From Boom to Bust: A Hedge Fund’s Rise and Fall
How one fund soared, struggled, and ultimately shut down—and what it reveals about today’s brutal hedge fund landscape
My readers are mainly familiar with the economics of hedge fund management businesses. It’s a struggle to get enough assets and you need a bit of luck with your launch timing but once you are up and running, if you can deliver some performance, you can make serious money. This was particularly true in the run up to the Global Financial Crisis when “two and twenty” was the norm.
It’s perhaps less true today when:
There is more competition
Fees are under pressure – one and fifteen is the new two and twenty and you might be lucky to get that
You are competing with a formidable S&P500 performance delivery
Compliance is a much bigger burden – you probably need $250m AUM today if you want to start an institutional hedge fund.
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Of course, there are still lots of small marginal funds around, but they are constrained in a straitjacket of having insufficient AUM to gain traction with institutional investors and it’s much more difficult to grow, to attract talent and to gain attention. One way round this is to write a Substack or blog and build an audience over time, something executed incredibly well by my latest podcast guest, Dan Rasmussen of Verdad Advisers. But again, it’s hard to stand out among the hundreds or thousands of finance newsletters currently. More on this in a future Substack.
In this article, I am going to run you through the economics of a once successful fund; its partners split up, the founder rebuilt the business but it eventually closed. It’s quite an old example and you would need to discount the successes as the fees won’t be as generous today, but I think it’s quite interesting as the management accounts were attached to the UK Companies House filings and for a period, you can see exactly where the money was being spent.
Here is the P&L:
Actual Hedge Fund P&L
Source: Behind the Balance Sheet Calculations from Companies House filings
That looks quite a good result, £34m turnover, £5m costs, £29m profit. Unfortunately for the partners, that isn’t a single year – that’s the cumulative result over 12 years! The fund did well in 2008 and consequently should have attracted decent inflows, but in the GFC, very few allocators had money. The chart shows that turnover fell off a cliff in 2012 (which was an 11 month year after 13 months the previous year):
Hedge Fund Long Term Turnover Trend (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
They obviously managed to attract some AUM in the GFC as you can see the positive trend in turnover through 2010. The trend thereafter is less clear so I have split this chart into two below. The number of partners increased from 6 in 2010 to 9 in 2011 to 11 in 2012. By the time the business closed, only 5 were left.
Hedge Fund Turnover Trend H1 (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
In 2011, there were significant investor redemptions and some of the partners left, and the fund was wound down and money was returned to investors. In 2012, a new fund was started which launched with £28m and by the end of February, the new year-end, had reached £39m. Hence turnover slumped in 2012 which was the only year they reported a small loss, in spite of halving the cost base – more on costs in a minute.
Hedge Fund Turnover Trend H2 (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
Assets fell to £32m in 2013 but performance must have been decent as turnover more than doubled. That trend continued in 2014, with AUM rising to £44m and turnover again more than doubling. The AUM is thought to have increased further but performance was more lacklustre, leading to the closure of the fund in 2017.
Hedge Fund Cost Trend (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
The business was tightly run with a very low budget. This is partly because in some years there were no employees, only partners, and hence the primary cost of labour is effectively “below the line”. More on the partners’ split below.
Margin Trend
Source: Behind the Balance Sheet Calculations from Companies House filings
With most of the labour being provided by partners, the margin is somewhat misleading, but it averaged 84% over the period, with that one year of losses as the business transitioned.
Principal’s Pay (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
The principal took home £2-4m p.a in the good years. The data in the chart above exclude a limited company which he owned 100% which took a further £150k-ish each year. When the business was restructured, he was down to an income of c.£500k pa or less, which he may well have considered pocket money.
The cost base is quite intriguing, and we have some great breakdowns thanks to the presumably inadvertent inclusion of management accounts in the Companies House filings. I say inadvertent as the individual partners’ drawings are also noted which is highly unusual and would generally be considered secret. I can only assume that these partners didn’t bother to look at the filings. I know there will be lots of UK hedge fund employees and partners reading this and I recommend taking 10 minutes to look at the statutory accounts your employer is required to file.
Summary Cost Breakdown
Source: Behind the Balance Sheet Calculations from Companies House filings
I don’t know why the wages bill fell so much in 2007 and to zero in 2008/9, but perhaps some of the work was done by partners or contractors, or perhaps the data wasn’t reported in the accounts. Establishment expenses comprised mainly rent and was fairly flat:
Establishment Expenses (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
The company had a good deal on office space – by 2017, their rent alone had quadrupled to £160k, as strangely, they moved to flashier offices in the heart of Mayfair. Perhaps their cheap lease had been terminated, because the business performance did not justify it. For those outside the UK, rents generally do not include business rates which are paid to the local municipality. They were clearly cost conscious as my cleaning and electricity bills at home are higher than this.
General Expenses (£)
Source: Behind the Balance Sheet Calculations from Companies House filings
The general expenses breakdown is more interesting. Market data is presumably the cost of the Bloomberg terminals for each analyst and PM. IT support costs are a major item and were quite variable, presumably depending on what initiatives they took to develop the website and internal systems. Travel is quite a low figure – when I was at the global hedge funds, I would do a few visits to the US and Asia annually, and probably a number of trips to Europe. I don’t know what the number was but it would likely have been a multiple of this fund’s total budget.
Donations are charitable but the recipient was not disclosed. Advertising would probably be the cost of promotional activity to appear at prime broker conferences and similar. The office equipment line is presumably rental of photocopiers etc while regulatory fees are lower than I would have expected. Members benefits are not disclosed, nor is staff welfare – lunch?
The rest are pretty de minimis, although please note that staff training should be a much bigger item in your budget. I know someone who can help…………
As mentioned, I thought it was extremely strange that they disclosed the names of the partners and their take-home pay. I have never seen this before. Here is the distribution:
Partners’ Profit Split
Source: Behind the Balance Sheet Calculations from Companies House filings
The principal took half the pot, his nr 2 took half the remainder and the rest was divided up between the junior partners – the ones that stayed throughout were taking c.£250k pa, not a bad result 15 years ago, but not much for a talented analyst or PM.
Conclusions
I think many young analysts look at rich and successful hedge fund principals and imagine themselves in the role, flying in private jets and buying the odd Ferrari if they have had a good week. In reality, there aren’t many successful hedge fund managers and even those who appear successful may not stay the course – this fund looked on top of the world in the GFC but it didn’t survive another 10 years.
The principal took out £12.3m over a 12 year period, around £1m pa pre-tax. It’s not bad money, but a good trader/investor would have likely made more working for a successful fund or a large investment bank.
And this was in an environment which was largely more benign for this activity. It would be harder today. Note also the cost control, something that you don’t often hear about in discussions of hedge fund profitability. It’s essential these days to have a partner managing the business in order that the CIO can focus on managing the money, and the clients of course.
This example is interesting also because the partners appear to have fallen out and the result was that the business effectively closed down, with the original fund being redeemed and a new fund started. Choosing your partners carefully and treating them fairly may sound obvious, but it’s certainly mission critical.
I haven’t disclosed the name of the fund as I want to spare the partners embarrassment. The principal has exited fund management and I believe has retired – he is apparently independently wealthy, if street gossip is to be believed.
The outcome could of course have been somewhat different and I think industry participants often under-estimate the role of luck – for example, getting off to a good start is critical but it’s in part down to luck. My real conclusion is just how impressive it is to have built a successful hedge fund business –managers who have been around for 15 or more years and who have continued to deliver performance deserve their rewards, in my view.