Back in 2014, we speculated that as the market rose ever higher on ever lower liquidity and ever more central bank intervention, if and when the moment came that price discovery was permitted again, the avalanche of selling would be unstoppable and the entire market would be halted indefinitely, very much as what happened to 2014’s high flying penny stock CYNK. The recent unprecedented all-day trading halt in the Tokyo Stock Exchange was a reminder of just how easy it is to shut down all trading with the flip of a switch.
Yet while a marketwide halt would not surprise us, what we find remarkable, is just how many investors now seem resigned, even if subconsciously, to never getting their money back after the next crash.
Case in point, in mid-February – when stocks were trading at all time highs just ahead of the covid crash – Izzy Englander’s multi-billion “pod-based” fund, Millennium Management, managed to raise $3 billion without batting an eyelid, a remarkable achievement for a hedge fund at a time when its peers suffered nearly $100 billion in outflows in 2019, just shy of the biggest annual outflow since the financial crisis.
Yet while Millennium’s ease at raising money was indeed impressive (the $40+ billion fund returned less than 10% last year, a third of the S&P, but has been consistently profitable for the past decade), what we found fascinating was not only the ease with which investors handed over their money to the 72-year-old former options guru Englander, but their willingness to be constrained by one of the most draconian lock ups in hedge fund history.
According to a Feb 12 letter from the fund to investors, the share class open to new investments would limit the amount clients can pull to 5% of their money each quarter, meaning it would take them five years to fully cash out. The 5% quarterly redemption limit means that in a quarter in which markets tank and investors want to pull their money, they will only be allowed to pull just 5%. In other words, Millennium investors have pre-emptively agreed to be gated to at least 95% of their capital following a “market event.” And all this just to be allowed to invest in the vaunted Englander’s hedge fund. Or is that private equity fund now?
One reason why Millennium pushed such draconian terms on new investors was that it already had a line of people waiting to give it money: the hedge fund raised $4.1 billion in 2019, when it opened to new capital for the first time in two years. Back in February, it expected new capital would reach $7.1 billion by March. The total would push its total AUM to roughly $50 billion, even as its regulatory assets under management surpass $200 billion (MLP is one of “those” hedge funds that rely a lot on bank repo arrangements).
Millennium’s remarkably long lock-up, one which would put many private equity funds to shame, came as most other hedge funds were trying to secure investor capital over longer periods to avoid sudden mass redemptions if markets turn volatile (which they did just weeks after the new lock-up class was announced).
Ironically, this is what we said in February, when the news of the lock-up class first emerged:
Millennium had withdrawals of at least $1 billion in 2008 as investors found themselves in need of capital during the financial crisis. One can argue that by effecting pre-emptive “gates” that allow investors to pull just 5% of their capital, Englander is telegraphing that the party is about to end and that investors will rush for the exits. The only problem: they won’t be able to as the fine print in their contract now says.
Just days later, the party did end, with the S&P crashing as much as 30% before staging a record rebound on the back of the biggest monetary and fiscal intervention in history. Yet all those new investors who would have wanted their funds back were barred from doing so.
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In any case, in the months following the March crash, Millennium’s capital raise was put on hiatus as most investors were more focused on holding on to liquidity than handing it over to hedge funds which have have once again failed to outperform the S&P500.
Until today, that is because as Bloomberg reported earlier, Millennium has successfully resumed its new capital infusion, raising another $2.5 billion for the new longer-term share class, and furthering its plan to create an investor base that is has virtually no chance of withdrawing its funds if another rainy day comes.
And since we are back to peak euphoria and potential LPs are once again lining up around the block to hand over their money to marquee names, Izzy Englander’s firm will cap fundraising through the end of the year at $4.5 billion, according to Bloomberg sources, up from its previous ceiling of $3 billion.
As reported in February, Millennium started a 5%-a-quarter share class in 2018 that didn’t include the three-year window for capital calls. That class now accounts for about $8.5 billion of assets, a little under a fifth of the fund’s total AUM. To force investors to switch, Englander returned profits from Millennium’s older share class, which enables redemptions in full over 12 months. Clients who had money returned could reinvest it in the longer-term structure.
Englander’s firm previously told clients it plans to return at least $5 billion to investors in 2020. That money was to come from its older share class, which represented about $37 billion of Millennium’s total $45.4 billion in assets.
One reason why Millennium can pull this off is that unlike most of its peers, it has had another stellar year, returning 14.7% this year through September, far more than the average hedge fund, which according to the HFR Global Hedge Fund index is up a paltry 1.7% YTD.
Furthermore, Millennium’s steady returns over a three-decade history has made the new structure an easier sell.
In a repeat of the fund’s February capital raise, under the newest share class, the firm has three years to call the pledged money from investors. Once that happens, clients will be able to withdraw only 5% of their holding each quarter, meaning it would take them five years to cash out completely. Effectively, investors limit themselves to having very limited access to their capital for years. And what happens if there is another crash in a few months, and this time the Fed fails to spark another monster rebound? For the sake of Millennium’s new batch of investors, we hope we won’t have to find out.