Over the past three decades, hedge funds have grown from a cottage industry into a powerful force in the world’s financial markets.
Although they come in endless sizes and permutations, hedge funds almost always use debt to magnify returns, sell short to profit from falling asset values, rely on a compensation structure that richly rewards hedge fund managers, and impose restrictions that limit access to institutions and high net-worth individuals. In general, they use investment strategies with the potential for higher returns, but also greater risk.
The success of early hedge funds led to an enormous influx of money. Assets managed by hedge funds ballooned from $237 billion in 2000 to more than $4 trillion in 2021, while the number of funds more than doubled to more than 8,000. Below are the seven biggest funds in the U.S.
Top 7 hedge fund firms in the U.S.
Ranking hedge fund firms by assets involves guesswork because they are not required to publicly disclose such figures or report financial results. This ranking, by assets under management, is based on estimates from Pensions & Investments as of 2021.
1. Bridgewater Associates
Founded by Ray Dalio in 1975, Bridgewater was originally a foreign-exchange consulting firm. Dalio began taking note of simple trading tactics, many involving currencies, commodities, and sovereign bonds that tend to endure over time. Over the years, these tactics, often revolving around interest rates and foreign-currency fluctuations, evolved into a series of huge hedge funds with varying degrees of volatility.
The 1,500 employees at the Westport, Connecticut-based firm now manage more than 20 separate funds, each buying and short selling a vast array of financial instruments in markets from Poland to Peru. Dalio’s macroeconomic, political, and historical insights are published each weekday in Daily Observations, a must read for many pensions and other institutional investors.
2. Renaissance Technologies
With its main offices in Setauket, New York, on Long Island, Renaissance’s sprawling office park teems with scientists specializing in such fields as astrophysics, voice recognition technology, quantum mechanics, and nuclear physics. Founder Jim Simons is a globally acclaimed geometrician, a former codebreaker for the National Security Agency, and founder of the vaunted math department at nearby Stony Brook University, where he once worked as a professor.
Renaissance arguably pioneered quantitative trading by harnessing vast amounts of computer power to uncover obscure and ever-changing price patterns in hundreds of markets ranging from grain futures to stocks, bonds, and derivatives. The firm’s flagship fund Medallion fund, available almost exclusively to Renaissance employees, has generated stunning returns of 39% annualized since inception in 1988. That’s net of both a management fee of 5% and a whopping 35% performance charge.
3. Millennium Management
Co-founder Israel “Izzy” Englander helped pioneer the idea of multi-strategy hedge fund investing, starting Millenium in 1989. The New York-based firm utilizes a platform style of investing with some 270 trading teams spread out in cities around the globe including Dublin, Tel Aviv, Geneva and West Palm Beach, Florida. A differentiating factor for Millennium is the notable autonomy it grants these investing teams, which pursue a variety of strategies.
For its part, Millennium headquarters provides large amounts of technological support to the teams as well as requisite legal, accounting, operations, and compliance resources. While the teams themselves are given wide latitude to pursue their individual strategies, Millennium closely monitors portfolios’ risk, working with managers to reduce potential volatility, by adjusting holdings or reducing leverage when necessary.
4. D.E. Shaw Group
Founded in 1988 by a Columbia University computer science professor, David E. Shaw, D.E. Shaw was a pioneer in the use of sophisticated data mining to uncover pricing anomalies in markets. The trading algorithms D.E. Shaw uses are a closely guarded secret, and the firm’s employees in its early years were even discouraged from divulging to family what they did for a living—or even where they worked.
The firm, headquartered in a midtown Manhattan skyscraper, has since expanded beyond its roots as a quantitative shop and, like Millennium Management, employs a variety of investing styles, making it one of the most successful multi-strategy firms. With Shaw having stepped back from the firm’s day-to-day operations to focus on molecular dynamics in the early 2000s, the firm now is run by a committee of six executives overseeing not only quant strategies—a math-based approach intended to outperform the broader market—but distressed credit, real estate, energy trading, and private equity funds.
5. Two Sigma Investments
In 2001, Tudor Investment Corp. President David Siegel and his chief financial officer, Mark Pickard, teamed up with a quant-focused executive from Amazon named John Overdeck. Together, and with the backing of Tudor itself, the trio launched New York-based Two Sigma Investments, applying scientific processes to portfolio management. The quantitative approach was utilized in a suite of funds—fundamental, event-driven, technical, and even one that systematically solicits feedback from Wall Street’s sell side, or the firms that sell products and services to investors.
Two Sigma, with over 250 doctorate holders, incorporated machine learning, distributed computing, and artificial intelligence throughout its investing process. As a group, Two Sigma hedge funds have never lost money in a calendar year. And the firm is using its massive computers to branch into a variety of other areas, including venture capital, private equity, market-making, and insurance.
6. Farallon Capital Management
Farallon, named for a group of barren Pacific islands off the coast of San Francisco, was founded in 1986 by Tom Steyer, a former Goldman Sachs mergers arbitration trader and Morgan Stanley mergers and acquisitions banker. Steyer considered himself a fundamental value investor and not a trader. And indeed, Farallon’s average holding period was as long as five years, an eternity by hedge fund standards.
Since Steyer stepped back from Farallon in 2012 to pursue political activism, including a 2020 presidential run, Farallon has been run by long-time associate Andrew Spokes. Today the firm pursues a variety of strategies, including credit, long-short equity, real estate, direct investments in illiquid situations as well as merger and other kinds of risk arbitrage, a strategy often used to speculate on whether a corporate takeover will be completed.
Citadel founder Kenneth C. Griffin started his career by trading convertible bonds from his undergraduate dorm room at Harvard University. Early on, the firm drew the ire of investors by limiting their ability to withdraw capital. The restrictions, however, were beneficial to both Citadel and its investors after the 1998 collapse of Long-Term Capital Management. Griffin, with access to capital, was able to buy distressed undervalued securities that rival hedge funds were forced to dump.
During the financial crisis, Citadel was particularly hard hit, losing 55% in 2008, much more than rivals. It was only able to fully recover and start earning its performance fee in 2012. Griffin has diversified over the years, establishing a market making brokerage and starting a reinsurance subsidiary to backstop losses for insurers.
The bottom line
Hedge funds, often criticized as taking undue risk, actually use a variety of strategies to generate profits, ranging from dedicated short-selling to merger arbitrage to global macro. Taken together, hedge funds can aid diversification and lower the risk inherent in the stock and bond markets, making them a useful tool for professional and institutional investors alike.