Overview
2020 was an unprecedented year for long/short investors being one of the most volatile and unpredictable years in recent memory. Many investors were able to capitalise on this, generating returns that were previously unheard of in the space. Portfolio Managers and Analysts were waiting with baited breath for the onset of 2021 and whether or not this volatility would continue. Now able to review the last 12 months, we can confidently say this volatility continued throughout 2021. Notwithstanding the continuation of the Covid Pandemic, factors such as earnings predictions becoming increasingly less relevant, sharp moves in bond yields and the impact of retail traders on stocks contributed to a year where Portfolio Managers ability to not only generate P&L but also protect it, was put to the test.
Managers 2021 response to 2020 was an raft of hiring and a dramatic increase in capital deployment. Millennium hired six new Portfolio Managers in London and eleven analysts – they also promoted eight of their analysts to having a sleeve/carve out, increasing their capital deployment by over $6b GMV. Citadel Global Equities & Surveyor, regardless of their attrition, still materially increased their long/short equity headcount throughout 2021 with ten new hires and increased their capital deployed by over $4b GMV. While Multi-Manager Platforms went on a hiring spree, Single Manager Funds were also able to take advantage of the hangover from 2020. While previous years had seen investor support waning in favour of the higher returns on offer with Private Equity & Private Debt funds, investor appetite finally increased in the Long/Short space. We saw notable fund launches with sizeable AUM such as FIFTHDELTA with $2.5b, Kersley Street with $350m and Lombardi Capital (rumoured to be at $500m).
Whilst this optimism was promising, the benefit of hindsight is that some of this overenthusiasm was misplaced. Volatility continued to not only produce market winners, but also market losers. Each fund reacted differently to this dispersion, with some allowing Portfolio Managers to reduce exposure in order to weather the storm (e.g. Millennium & Lighthouse) while others simply cut teams that were in the sectors plagued by Covid (e.g Surveyor).
Reducing Exposure in 2021
Although the volatility throughout 2021 meant that long/short investors were largely bullish, this changed dramatically in Q4. A combination of irrational moves, sustained de-grossing in November & December and the omicron variant emerging meant that Portfolio Manager’s ability to acknowledge upcoming market volatility and reduce their exposure accordingly became crucial in order to survive 2021. This can be clearly demonstrated by taking the Industrials & Materials spaces as a case study.
Industrials & Materials as sectors certainly had a resurgence last year, with increased volatility and supply chains across the sector meaning that the once stagnant markets were providing returns which were previously unachievable. At Millennium, a key Industrials & Materials portfolio hit +$120m by October 2021. The lead Portfolio Manager on the team recognised that some upcoming volatility in the space would mean that while their earnings estimates may be accurate, they were in reality irrelevant and so to protect their P&L the best move would be to reduce exposure to zero throughout November and December. Management allowing the Portfolio Manager to reduce their exposure ultimately resulted in the team’s P&L being protected, and their annual sharpe was one of the fund’s highest for 2021. Lighthouse took a similar approach to Portfolio Managers in the sector, even allowing a newly launched fund in mid 2021 to reduce their exposure completely in Q4 in order to protect any P&L and not unnecessarily have to weather a storm. Conversely, Citadel’s process driven approach does not allow teams to reduce exposure, and this led to attrition. A key Portfolio Manager focused on Industrials was not able to reduce his exposure across Airlines & Airports, sectors that continued to be plagued by the Coronavirus Pandemic, after hitting a significant drawdown they were let go from the fund in late 2021.
Essentially, while long/short platforms need to rely on process in order to protect returns and generate alpha throughout all market conditions, 2021 demonstrated that there needs to be a degree of nuance and flexibility here. Reducing exposure should not always be viewed as a cowardly risk averse move, as it can often protect P&L during the short bursts when the standard fundamental bottom up approach simply cannot defend against these new outlier factors that continued to present themselves in 2021.
Sector Concentration Throughout 2021
European Long/Short funds have always been at odds with their US and Asian counterparts. While the latter regions tend to favour Healthcare and TMT names, European funds have historically weighted heavier in sectors supported by real assets like Industrials and Materials. The classic market neutral long/short multi-manager funds reflected this trend, pre 2021 Point72 was 50% weighted towards these sectors, with Millennium not far behind at 40% and Citadel just below 30%.
The resurgence throughout 2021 in the Industrials & Materials space only strengthened this bias. Millennium launched five new Industrials & Materials Portfolio Managers, increasing their number of portfolios in the space by 62%. Given the increased volatility in the markets, Millennium was able to generate stellar returns in early 2021 in a space with historically plagued with stable but low returns. The non market neutral space clamoured to increase their exposure in a space historically left to the market neutral firms – for example Carmignac hired Jean Francois Louvrier of Pictet to launch a long/short fund with an Industrials & Materials bias.
As previously explored, this increased volatility led to a disastrous Q4 for many in the space. Preliminary figures indicate that 1/3 of these Portfolio Manager’s annual gains were lost throughout November and December.
Certain funds held steadfast on their approach to not overexpose in any particular sector regardless of the market trends emerging and competitor appetite. Notably, with this resurgence Citadel only hired one additional Industrials & Materials team in Europe, opting to also add to their TMT/Consumer exposure regardless of the threat of higher interest rates and rising inflation that is plaguing the Tech sector. It is undeniably that their dedication to their process vs market trends quite literally paid off, with their market neutral long/short Wellington fund posting returns of 26% - almost double Millennium’s returns of 13.5%.
The Return of the Single Manager Fund Launch
Attrition due to hitting a draw down is par for the course in long/short equity, however a notable difference in 2021 was where these investors moved to. Typically when a high quality investor hits a drawdown, competitor long/short funds will seize the moment to bring on the individual without having to even consider sizable guarantees or a sign on bonus. I would venture to say, 2021 saw the return of impressive fund launches. One simply has to think about which notable Portfolio Managers were let go throughout 2021 and where they have ended up. Tio Charbaghi, one of Citadel Global Equities most impressive names in the Industrials space, launched FIFTHDELTA alongside Niall O’Keefe vs opting to join a competitor long/short multi-strategy. Igor Kryca, alongside his number two Talgat Irisbekov, spent seven years building up a reputation at Soros as a European Generalist who could pivot opportunistically around sectors while still being able to do the deep dive fundamental bottom up work necessary to consistently generate strong returns. Irisbekov in particular, as Kryca’s shorting specialist, managed to generate on average returns of +4% during his six year stint there. Rather than opting to move as a team to a long/short multi strategy fund they launched Lombardi in late 2021 with a rumoured $500m in AUM.
Institutional investors have historically been hesitant to put sizable capital behind single manager long/short funds, instead favouring the large multi-strategy fund where they feel their capital is protected. 2021 saw a notable shift however, the politics of personality almost came into play where investors wanted to have a face they trust and genuinely believe in the individual Portfolio Manager’s investment philosophy.
Essentially, the appetite amongst institutional investors for long/short funds increased, with the ‘brand name’ Portfolio Managers managing to persuade investors that their deep knowledge in the space meant their capital was protected in the long term across market conditions.
FIFTHDELTA, set up by Industrials & Materials legends Tio Charbaghi and Niall O’Keefe, launched at a record $2.5b as a single manager Industrials & Materials focused long/short fund. As previously noted, the expected route for Charbaghi after hitting a drawdown in early 2020 was to leverage his nine years at Citadel into a similar seat with a different multi-manager platform. Instead, Charbaghi was able to leverage his experience alongside O’Keefe’s status in order to be a founder of one of the most anticipated single manager launches in the last five years.
Lombardi may not have hit quite the same level of AUM, but ex Soros alum Igor Kryca & Talgat Irisbekov managing to raise a rumoured $500m after hitting their drawdown in mid 2021 at Soros was unheard of in previous years.
The shift has certainly affected talent pools at both the Portfolio Manager and Analyst levels, with previous incentive structures not able to compete with these new market dynamics. At the Portfolio Manager level, the multi-strategy promise of increased capital management responsibilities and a sizable sign on or guarantee struggled, and likely will continue to struggle, to compete with the allure of launching a fund. Multi-strategy funds largely responded in one of two ways. On the one hand, certain funds highlighted their offer of a hybrid structure, pitching themselves as the ‘best of both worlds’ acting almost at the crossroads between a multi-strategy fund and a seeding platform. In particular Schonfeld and Lighthouse could take advantage of these new dynamics having historically carved out their niches in this space. Schonfeld increased their European Portfolio Manager headcount by 30% in 2021. Throughout last year, Lighthouse onboarded several high profile Portfolio Managers from quality firms including alumni from Millennium, Citadel, Surveyor, Visium, UBS O’Connor, Balyasny & Carlson. Examples include Fabio Lopes and Felipe Cruz in London, Ilya Boroditsky in Chicago and Seth Turkeltaub & Anup Patel in New York. On the other hand, funds that are simply not structured in a way that meant they can offer this hybrid structure were forced to find longer term incentives in 2021 than the initial cash of increased AUM and a sign on or guarantee. These multi-strategy funds competed primarily by introducing sliding scales for Portfolio Managers’ percentage pay-outs. This increase in the use of sliding scales was incredibly noticeable throughout 2021. Pay-outs were able to increase up to 25%, and so Portfolio Managers moving to a competitor multi-strategy fund, even if their previous year’s performance was poor, were negotiating deals that had less of an emphasis on a sign on bonus or guarantee. The general view has been that a sliding scale has more longevity as an incentive and therefore can compete with the promise of a successful fund launch.
At the analyst level, the pre 2021 consistent decline in fund launches meant that equity analysts were frustrated at the lack of opportunities at anywhere that was not the standard multi-strategy platforms. The overwhelming consensus was analysts felt forced into a market neutral/shorter term investment style that did not necessarily align with their investment philosophy. From a talent perspective, the comeback of the single manager has not gone unnoticed at this level. Typically analysts were keen to move into seats at competitor long/short platforms in order to increase their compensation. However, around 80% of buy-side analyst conversations last year revolved around a willingness to take a reduction in compensation in order to move into one of these, now more coveted, seats where the investment philosophy is more flexible around market conditions.
Conclusion
Between the ongoing Covid Pandemic, meme stocks, irrelevance of earnings and sharp moves in bond yields – 2021 was certainly proven to be as volatile an environment as 2020, if not more so. This increased volatility undoubtedly resulted in increased returns, but the challenging environment also resulted in increased losses. Many long/short investors were able to utilise their fundamental approach to produce advantageous returns throughout 2021, however Q4 demonstrated that acknowledging the limitations of a fundamental approach was key in order to protect those returns.
Sector concentration continued to have an impact. Into 2022 funds should look for ways to ensure they are firstly not underexposed in any sector that could have a resurgence and secondly not overexposed in any sector that may prove to be too volatile. The balance is tricky, but key especially for multi-manager platforms.
The return of the single manager fund though has been the most unexpected outcome of 2020 on 2021. Single manager funds are back – and with it increased competition for talent. The multi-manager platforms will have to continue to compete with these funds who can deviate from the standard market neutral approach.