The hot new hedge fund strategy - stop being a 'hedge fund'

There has been a rush of hedge funds suddenly converting to so-called "family offices" in the past few months.

A family office manages only the money of the hedge fund manager, his or her family members, and the money of some of the fund's key employees.

The sudden switch has come during a period where many funds have struggled for performance. The average hedge fund has fallen 3.48%, according to data from HFR.

Scott Bommer of SAB Capital, which had $1.1 billion in assets at the end of last year, said in a letter he'd return investor money after 17 years of running his fund, Bloomberg reported. He will now focus on managing his own money, the report said.

The SAB Overseas Fund was down 10.6% through the first eight months of the year, according to Bloomberg.

Poor performance

Earlier in the week, Doug Hirsch, the founder of Seneca Capital, said he too would return all outside investor capital. Seneca makes wagers on corporate events such as mergers and acquisitions and bankruptcies, which is an area has been challenging lately. According to HFR, the average event-driven fund fell 6.89% this year. Seneca's domestic fund is down 6% for the year, according to Bloomberg.

In early December, Michael Platt's $8 billion BlueCrest wrote to investors that he would be returning outside capital. Platt cited downward pressure on fee levels, the cost of hiring the best talent and difficulty in meeting the needs of a large number of diverse investors as reasons for making the move.

And back in May, John Thaler wrote to investors that he would be converting $1.7 billion JAT Capital into a family office so he could spend more time with his "young family."

They join a handful of hedge fund industry titans - including Stanley Druckenmiller, George Soros, and Steve Cohen - who have been running their firms as family offices in recent years.

There are a few reasons why a hedge fund manager to transition to a family office, Stan Altshuller, the cofounder and chief research officer of hedge fund data firm Novus, told Business Insider. The first is the challenging investment environment.

"The most recent bull run has been uncharacteristically difficult for hedge fund managers," he told Business Insider.

He gave for a bunch of reasons for why it has been so difficult, ranging from limited dispersion between equities, which makes it difficult for manager to make long/short bets, to concerns around global growth that have impacted macro fund managers. And then there is the problem of crowded trades.

Here is Altshuller (emphasis ours):

"These days there are more talented, hungry, driven investors looking for alpha than ever before. And they are finding limited opportunities and jumping on them. This creates crowded trades that were a major culprit in the 2015 hedge fund underperformance. Once managers get spooked by, say, an energy price shock, they pare back their risk and realize that their perceived liquidity just dried by since everyone else is selling too. That's when crowded trades can cut deep into manager returns - and they need to curb those losses because investors will scrutinize monthly numbers. They become short termist forced sellers, not a life any manager wants to live."

It is also expensive to run outside money below a certain level of assets.

"The regulations and onerous reporting requirements from the SEC these days makes it a losing game for managers running under $200 [million]," he said.

There are other reasons too. Altshuller cited underperformance, lack of investment opportunities and stress for managers.

"This plays a big role believe it or not, for managers that have already made their millions and do not want to deal with the extreme stress of running someone else's money in such a difficult environment," he said.

"Hedge funds are complicated and investors do not always have the patience to really understand the last five year's underperformance."

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