Posted by on October 12, 2016 9:40 pm
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Categories: Barclays Capital Markets Central Banks Cohen Economy Expert Networks fixed HFT New Normal SAC Smart Money Steve Cohen

Despite the seventh consecutive month of gains for the broad hedge fund universe, calls for increased compensation have largely fallen on deaf ears as growth in AUM slows to the weakest since the financial crisis. However, as WSJ reports, Point72’s Steven Cohen is boosting the bonuses for top traders at his ‘family’ fund. There’s just one catch – they have to beat the market!

While this seems like a fair demand, this could be a big problem, as BofA notes, active managers are now more exposed to beta than they have been since 2008.

In other words, instead of taking “active” advantage of stock dispersion and alpha generation, all the “smart money” is doing, is simply adding leverage to broader market surrogates, and doing what every other investor at home can do for free: ride the S&P500.

And as Barclays wrote in a recent report titled “Against All Odds“, looking at hedge fund alpha and returns, from 1993 – May 2016, HFs produced cumulatively ~134% of alpha. However, peak cumulative alpha over the period was 139%, achieved in 2011, which suggests that in the last almost 4.5 years, HFs actually generated negative cumulative alpha starting around 2011. Incidentally, that is around the time when both central banks fully took over capital markets, when “expert networks” were busted, and when trading on inside information became virtually impossible.

More specifically, Barclays calculates, the average monthly alpha has declined to -0.07% (annualised ~0.8%) from 2011 to May 2016 compared to an average of +0.48% (-5.9% annualised) for the entire period analysed (1993 to May 2016).

The only issue is that “active managers” collect a fee for manufacturing that alpha… and so that is the narrative that Cohen is attempting to break with his “beat the market” comp scheme.

Point72 had been paying its stock pickers a fixed 20% bonus on investment returns regardless of how they performed against broader benchmarks. That meant they could be paid handsomely just for matching a rising market.

Under the new bonus system, Point72 will boost those payouts to as much as 25%, but it will only pay the top bonuses on so-called alpha, industry parlance that roughly translates to investment performance above a market benchmark.

Point72 President Douglas Haynes said the change is designed to lure new staff during a potential shake-up of the hedge-fund industry under pressure from a yearslong stretch of subpar performance.

Mr. Haynes said Mr. Cohen’s firm wanted to send a message that it is the most lucrative place for the best traders, and that there are consequences for those who fall behind. Some staff also kept 25% or more of their trading gains at Mr. Cohen’s SAC Capital.

The changes will apply to roughly 250 investment staff at Point72, based in Stamford, Conn. Bonuses for traders who are judged to produce below benchmarks will be cut from current levels.

As we concluded previously, however, when one cuts through the chase, what the above really boils down is two things: over the past 5 years, it has become far more difficult to trade on inside information following the SAC debacle, but more importantly, central banks have grotesquely manipulated markets to the point where no fundamental analysis matters, and where only quant strategies (i.e. HFT frontrunning) remain profitable.

As for all those other millionaires suddenly finding themselves in a Darwinian fight for survival in this paradoxical new normal, our condolences, violins and all.

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