As the first generation of hedge fund managers — investors like Ray Dalio and Carl Icahn — creep into the winter of their lives, they are faced with a nagging question: succession. As in, who will run the billions of dollars in their funds once they step aside.
Or, more accurately, "if" they step aside. It is a peculiarity of the hedge fund world that managers rely on their names to bolster investment and raise capital, and yet it is their very notoriety that undercuts the ability of someone new taking over.
"Many people look at the founders of hedge funds as the personification of the fund, and it can be hard to persuade investors that the founders delegated responsibilities broadly," said Richard Lannamann, consultant at Spencer Stuart. "They have to persuade investors that their successors are worthy of taking on the fund."
Put more bluntly, many investors decide to invest with a particular hedge fund based primarily on who is running it, and the bigger and more recognizable the name, the better. Managers know this, and therefore either don't make succession planning a high priority or find some alternative to giving up complete control.
"Succession plans are generally subject to the strategy and whether investments are being made by virtue of a process or a specific person," Ron Geffner, partner at law firm Sadis and Goldberg, said. "If it's a person, it depends at what point in their career are we addressing the question."
Name recognition is valued so much that some managers choose to close their hedge funds instead of appoint someone else to replace them when they retire. This is what happened with legendary investors George Soros, who stepped down from Soros Fund Management in 2011, and Stanley Druckenmiller who closed the $12 billion Duquesne Capital in 2010.
A less drastic alternative to giving up control is to sell off all or part of the fund. Think of it as a partial succession plan, where the manager in this scenario tries to cash out before leaving the fund in the hands of someone else.
In his report last year on succession planning in the hedge fund industry, Lannamann identified David Shaw, founder of D.E. Shaw & Co., and Henry Swieca, a cofounder of Highbridge Capital, as managers who chose to bow out through a sale. Shaw sold 20% of his firm to Lehman brothers in 2007, while Swieca in 2004 sold 55% of Highbridge to J.P. Morgan Asset Management after agreeing to stay on for five more years. Swieca stepped down in 2009, the same year that J.P. Morgan purchased most of the shares outstanding.
Hedge fund managers who have tried to impose an orderly succession plan have had varying degrees of success. At Caxton Associates, founder Bruce Kovner tapped his chief investment officer, Andrew Law, to take over the $10 billion hedge fund in 2011 so that the then-66-year-old Kovner could retire. The firm's performance has struggled since Kovner's departure. In fact, in October of last year, it announced it would cut its fees as assets dipped to $7.5 billion.
Then there's the case of Chris Shumway. After Shumway's 2011 announcement that he would leave his $8-billion fund Shumway Capital in the hands of Tom Wilcox, investors reacted by promptly withdrawing $3 billion. The problem here, Lannamann said, was poor planning.
"Chris Shumway announced a successor and all the money basically left," Lannamann said. "There hadn't been the preparation over the years prior in making sure the responsibilities had devolved and making sure investors understood that and accepted that."
Perhaps as a result of what happened to Shumway, some of the biggest hedge fund managers have chosen to slowly decrease their activities while increasing those of their top lieutenants before fully stepping away from the fund. At Bridgewater Associates, for instance, Dalio started to share his CEO role with three other executives in 2011. He then traded that title for that of "mentor" while keeping his chief information officer position at the $140 billion fund, said to be the world's largest.
At Elliott Management, founder Paul Singer told investors in a 2011 letter that he'd created a four-person board to take responsibility for the fund should he become unable to manage it through "death, incapacity or otherwise."
Bridgewater Associates declined to comment, along with other top hedge funds.
As a new generation of hedge fund managers steps into the spotlight, many, like David Einhorn, at 44, and Daniel Loeb, 51, may be a ways from retirement. But they'll be watching their predecessors' every move as they grow closer to hanging their hats up, not only to see who exits the business successfully, but, maybe more importantly, to see who doesn't.