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All Cash, No Splash

The glam may be gone for hedgies and their investors—but the money keeps rolling in

On an early September night at Lincoln Center, a veritable den of tiger cubs gathered to toast their papa. It was the 80th birthday of hedge-fund pioneer Julian Robertson, one of the richest men in America and angel to dozens of funds. Naturally, it was a star-studded affair: New York City mayor Michael Bloomberg hobnobbed with novelist Tom Wolfe; Mitt Romney sent greetings as part of a film tribute. Musical guests included the drum corps from Robertson’s alma mater, the University of North Carolina, imported specially for the evening. But the 200-person fete could actually be deemed modest compared to the sorts of parties these guys used to throw. Even the grand harvest moon was muted, covered by clouds on the unseasonably cool evening.

Robertson is a member of a rarified club: early hedgies who got super wealthy before others caught on. Back in 2005, “Get Richest Quickest” was how one magazine cast the world of hedge fund managers. Setting up a fund was as easy as plugging in a Bloomberg terminal and much more lucrative than investment banking, a career that smacked of drudgery. The only more surefire moneymaker was turning your house into a piggy bank. Perhaps most appealing, though, was hedge funding’s exclusivity factor; because they’re not sold to the public, a red rope separates serious money from everyone else’s. Hedge funding was for the 1 percent. It was a wonderful time.

Not so much anymore. Less than a decade after its heyday, hedge funding has become overcrowded, and underwhelming. Hedgies aren’t exactly going broke, but they aren’t producing the outsized returns of yesteryear, either, which means the outsized earnings are rarer as well. The days of globetrotting and Cristal-on-the-company are over; these days, managers are a lot less likely to be debating the merits of the Learjet 60 versus the Citation Excel than the cheapest way to fly commercial. “My trip to the Hamptons is on the way to see the lighthouse in Montauk,” jokes Eric Almeraz, partner at Apis Capital Advisors. Except he’s serious in one respect: no swank beachside estate for him. Investors are putting their Manolo Blahniks down on their managers getting rich while their nest eggs barely stay whole. 

“Managers are working three times as hard and earning one-third as much,” says Carl Berg, founder of Catalyst Financial Partners, a matchmaker for investors and managers. Transparency is up; fees are slipping. (The classic hedge fund fee is called “2 and 20”—2 percent of assets managed plus 20 percent of any profits—and in their prime, some firms charged as much as “3 and 30.” Now, however, some are lowering one or both fees—or dropping the “20” entirely). Even hedge fund star Caxton Associates has reportedly trimmed its charges, although they remain among the highest. The red rope has fallen. And so, much of the fun is gone. Because the irony, of course, is that if you actually succeed at making big money, everyone may assume—or at least wonder—if you’re the latest Raj Rajaratnam (the billionaire former hedgie who is currently serving an 11-year prison sentence for insider trading).

Blameor creditthe feds, whose new regulations are making it more tedious, as well as far more costly, to set up a new hedge fund. (Consider the 42-page document to be filed with the Securities and Exchange Commission and the back-office support to make sure all the dollar signs are real, which can cost up to $500,000, even before the first due diligence meeting.) Blame the market crisis or Bernie Madoff. Blame the press for showcasing hedgies hopscotching around the globe, tasing employees for their own amusement, and trading on insider information. Don’t forget to hold responsible the aspiring billionaires who piled into the industry only to show how good they were at losing other people’s money. While you’re at it, throw some credit in the direction of Occupy Wall Street. 

That’s not to say the pot is empty. In fact, one concern among hedge funders is that there’s too much money in the industry, says Simon Lack, author of The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True. After the market crash in 2008, investors briefly fled hedge funds. Then they began pouring money back into the sector, mostly seeking the true platinum names. But hedgies are struggling to find winning investment strategies of their own, the sorts of ideas that earned earlier managers their seven-figure salaries. Those guys made it big by forging new strategies in ways that aren’t being matched today: When Ken Griffin began trading convertible arbitrage in his Harvard dorm room, he was a pioneer. Now everyone knows how to do that.

What’s more, the competition has gotten stiffer. The hedge fund industry has expanded exponentially since 1990, when fewer than 700 managers toiled in obscurity, to almost 10,000 now. Hedgies are faltering as they try to finesse the European soap opera (Will Greece survive another day? Will the Spanish bond auctions fail?), negative-yielding bond rates, and the zigs and zags of the U.S. recovery. Even George Soros returned money to investors last year, preferring to open a family office for his $25 billion nest egg. Imagine: The man who nearly broke the Bank of England with his bet against the British pound in the early 1990s is saying ‘feh’ to the paperwork and transparency rules of the Dodd-Frank financial reform legislation.

Despite the fact that the new regulations aim to give investors access to more information on their investments, they’re still worried. In 2012, Barclay’s Hedge Fund Index was up only about 6 percent, almost two-thirds less than the S&P return of 16.4 percent. Some funds have reportedly shut down rather than face the scrutiny of Preet Bharara, U.S. Attorney for the Southern District of New York, who has won convictions on 69 of his 72 targets. And so, the ultra-wealthy, always meticulous stewards of their assets, have grown even more careful, hiring corporate investigations firm Kroll to check out the bona fides of managers, or tapping intel around the globe to keep tabs on the guys who are keeping tabs on their money. Some investors won’t use a manager if he’s getting a divorce, says Brian Shapiro, president of Simplify LLC, a firm that offers advisory services for hedge fund and private equity investors. They worry that the financial pressure could cloud the manager’s judgment.

All of which is also making it harder for the new kids—the HBS and Wharton and Columbia grads—coming in. Big institutional investors can’t afford the due diligence to check out the new talent. If Ray Dalio loses money for a couple of years, your board won’t ask why you put money with the world’s largest hedge fund. But if a no-name manager loses money, the board will probably go berserk.

That puts partners like Eric Almeraz of Apis in a tough spot. Apis rode the precipitous rise and fall of the hedge fund business. Founded in 2004, the fund peaked at $650 million in assets and was named a top 75 performer by Barron’s. Then came 2008. Apis’ biggest investors, funds comprised of hedge funds, pulled their money as investors panicked; Madoff, after all, had duped many funds of funds. Today, Apis boasts $50 million and a lifetime return of nearly 10 percent net of fees. His sweet spot, these days: The ultra-wealthy family who knows that a million-dollar investment in Apis will be a lot more meaningful to Almeraz than to the $130 billion Bridgewater Associates. But it can be a tough sell.

Of course, the news isn’t all dire. The financial gurus are saying that things are looking up, and hedge funds, along with private equity, real estate and alternative investments will continue to grow faster than any other asset class. The world of investors is broadening as the hedge fund world takes down its “Members Only” sign and hangs out a new shingle saying “Your money welcome here!” The new rules, meanwhile, include legislation that will enable hedge funds to advertise. The glam may be gone, but if you listen closely, you’ll hear the sound of the Wall Street marketing machine getting primed.