How Schonfeld fell into Millennium’s embrace

In March 2020 Schonfeld Strategic Advisors was rocked by the market turmoil unleashed by the pandemic.

The New York-based agency’s flagship hedge fund was down about 16 per cent and its prime brokers had been asking it to place up extra collateral, in accordance with three individuals with direct information of the matter. 

Needing to supply money in response to a routine margin name as markets moved in opposition to it, Schonfeld thought-about its choices. It had beforehand held casual discussions with Millennium Administration a couple of potential tie-up, and one thought placed on the desk that month was for its a lot bigger rival to supply some capital, two of the individuals mentioned.  

Whereas the talks with Millennium didn’t come to fruition, Schonfeld managed to shore up its place. That spring it raised about $2bn from traders, together with within the Center East and Asia, who had attributed the drawdown to rising pains.  

However now, following a lacklustre interval of efficiency and third-quarter redemptions of $1bn, Schonfeld has restarted discussions with Millennium.

The Monetary Occasions reported this week that the companies had been in superior talks over a tie-up that will see Millennium put billions of {dollars} to work with its smaller rival. The transaction, the most important deal of its form, could be with out precedent within the $4tn hedge fund business.

“Is that this a rescue act for Schonfeld?”, requested a senior govt at one London-based rival. “It’s fairly a giant step to take that a lot cash from a peer. It’s not what you’d do in case you had free alternative.”  

The 2 companies declined to remark.

Schonfeld’s capitulation to Millennium displays the altering fortunes of a hedge fund supervisor that has struggled to maintain up with giant rivals. Neither of Schonfeld’s two funds have made cash this 12 months, including to an underwhelming 2022 wherein the agency lagged far behind the likes of Ken Griffin’s Citadel and Millennium. 

Between them the 2 best-performing names within the multi-manager universe make use of a whole lot of groups of autonomous and extremely specialist risk-takers, which commerce a spread of various methods and function inside strict threat limits. 

Schonfeld started life in 1988 as a household workplace managing the cash of founder Steven Schonfeld, a former stockbroker, and didn’t confide in exterior traders till 2015. Since then its belongings have grown dramatically, because the multi-manager mannequin it runs rose in recognition amongst traders.

The agency was amongst those who picked up inflows when larger managers comparable to Millennium and Citadel had been closed to new cash with lengthy ready lists to get in. Schonfeld’s belongings have doubled up to now two years, from about $6bn to $12bn. 

As belongings have swelled, Schonfeld has expanded past its roots in computer-driven buying and selling, including discretionary macro, basic fairness and glued revenue methods. It employed Colin Lancaster in Might 2021 as international co-head of discretionary macro and glued revenue to construct out a enterprise on this space. However the agency’s crown jewel remains to be its statistical arbitrage technique, which makes use of algorithms to use patterns in securities pricing, traders say.

Schonfeld’s fast growth was partly enabled by the “pass-through” bills mannequin that could be a defining attribute of the multi-manager platforms. As an alternative of an annual administration price, the supervisor passes on all prices — together with workplace rents, expertise and information, salaries, bonuses and even shopper leisure — to their finish traders. The concept is that managers can make investments closely in areas comparable to workers and expertise, with the fee greater than offset by the ensuing efficiency enhancements.

One prime dealer mentioned Schonfeld had been “one of many largest payers of sign-on bonuses” that may run into tens of millions of {dollars} and are one of many instruments employed to lure portfolio managers within the conflict for expertise that’s sweeping throughout this a part of the business. Prior to now two years, Schonfeld’s headcount has grown from about 600 to greater than 1,000.

Schonfeld’s experiences replicate one other key dynamic among the many platforms. The multi-manager mannequin is considerably extra headcount-intensive than conventional hedge funds, and seems to have much less working leverage as companies develop larger.

“As belongings scale, headcount (and with it their price base) tends to develop on a linear foundation,” mentioned a report final 12 months by Goldman Sachs prime brokerage, which estimates that multi-managers account for simply 8 per cent of the hedge fund business’s belongings however roughly 1 / 4 of complete headcount.

However crucially, if the amount of cash a agency manages declines, prices don’t fall in step with the lower as a result of it’s onerous for managers to chop spending on the identical tempo. Which means fewer traders find yourself footing a bigger invoice that eats into returns, which may set off more money being pulled out.

“If belongings begin getting redeemed, the traders which can be left behind get left with the brunt of the prices,” the prime dealer says. This incentivises purchasers to “redeem shortly and never get caught,” he added. “You don’t wish to be the final particular person left holding the bag.” 

In response to traders, the problem for Schonfeld is that it has doubled its belongings and elevated its price base by way of a hiring spree — with out placing up the efficiency figures to match.

Schonfeld is the third best-performing title within the multi-manager universe over the previous three a long time, behind solely Citadel and Millennium. However its returns have tailed off over the previous two years. Within the first eight months of this 12 months each its flagship fund and its basic fairness technique are roughly flat, and final 12 months they returned simply 4.5 per cent and three per cent respectively, in accordance with traders. 

Millennium, in the meantime, recorded double-digit returns final 12 months and is up 7.6 per cent within the first three quarters of 2023, whereas Citadel broke information with a $16bn revenue in 2022 and gained 12.6 per cent per cent within the first 9 months of the 12 months. 

As returns have dwindled, the phrases with which Schonfeld secured cash have paved the way in which for future challenges. 

Because it opened to exterior traders, Schonfeld has supplied purchasers month-to-month liquidity, which permits them to drag their cash out as soon as a month. This leaves the enterprise susceptible to mass redemptions, notably with returns having declined and a higher-interest price atmosphere that means traders can park their cash in safer belongings for a wholesome return. 

To make sure the longer-term safety of its enterprise, Schonfeld has lately been providing purchasers a price low cost in return for brand spanking new phrases below which it might take them so long as two years to withdraw all their capital. Greater than half its capital is now locked up till the top of 2024, in accordance with an individual near the agency.

In distinction, Millennium has been earlier and extra proactive in taking steps to stabilise its enterprise and forestall large-scale redemptions after struggling mass outflows in the course of the monetary disaster. In 2021 it returned cash from a shorter-term share class that allow purchasers exit in full in a 12 months, and moved cash to a longer-term share class that will take traders 5 years to exit in full.

Schonfeld’s 2020 expertise prompted it to speculate closely in its threat administration course of and diversify away from its giant fairness publicity, in accordance with one investor, who mentioned what units the agency aside from different multi-managers is its transparency.

Chief govt Ryan Tolkin “could be very approachable”, they mentioned. “If I wished to speak to any of them I may and I worth that since you don’t actually get it from different giant platforms.”

Tolkin has been credited with serving to to construct a enterprise that has much less of an eat-what-you-kill mentality than different multi-manager rivals. However traders say he’s additionally adjusting to a quickly rising agency that below his watch has expanded past its core DNA in systematic buying and selling.

The 37-year-old, whose father Brad is shut mates with Steven Schonfeld, in accordance with a current Enterprise Insider article, joined the agency as chief funding officer in 2013 from Goldman, the place he was part of the funding financial institution’s company credit score staff and labored with Justin Gmelich, now a co-chief funding officer at Millennium. He was named to Schonfeld’s newly created position of chief govt in January 2021 whereas retaining his CIO title. 

Since information of the tie-up leaked, the 2 companies have been inundated with calls from purchasers. Their message to traders is that nothing has been finalised and they’re nonetheless understanding what the partnership will appear like. However a number of choices are being thought-about. 

Amongst them is a individually managed account for Millennium, or the bigger agency taking all of Schonfeld’s capability and kicking out its present traders, in accordance with individuals accustomed to the scenario. One of many individuals mentioned it was vital to protect Schonfeld as an unbiased firm given its distinct model and tradition.

Individuals who know Izzy Englander, Millennium’s founder, say the 75-year-old will in the end be holding an in depth eye on the cash invested with Schonfeld. He’ll wish to ensure that “no matter cash is operating by way of them goes to be below Millennium threat controls,” mentioned one one that labored alongside him for a number of years. “It’s an enormous muscle flex by Millennium, they’ve capital and so they’re neutralising a competitor.” 

For Millennium, a tie-up is smart, in accordance with a number of individuals accustomed to the agency. The hedge fund has billions of {dollars} in long-term capital and by teaming up with Schonfeld it could actually shortly put cash to work with out the fee, time and complexity of hiring Schonfeld’s greater than 100 funding groups. “If Schonfeld accelerates downwards shortly, Millennium will have already got a hand within the pot and may see who is nice,” mentioned the prime dealer.

For Schonfeld, a tie-up with Millennium brings it steady capital and economies of scale that come from tapping into the bigger and extra established agency’s infrastructure and techniques. Millennium is wagering that it will assist Schonfeld reboot its efficiency.  

“The present portfolio managers at Schonfeld are in all probability fantastic with a tie-up,” mentioned one prime business insider. “What’s the choice, get fired quickly after which get a job at Millennium anyway?”