As hedge funds go through tough year, private company bets ease pain

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Investments in private companies save the year for stock picking hedge funds.

Leading managers who invest in public and private companies in the same funds have seen their public investment portfolios plummet, weighed down by losses from the January meme rally and a pullback in fast-growing tech stocks. But soaring private company valuations and an IPO market in the United States have boosted their private betting. This has helped to mask their poor performance in public markets and increase their overall returns.

Dan Sundheim’s $ 25 billion D1 Capital Partners, for example, is down 4% in its public betting for the year through September, but up 71% before fees on its private investments, have declared people close to the company. The S&P 500 posted a total return of 15.9% for the period.

D1 clients opt for share classes that offer different levels of exposure to private investments. Clients of the share class that can invest up to 15% in private companies saw gains of around 4.5%, after fees, over the period. The gains amount to 14% and 21% for clients of share classes able to invest up to 35% and 50% in private companies.

Meanwhile, Boston-based Whale Rock Capital Management has lost 11.2% on its public investments in a hedge fund that can invest up to a quarter of its clients’ money in private companies, said people close to the fund. The fund’s private betting performance reduced the fund’s losses to 3.3% for the year through September.

Hedge funds without private companies in their portfolios have had a more difficult time. Light Street Capital Management, a Palo Alto, Calif., Based company that manages growth and other funds as well as a hedge fund that only invests in public companies, is down 18.6% for the year through September in its hedge fund, people familiar with it said. with the firm. This reduced the size of the fund to around $ 1.7 billion. Its growth funds have performed much better, people said, with the first fund of its kind on Light Street, whose investments include catering software provider Toast. Inc.

and the software development company GitLab Inc.,

should have an internal rate of return of more than 100%.

The rush for private investment by public market investors has helped fuel soaring valuations of private companies. And because hedge funds, along with mutual funds and sovereign wealth funds, deploy billions of dollars, they often crowd out venture capital and growth funds.

According to a recent report by Goldman Sachs Group Inc., hedge funds accounted for 27% of funds raised in private tours this year through June, although they only participated in 4% of transactions.

“These technology companies are growing exponentially and managers want to take advantage of this huge exponential growth for their clients,” said Susan Webb, founder and chief investment officer of New York-based outsourced investment firm Appomattox Advisory.

The potential for higher returns is striking. Private equity and venture capital strategies have gained an average of 14.2% per year over the decade ended 2020, Goldman said, while hedge funds have averaged half of those annual returns overall. during the period and were under the stress of regular redemption cycles.

Toast, a catering software provider that went public last month, is an investment from a growth fund of Light Street Capital Management.


Photo:

Richard Drew / Associated press

Hybrid funds can offer distinct advantages, said Udi Grofman, global co-head of the private fund group at Paul, Weiss, Rifkind, Wharton & Garrison LLP. “The beauty of the structure is that it allows investor capital, between two private investments, to be exposed to public markets,” said Mr. Grofman. Clients typically use cash to fund capital calls from venture capital and private equity funds.

Stock selection hedge funds had a record year in 2020, supported by markets that hit new highs after hitting a low in March.

Their fortunes in the public markets have changed this year. The stock rally even in January, which sent the price of companies like GameStop Corp. and AMC Entertainment Holdings Inc.

at extraordinary heights, inflicted losses on a myriad of hedge funds. Whale Rock gained 71% last year, while D1 share class investing up to 15% of clients’ money in private companies climbed 60%; in January, they lost around 11% and 30%, respectively, in their public investments alone.

While D1 nearly recouped those losses, Whale Rock and other growth-oriented stock pickers struggled. Fund managers say sector rotations which have in turn promoted growth or value have made it difficult to navigate markets. Long underprivileged sectors such as energy and finance are tearing apart.

Meanwhile, private markets continued to be favorable. The US IPO market is booming and companies continue to raise more money in the private markets than in the past. Hedge funds contribute to the sustained pace of fundraising. D1 and Tiger Global Management, which manages a series of private equity funds in addition to a hybrid hedge fund, participated in private funding rounds this year through September at a rate of more than one deal per week. for D1 and more than two operations every three days for Tiger, according to PitchBook Data Inc.

Mr Sundheim, 44, who started D1 after several years as an investment director at Viking Global Investors, told a recent introductory equity conference that he didn’t expect to become so big in private companies he did. D1 is invested in 90 private companies, he said.

He said the judgment was the only competitive advantage in government procurement, as private procurement offered the added benefit of the reputation of companies playing a role in accessing deals. He said that D1 in its early investments acted as a resource for management teams to be strong references for D1. Sundheim also said he was confident in his public investment portfolio over the next three to five years.

Write to Juliet Chung at [email protected]

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