The Future of Multi-Managers

Welcome to the forty-sixth Pari Passu newsletter.

Today, we are going to learn about a hot topic of these days: the future of multi-managers hedge funds.

The Future of Multi-Managers

Millennium Management, Citadel, and Point72. What these three firms all have in common is that they are all some of the largest hedge funds of today – they reached their scale by adopting a new platform that is becoming more and more popular with investors today, the multi-manager platform. At a high level, multi-managers are exactly what they sound like – large funds that employ tens if not hundreds of portfolio managers (“PMs”) who individually trade a pocket of funds and contribute to the broader firm’s PnL (profit and loss statement, i.e., the firm’s bottom-line income). But what exactly makes multi-managers so special? And what does their future look like?

Chapter 1: Diving deep into multi-managers

Firm structure and risk management

Splitting multi-managers into two, you have the front-end and back-end. The front end represents all investment teams, ranging from 6 to 100+ portfolio managers in individual “pods” [1]. The system is often likened to portfolio diversification, where each stock implicitly generates alpha (with some component of market sensitivity – beta) and overall portfolio volatility since you spread your risk out among many stocks, so if one stock does badly, it will have less of an effect on the full portfolio. This works the same way with multi-managers, who hire PMs on the basis of having strict drawdown limits (that is to say, if their portfolio returns fall below specific thresholds, they lose a portion of allocated capital, and if it falls even further, they are fired). The “hire-and-fire” approach has been highly notorious for its lack of job stability compared to longer-term single managers, although it is becoming more accepted to move between multi-managers.

The back end represents the entire operational and technology stack behind multi-managers. To preface this, multi-managers typically focus on an extremely broad range of strategies in their efforts to maximize diversification, encompassing relative value (fixed income, fundamental equity), arbitrage (merger, capital structure, convertible, index) and quantitative. Together, these strategies utilize vast swathes of data, from alternative data for equity investing to financial datasets for quantitative strategies, which require a large infrastructure network to support data gathering and analysis. Equally, risk management is critical to ensuring minimized volatility and robust support to individual PMs when trading, and thus multi-managers pour millions into sophisticated risk management – most top funds have a 1:1 ratio between investment and support staff. [2]

Talent

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