Burning Man

When Man group imploded and lessons for multi-strategy hedge funds

“I know Man Group is a leveraged house of cards, but it seems to keep working and everyone loves them, so I bought some shares”, said one of the largest US long-only financials investors to me just before the Global Financial Crisis (GFC).

The fun thing about writing sell-side research reports about Man Group was the title: Good results would give us “Best Man”, “Top Man” or even “The Best a Man Can Get”. Profit warnings gave us “Man Overboard”. The difficult thing about making stock recommendations on Man Group was that the bank I worked for made tons of money from them. Not only was Credit Suisse its investment banker – with the joint banker Merrill Lynch perennially bullish – our private bank made huge amounts of money from selling Man Group’s products and then it acquired one of my biggest clients.

Man’s share price rose by 12x in the decade to June 2008 peaking at over £6 per share. It made revenues of $2.8bn and profits of around $2bn in the year ending March 2008, making it one of the most profitable hedge fund groups in the world.

The following 4 years saw the share price decline by 90% to a trough in the summer of 2012. Manny Roman and Luke Ellis stabilized the ship, but the share price has oscillated around £2 for the last decade. AUM is now $178bn (versus the $70bn at the start of 2008) driven by asset inflation, acquisitions (of lower-margin businesses), and new clients but revenues and profits are a fraction of what they were at the peak.

Man Group had a substantial institutional fund of funds AUM, but this business was under massive fee pressure even during the firm’s pre-GFC heyday. Within its private client business, the majority of revenues came from structured products where it charged huge management fees of 4% (400bp’s) and performance fees on top. Unlike peers, Man was charging fees on exposure and not client funds. I never thought I would see hedge fund fees as high as this for an industry segment until I heard of the “pass-through" model of “pod shops”.

Man’s structured products typically had an exposure of $160 for every $100 of client funds. Although this was less than the average hedge fund, the majority of this $100 of client funds was used to buy zero coupon bonds to provide capital protection. The remaining funds had to be leveraged around 4x using mostly derivatives rather than debt financing. The former was predominantly through Man’s flagship managed futures fund AHL, which had an enviable track record of 20% per annum returns with limited drawdowns.

When interest rates collapsed and never returned following the Global Financial Crisis the business model of capital-guaranteed products was broken. But Man had an added dilemma: a terrible run of performance by its AHL fund including a big drawdown. Margin calls forced billions of these structured products to be deleveraged completely.

It didn’t help that Man Group’s diversification strategy failed.

One of its first attempts to get access to high-quality capacity was buying a stake in BlueCrest in 2003 but they had a fractious relationship with Mike Platt and couldn’t leverage the stake to add capacity. Eventually, Man sold out of BlueCrest and Platt has of course had an incredible run of returns since becoming a family office.

More meaningful was the acquisition of hedge fund GLG for $1.7bn by Man Group in 2011. By this time GLG was past its prime and most of the star managers like Philippe Jabre, Grey Coffey, and Noam Gottesman had either left or checked out. Only $7bn out of the $24bn of GLG’s AUM was even charging the standard hedge fund structure of 2% management fees and 20% performance fees. With its high employee cost base, GLG’s profitability was also very low at the time.

Unlike Partners Group (which I wrote about last time) where the client base was supportive of the pivot from fund of funds to direct private equity, the demand amongst Man Group’s traditional client base for GLG’s equity-focused products was underwhelming. In a June 2010 report “Man Group – Distributing GLG – rating Neutral”, I wrote the following:

Demand for equity long/short in Asia especially Japan – Our channel checks with distributors across Asia suggest that the demand for equity long/short is significantly less than managed futures. Asian private clients are attracted by the lack of correlation to the level of markets and liquidity of managed futures and global macro managers…. We believe the preference for managed futures and global macro ahead of equity long/short is even greater in Japan. This is based on our channel checks with distributors, and we are unsurprised by this given the decades of deflation and falling equity markets. We would note that it is not just AHL that sells in Japan, but other managed futures products are popular.

The implosion of Man Group is ancient history now but there are timeless lessons. Highly leveraged funds. Investors looking for uncorrelated returns. Products that are dependent on the low correlation between the components. The continuous search for new capacity.

All of this reminds me of the challenges of the $670bn multi-strategy hedge fund universe of which more than half are in the form of multi-manager “pod shops” that have lots of discrete investment teams. “Pod shops” may not sell capital-guaranteed products but they sure have many of these characteristics.

According to the Office of Financial Research (part of the US government) at the end of June 2024 the gross leverage of multi-strategy hedge funds was 10.7x compared to 2.3x for equity hedge funds. The gross leverage a decade before that in June 2014 was 3.9x for the multi-strategy hedge funds universe and 1.9x for the equity hedge fund universe. Unsurprisingly, relative value hedge funds have consistently been highly leveraged at around 20x given they focus on the basis between low-risk fixed-income securities, but macro hedge funds have seen a similar increase in gross leverage to multi-strategy firms. A similar increase can be seen in net leverage ratios over time.

Looking at gross leverage data depending on the size of the hedge fund shows a wide range between highly leveraged larger firms and less leveraged small hedge funds. Of course, there is an overlap here where most multi-strategy firms are large, and large firms just like Man Group in its golden age can access financing and structures more easily. A recent Bank of England thought piece suggested that regulators should monitor leverage by investment style within multi-strategy “pod shops” rather than on an aggregate basis.

The media keeps trotting out former employees of “pod shops” to explain their secret sauce, but I am none the wiser after listening to these guys. Focusing on Sharpe ratios and risk-adjusted returns within a pod and correlation across their various pods of portfolio managers is all pretty obvious but the quants at Man Group used to do that as well. Backward testing of correlation is all great until you get punched in the face as Mike Tyson said.

Another key lesson from the Man Group experience is what you can sell to one set of customers may not be in demand from other customers. Outside of Citadel and Millennium many of the large pod-shops have been putting up decidedly average returns that may be acceptable for a small segment of endowments and pensions funds looking to offset the volatility of their large private equity allocations but are unlikely to attract other types of investors. This will be particularly challenging if interest rates don’t go down as much as expected.

Finally, the bad bets placed by Man Group on diversification are a cautionary tale. The only hedge fund that has hit it out of the park on diversification in a similar way to the private markets giants is Citadel with its infamous move in commodities, which involved different risk tolerances and becoming the first multi-strategy hedge fund to enter the physical energy markets.