Blackstone on hedge funds: Why multi-strats are back

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Voiceover: This podcast is intended for institutional and professional investors, not for retail use.

Kumar Panja: Welcome to the J.P. Morgan Making Sense channel. I'm Kumar Panja and I'm excited to be joined by two very knowledgeable leaders from Blackstone. Joe Dowling, who is a Senior Managing Director and Global Head of Blackstone's multi-asset investing business called BXMA, and Riad Abrahams, who is a Senior Managing Director in BXMA as well, where he serves as Head of Strategy, Risk and Quant Analytics. Welcome, gents.

Joe Dowling: Kumar, thanks for having us.

Riad Abrahams: Thanks, Kumar.

Kumar: Today, we're going to be focusing on the multi-strategy hedge fund space and the way in which investors are increasingly using multi-strats, multi-strategy as a powerful tool within their alternatives portfolio. And Blackstone have been investing in this space for 29 years, am I right?

Joe Dowling: You are.

Kumar Panja: And are both investors in multi-strategy hedge funds as well as having their own multi-strategy solutions, so I'm really keen for them to share their views on the segment. But first, let me set the scene with some numbers and my colleague Katie Crawley in the Capital Advisory Group published a report on multi-strats. And according to which the space in terms of size as we see it expressed in assets under management is estimated to be $595 billion at the end of 2025. That number will have gone up already this year substantially. That is a year-on-year increase of $92 billion, which is up 18%. And that AUM growth can be broken down into $61 billion of performance and $31 billion of new inflows. And that is the highest that we've observed since we started to track the data in 2020. Performance for full year 25 across our group of multi-strats that we track was 11% last year. It was 11.8 at the end of 24. But interestingly, larger funds outperformed. So the AUM weighted return was in fact closer to 12.5% last year. The spread of returns between cost pass-through firms and non-pass-through firms narrowed last year. And we'll get into those terms and the significance of that a little bit later. Needless to say, the team here has seen a lot of interest in this space from our conversations with the full spectrum of investors. It's also a popular discussion topic for a number of reasons that we're going to get into. So, Joe, kick us off. Why do you like multi-strategy funds?

Joe Dowling: I think fundamentally that the demand for multi-strats and the demand for multi-strat solutions stems from the underlying problem, which is that stocks and bonds are correlated a lot more than investors think. If you look back over 50 years, it's 62%. And that has risen since 2022. And obviously, we know we live in a world that is very volatile, a world where deglobalization is happening. And that has resulted in a lot of winners and losers and a lot of volatility. And that's just the perfect weather for these strategies. And as an allocator, people are looking for something that's completely uncorrelated to stocks and bonds. And multi-strats are the solution. So, yeah, I'm not surprised by your statistics.

Kumar Panja: And as investors rethink this traditional 60-40 portfolios, what's the nature of the demand that you're seeing from your investors for multi-strategy solutions?

Joe Dowling: The demand is across the board for hedge funds in general. It's the number one asset class in 2026 for allocators, which I can never remember a time where that was the case. Can you, Riad?

Riad Abrahams: Yeah, I think it's actually the second year in a row that hedge funds are the most sought-after asset class. And within that, multi-strats are obviously in huge demand. I mean you quoted the growth over the last 12 months. If you zoom out, I think over the last five years

Joe Dowling: 16%.

Riad Abrahams: Yes. And that's compared to the rest of the industry at around 4%. So, I think this problem that traditional portfolios face given the shift in the correlation regime, institutions recognize it and they're gravitating towards multi-strategy solutions as the answer.

Kumar Panja: How should investors be thinking about using multi-strategy funds in their portfolio? Should they be using more of it? Do you think they are underweight currently?

Joe Dowling: I definitely think people in general are underweight, the asset class. You can see some of the Ivy League endowments are actually now at 20% in their portfolios across the board. They're using it as a fixed income substitute in most cases. But if you look at allocations to multi-strat, they're quite low. And I think people have a host of reasons to not like them. But the reality is that these firms have been delivering, especially the top ones, year after year after year, an uncorrelated double-digit return with a high sharp. That is nirvana for investors.

Riad Abrahams: Yeah, just to put some numbers around the long span of performance for multi-strat. So, the longest index is the pivotal path multi-strategy index. It goes back almost 30 years. And so, if you think about multi-strats over that period, they've delivered 9% returns with less than 5% volatility.

Joe Dowling: It goes back 30 years, Riad? Is Millennium the only fund at that point?

Riad Abrahams: It's a more limited index back then for sure. But if you compare it, that's actually ahead of equity returns. Over that same time period, equities have generated an 8% return with 15 vol. And bonds have only generated a 3% return with 6 vol. So, multi-strats are delivering you equity-like returns with a fraction of the risk. And so, if you think about that as your portfolio objective and what can be realized, multi-strat should be a core holding in any institutional portfolio, any individual's portfolio. And I think that's why, as Joe mentioned, you see that the most sophisticated pensions, sovereign wealth, endowments, their absolute return allocation is around, I think it's 20%.

Kumar Panja: So, multi-strategy funds often come with perceived challenges, Joe, as you mentioned. And these are things like closed to new money, i.e. capacity. They have high fees or pass-through fee structures. They have increased their terms in terms of their liquidity. There is a question around the level of transparency that is sometimes provided. And there are increasing correlations between multi-strategy firms as well. How do you think about these trade-offs, particularly when building a platform? And how do you differentiate? How does Blackstone differentiate its approach to investing in multi-strategy funds?

Riad Abrahams: So, look, I think the top institutions here have done a phenomenal job. I mean, they have delivered, right? We talked about some of the returns over time. But that prevailing model, broadly, it includes running maybe 100 or 200 individual teams. But most of those teams are doing something quite similar, which is they're running some version of an equity long-short strategy. If you look at those individual teams through the use of kind of the risk models and leverage, what they do is they basically have each pod generate a low return on assets that they then apply a lot of leverage to to get a very high return on equity. And that helps fund the compensation for the PMs through a structure called the pass-through fee structure. That sort of describes the prevailing model.

Joe Dowling: I would emphasize people underestimate how big a moat the top players have created in not only their recruiting, and this is a big recruiting business, in their information technology, in their policies around using the center book, using leverage. It is formidable. And we've seen many sophisticated people try to come into this industry with the hopes of creating a firm and failing. Very talented people.

Kumar Panja: That's a good segue into the question. What do you think are the barriers to entry in this space? And more broadly then, because I guess there might be two sides of the same coin, what makes a good multi-strategy firm?

Joe Dowling: Well, again, I think we talked about it. It all comes down to the durability of the return, the consistency of the return, how high quality is it. Does it stand the test of time? And markets test you. I mean, if you look at just at a 60-40 over the last five years, there have been seven quarters where it's been down. And it's during these periods or the big macro dislocations like 2008 where these firms have come through and protected capital. It is a very, very hard thing to do.

Riad Abrahams: Yeah. The really great ones, as Joe mentioned, they excel at attracting talent, right? And they're constantly filling the funnel of new potential PMs. They are able, through their infrastructure, to arm those PMs with access to data and very formidable trading operations. And then I think that one of the key, key things that the best ones do…

Joe Dowling:  …risk management

Riad Abrahams: Is they manage risk very well, right? And there are different variants of how they do it, but broadly, they're able to factor neutralize their portfolios. They employ different stop-loss approaches. And that is what has really reduced their correlation, reduced their volatility, and allowed you to create this compounding stream through time. So, I think, again, that that prevailing model, the guys at the top have done an incredible job at it. But as you say, Kumar, a lot of them are also now closed and so a bit more difficult to access.

Kumar Panja: So Riyad, you've talked about some of the challenges to the traditional way that largest managers deliver on the promise of multi-strategy returns. Is there an alternative approach and what is that approach?

Riad Abrahams: Well Kumar, just to summarize again, I think those challenges are high fees, high leverage and challenging investor liquidity. And I would say an alternative approach would be one that uses a centralized team that deploys capital across multiple internal strategies as opposed to many teams effectively running the same strategy. That in turn could enable a portfolio construction approach that can really de-emphasize leverage as the primary means of risk control and instead capitalize on the power of something that we like to call stacking structurally uncorrelated alphas together across asset classes. It's a model that can probably plug into a broader ecosystem of proprietary data, insights, idea generation, obviously tech infrastructure that will effectively reduce the operating expense burden and compensation burden of the prevailing kind of platform approach. And that really allows you to pass along the savings that come with scale economies to the end customer and investor. And then finally, I think it can be one that achieves a better balance between investor liquidity and business risk by really building upon the benefits of deep duration, of longevity, institutionalization that large scaled firms enjoy.

Kumar Panja: OK, Riad, and I think I know the answer to this question, but does Blackstone adopt this approach and have this ecosystem you talk about?

Riad Abrahams: Well, naturally, Kumar, I'm going to say yes. And when it comes to liquid markets in particular, it is our multi-asset investing division, BXMA. You know, Joe mentioned this earlier, but across BXMA alongside our absolute return business, which largely deploys capital through external manager partnerships. We also have a direct investment business that today manages 18 billion dollars and runs 11 internal strategies that really span the spectrum of asset classes. And historically, that platform has really served institutional investors, but the same capabilities are increasingly supporting the needs of high net worth investors and families where access to this type of return and risk stream has historically been limited.

Kumar Panja: That's great. That makes a lot of sense, Riad. Thank you. So, as we're talking about the challenges, one of the things we constantly have a debate with our investors in conversations is the level of fees for multi-strategy funds.  We  tell them that you focus on the net return and that's what you should care about. But nevertheless, fees and the level of fees and more importantly, the share of Alpha that they receive as LPs seems to be a sticking point. What do you say to that, Joe?

Joe Dowling: Absolutely. It's the biggest objection that we hear from investors. But if you think about it, these are limited capacity strategies. And whenever something is limited, you have pricing power. And the demand for these multi-strats is really exceptional. Every time they open, they can immediately fund tens of billions of dollars and they've earned it because they've outperformed as Riad said earlier in the statistics. So, I like to focus on the net return and its consistency. Yes, the fees are high but the best performers deserve those fees.

Riad Abrahams: Yeah. And I think that at a high level, it's consistent, right? Generally, the funds that have performed the best through time, they do have the highest fees. And so, you shouldn't be necessarily uncomfortable with high fees. But high fees do create a high burden when you look at those net returns. And I think a lot of platforms, not the top ones, but some platforms have adopted this pass-through fee structure and it's compromised the net investor's experience because there's a big hole you got to climb out of. We like there to be just a lot of alignment between the manager as well as the investor.

Kumar Panja: Okay. So, where are you seeing the most innovation within the multi-strategy space today?

Riad Abrahams: Yeah, I would say two areas. Number one, and I think this is a derivative of their growth and how investors have flocked to them, but you see more external allocations. And so, if you looked back in 2022, just over the last three years, 50% of multi-strats were doing some form of external allocation. That has grown to 75%. A big way they do that is through the use of external SMAs. That has grown from 25% a few years ago to nearly 40% today. So, I do think that they are in some ways moving towards that more traditional…

Joe Dowling: Towards our business.

Riad Abrahams: Yeah the portfolio of funds approach, and I think there is a bit of convergence there. Number two, I think they are in some ways beginning to live up to their name as multi-strats as opposed to just multi-PMs. You see them expanding into other asset classes. I think everyone has read about the expansion into commodities. There are some that are now expanding into private credit. So, I think they are trying to put more arrows in the quiver. That's something that we applaud. I think that's a hallmark of what we're able to do because of our access to all of the different strategies that we run internally across the firm.

Joe Dowling: I think investors underestimate the amount of innovation that's happening at these firms, especially around the center book, the use of AI, and isolating super alpha performers and amplifying those performers overall in the portfolio construction.

Kumar Panja: Riad, we mentioned earlier cost pass-through funds and non-cost pass-through funds. Can you spend a minute or so just talking about what pass-through actually means? Yeah.

Riad Abrahams:  Yeah, so if you rewind the clock, I think back when sort of we were all initially in the business, the traditional hedge fund model was a 2 and 20 model. So, 2% management fee, a 20% incentive fee, and then the GP, the actual hedge fund manager, used that compensation to compensate all the underlying investors on the team, to pay for the research cost, to pay for the data, to pay for the offices, to pay for all of the various inputs into the investment strategy and running a complex business. Today, there's something called the pass-through fee structure, where before that incentive fee is even charged, all of the underlying costs of the hedge fund itself are passed through to the end investor. And so, those data costs, those research costs, and very, very importantly, the direct compensation for the underlying investors, for the PMs, all of that actually goes to the end investor. So, what does that all mean at the end of the day? You know a traditional hedge fund model of old, the LPGP share was probably something around 70-30. If you look at the platforms today, and you've written on this, other banks have written on it, the LP on average is keeping about 40 cents of every dollar. So, there is an enormous burden that investors now have to bear to access that traditional multi-strategy model.

Joe Dowling: But Riad, it has a fixed component and a variable component. So, when you were implying the 42, that's based on quite a high return. So, let's remember that.

Riad Abrahams: That's true. And I think in-

Kumar Panja: Or should be.

Riad Abrahams: 100%.

Joe Dowling: It is.

Riad Abrahams: If you look at it, that's for funds that are netting around a low double-digit return.

Joe Dowling: Right.

Riad Abrahams: I think what you also have to think through is because of the war for talent, some of that compensation has become semi-fixed. Because you hear about the payouts all the time, these guaranteed payouts. And so, the traditional pass-through model was 100% variable. So, it was in some ways fully aligned. Now, there is a little bit of this semi-fixed nature to it. So, you have operating leverage alongside financial leverage.

Joe Dowling: Right. But there's always been a fixed component though in terms of your trading costs and those base necessities.

Riad Abrahams: Yes. But the compensation has become-

Joe Dowling: Correct.

Riad Abrahams: Semi-fixed.

Joe Dowling: But your point is more subtle, which is when you're paying for people in the war of talent, they get to put that through the pass-through. So, it increases effectively your fixed component of the pass-through.

Riad Abrahams: Yes.

Kumar Panja: And so what will distinguish successful multi-strategy platforms in the future? Will it be this use of continued investment in technology?

Riad Abrahams: Yes, I think technology and risk management and AI. I think one of the challenges with their success and their very large footprints today is it becomes naturally harder to make sure you're doing something differently than the others. Because you're in some ways, as we were just describing, you're becoming the market, at least in terms of kind of hedge fund trading. And so those that are able to continue to evolve the way that they deploy the capital, the strategies in which they invest, and importantly, the way they use data and leverage AI, that will really, I think, allow some to separate further from the pack.

Joe Dowling: If you think about it, because of the strong demand for this type of investing and their limited capacity, what they've been able to do is lengthen up the lockups around that capital. So the logical thing for me, for them to do, is to start expanding away from purely liquid strategies into a giant TAM of what I would call semi-liquid strategies or less liquid strategies. And so that's probably what you're going to see them do as they move forward.

Kumar Panja: So there's plenty going on in this space.

Joe Dowling: Plenty of addressable market. It's going to be very interesting to see, because they're going to bring their sophisticated risk management and their incredible technology advantages to these sectors, and they will eat up a lot of alpha.

Kumar Panja: All for the benefit of investors.

Riad Abrahams: As it should be.

Kumar Panja: Excellent. Thank you. One last important question that I think our listeners want to hear about. Do you know what the theme this year will be of your holiday video?

Joe Dowling: No one ever knows except for John Gray, who actually writes the holiday video himself, which is a little known fact. And even Kumar, when they film it, and they film it in the fall, we will never know the plot until the whole movie is shown to us, because they compartmentalize everything. So when you go to do your part, they give you your two lines, but when you ask about the plot line, they say, we can't tell you. And they put together, so a lot of us will be talking, and we still can't figure out what the plot is. So we'll all find out at the same time.

Kumar Panja: Amazing. Well, we look forward to that as well. Okay, I think we're at time. That was excellent. Thank you so much, Joe and Riyad, for speaking with us today.

Riad Abrahams: Thank you.

Joe Dowling: Thank you for having us. Thanks to our listeners. Stay tuned for the next episode. In the meantime, stay well.

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