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A Wall Street billionaire just nailed the 4 things that are rocking the hedge fund industry

July 23,2016 19:11

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Tony James, president of
Blackstone Group.

The hedge fund industry is in turmoil.

High-profile funds have
been ensnared in scandals. Performance at some of the
industry's marquee funds has
been weak. Hedge fund managers are increasingly finding

themselves out of a job.

Tony James, COO of the alternative-investing giant Blackstone,
ran through some of the challenges facing the industry on an
earnings call on Thursday.

It isn't the first time the billionaire has talked about
the challenges facing the industry. He said in May that hedge
could lose as much as 25% of their assets.

And on this occasion, he provided a perfect summary of why
the hedge fund industry is struggling:

"Frankly we expect to see assets move from human managers to
machine managers. We also expect to see assets moving from high
fee managers to lower fee managers or lower fee vehicles.
And in some cases, assets moving from vehicles with lots of
liquidity to assets with less liquidity. But I do think, I
think fundamentally, when you have an industry which has
underperformed the market averages and charges 2 and 20,
there is going to be a lot of fee pressure on a lot of managers."

Let's unwrap that a little.

First, the hedge fund world is increasingly reliant
on computers and mathematical models, as opposed to human
traders. Institutional
Investor in May released its annual list of the
top-earning hedge fund managers, and six of the top eight
were quants, or managers that rely on computer programs
to guide their investing.

Second, there is a move toward
lower-cost alternatives, such as liquid-alternative funds, as
they provide hedge fund-like investments with lower fees. That
has the potential to draw assets away from hedge funds.

Third, with interest rates so low, investors are having to
move to less liquid areas of the market to find returns. That
includes things like
direct lending, real estate, and distressed debt.

Computer-driven funds are
taking over from human traders.


Fourth, hedge funds charge hefty fees
— typically 2% of all assets and 20% of profits —
in return for beating the market. That hasn't happened, though,
prompting disappointed investors to turn up fee-cutting

Blackstone has been affected by these
challenges. Blackstone's hedge fund unit saw a 1%
increase in related-fees revenue and a 1.4% gross return,
according to
second-quarter results.

Overall, the hedge fund
industry's return was at 1.6% through June, according to
Hedge Fund Research. That's less than half the gains in the
S&P 500.

Blackstone's $1.9 billion hedge fund, Senfina Advisors, has lost
15% this year,
Bloomberg reported. That was largely dragged down by
"stock-specific movements uncorrelated to Brexit," which led to a
3.5% decline in June.

Overall, Blackstone beat expectations with a 2%
jump for its second-quarter profit, driven by strong real-estate
sales and credit returns. Its economic net income,
which measures unrealized and realized investment gains,
was $520 million in the three months ending in June.

Blackstone now manages $356 billion in assets, a 7% jump on
the year, according to the company's results. Other alternative
assets-management firms — KKR & Co., Carlyle
Group, and Oaktree Capital Management — will report results next

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