While no investor wants to see a blowup in their portfolio, not all meltdowns are created equally.
Institutional investors, the so-called smart money, have to decide whether the manager made a bad investment or a bad decision.
"What I say is most important is that we know that the managers that we're hiring are staying true to what we hired them for," said El-Hillow, the chief investment officer of $418 billion Russell Investments, which, in addition to running its own funds, invests in other managers.
It's her job, she said, to understand the exposures, leverage, and risks from any individual investment and protect against that in the broader portfolio. In other words, deciding which funds in the red deserve patience and which have lost the firm's trust.
El-Hillow spoke to Business Insider on Thursday morning, as Leopold Aschenbrenner's Situational Awareness was forced to sell the bulk of its public equity book due to margin calls. While Citadel now owns a majority of its equity positions, the fund is still planning to invest in both public and private companies, Business Insider previously reported, and kept its large position in Anthropic.
While Russell is not an investor in the fund, El-Hillow said a significant loss doesn't mean an automatic redemption, but it can be a wake-up call for some funds that believe a good idea will always win out. Structuring and risk management are just as important considerations for Russell, she said.
"Timing is often the trickiest thing with investing to get right," she said.
A variety of factors go into every market move, and idiosyncratic asset managers hoping to beat the S&P 500 take positions that can, occasionally, go against the consensus view.
"You might have so much conviction in a particular stockpicker or investor that you want access to them, but the way that they deliver their strategy is riskier, and so you've got to size it appropriately so you can stay in when they hit rough patches," she said.
Issues come when funds begin to trade irrationally because of market volatility, said El-Hillow.
"Sometimes the market does something that's not expected, and how you manage through that can be telling to an allocator as to whether you trust them and their judgment," she said in an interview at the firm's midtown Manhattan offices.
Sticking with a fund that has to make up significant losses also requires understanding the risk factors tied to the founders' incentives. Often, hedge funds earn performance fees only when they are above their high-water mark — meaning managers will not generate the more lucrative fees until they are back in the black.
It's one of the reasons Melvin Capital shuttered in 2022, after the firm sustained heavy losses during the retail-trader-led short squeeze on the manager's bet against video-game vendor GameStop. The firm's founder, Gabe Plotkin, had tried to reorganize the firm into smaller funds that would require backers to pay performance fees again, but investors pushed back against the idea.
"Are they going to be taking the right kind of risk, or are they going to be taking outsize risk in order to dig themselves out?" El-Hillow said. Monitoring staff turnover following significant losses is another data point allocators use as they diligence managers dealing with drawdowns, she added.
Ultimately, communication and transparency trump all. Russell partners with hedge funds often via a separately managed account, which allows El-Hillow and her team to see holdings and exposures in real time, rather than in a monthly or quarterly update. Choppy performance periods or any tweaks to an investment thesis should be communicated clearly and quickly.
"We've got to know what they're doing and why they're doing it so we can make a good decision on whether we need to take action," she said.
