunistically into new business lines.”
Perhaps it is also best to watch Balyasny’s actions in this regards, but what he does. His hedge fund has nearly doubled in size from the point of the August 2015 market call that avoided the market crash. Instead of promising investors that they can beat the market in large cap stocks where a flood of research commoditized knowledge and edge, Balyasny focuses on delivering reasonably consistent returns noncorrelated to the the general stock market.
The letter was first reported by Nishant Kumar of Bloomberg News