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Hedge Funds Turn to Private Capital Playbook in Search of Assets

(Bloomberg) -- Hedge funds are trying on new stripes as the industry’s traditional investing style loses its luster.

Dan Sundheim likes private equity. Tom Wagner seeks a drawdown fund. Steve Cohen eyes venture capital.

“Hedge funds are increasing their breadth of offerings, such as adding venture funds, private credit and illiquid strategies with longer lockups,” said Joseph Gasparro, who helps hedge funds build capital as head of Americas capital services content at Credit Suisse Group AG. “By employing new offerings, firms diversify their product base and increase the stability of their assets.”

Even successful managers see the urgency to evolve in the face of market pressures from quants, indexers and President Trump. While the industry suffered outflows and dismal performance through the first 11 months of 2018, managers are following big investors into the booming world of private capital.

Hedge funds are partly responding to the demands of investors. They are “challenging” managers about products that best fit their needs and pushing for customization and diversification, according to a 2018 global survey by consulting firm EY.

Hedge Funds Turn to Private Capital Playbook in Search of Assets

Sundheim: Private Equity

Sundheim led one of the biggest hedge fund launches of 2018 on the strength of his record as the former investment chief at Viking Global Investors. He also put as much as 35 percent of capital from investors in private companies, with the balance of the hybrid fund in publicly traded stocks.

D1 Capital Partners, which manages $5.1 billion, tapped the growing interest for private investments. Private equity had another strong year in 2018, bringing in about $415 billion in fundraising through Dec. 21, according to data compiled by Bloomberg.

The hedge fund, which started trading in July, made its biggest private investment so far in electronic cigarette startup Juul Labs Inc., according to a person familiar with the matter. Juul in December sold 35 percent of itself to Altria Group Inc. and decided to use a portion of that cash injection to pay dividends to shareholders, including D1 Capital, the person said.

Sundheim’s hybrid fund was flat through November. It fell as much as 8.4 percent in October as the stock market plunged. The company declined to comment.

Wagner: Drawdown Fund

Knighthead Capital Management, a distressed-debt hedge fund founded in 2008, is raising money for its first drawdown fund to make opportunistic wagers.

Knighthead, which saw its assets shrink slightly to $3 billion last year, is using a strategy more commonly found at private equity firms. The drawdown fund gives the firm money it can use later once events, such as bankruptcies and defaults, arise.

The firm is pursuing as much as $750 million for the fund. Wagner, the co-founder, told Bloomberg TV that his firm hopes the fund opens the door to a new set of investors.

“We believe that the credit cycle is nearing or has neared its end and the number of new opportunities will increase significantly in the quarters ahead,” Wagner said by telephone last week.

Cohen: Venture Capital

Cohen, a hedge fund billionaire, is upbeat about venture capital these days.

His Point72 Asset Management has talked to investors about the possibility of raising outside capital for a venture fund that could exceed $750 million, Bloomberg reported in November. The move comes as investors put more money behind venture deals in the first three quarters of 2018 than in all of 2017, according to a report by KPMG.

Cohen, who makes venture investments in AI and fintech with his own money through Point72 Ventures, said recently that he aims to build out a full-scale operation. He predicted ho-hum hedge fund returns over the next two years and money continuing to flow into index investing.

“The world keeps changing and if you want to stay in this business, you got to change, you got to keep changing,” he said in November at the 92nd Street Y in New York. The firm, which manages $13 billion, declined to comment.

Private Re-Run

Hedge funds have dabbled with private capital before. Picking stocks is one thing; knowing how to grow a company is another.

During the last recession, hedge funds began showing up to invest in private equity deals. But then they disappeared, said Michael DiPiano, co-founder of NewSpring, a private equity firm established in 1999.

“Many found it too difficult,” he said. “The good players spend years building their knowledge base to be good at what they do.”

That won’t stop hedge funds from trying again. About 35 percent of hedge funds offer private credit products or plan to by 2020, and 28 percent aim to provide private equity investments, according to EY’s survey.

“This is a story that has been growing over the years, but has accelerated and come more into focus in 2018 given the environment, and is likely to continue in 2019,” said Credit Suisse’s Gasparro.

©2019 Bloomberg L.P.