Many former mutual-fund stars who jumped to the long-short league have
BUSINESS WEEK SEPTEMBER 17, 2001
FINANCE
Hedge-Fund Follies
Many former mutual-fund stars who jumped to the long-short league have
`The tech sector is going straight up." These fateful words marked both the beginning and the end of Craig Ellis' brief stint as a hedge-fund manager. The day was June 26, 2000, and Ellis was rattling off stock picks for CNNfn's Talking Stocks broadcast. It was also day one of his Madison Avenue hedge-fund firm, Safari Capital Management. Ellis was banking his future on past accomplishments, namely a 168% return in 1999 for the Orbitex Info-Tech & Communications Fund. He had a short list of must-have stocks, all but one of which were losers by December--as was Ellis' new venture. Today, Ellis is living in his fixer-upper home in South Hampton, N.Y., on Long Island, and he's unemployed. "I tried, and I didn't do well," he says. Now, "I'm a plumber and a carpenter."
Ellis is one of a slew of hotshot mutual-fund managers who have sought their fortunes in the $500 billion hedge-fund business. Lured by the prospect of earning a typical annual management fee of about 1% of assets and a heady 20% of profits--translating to salaries in the millions, rather than hundreds of thousands--many abandoned the security of large fund shops to strike out on their own. But the odds in favor of a new hedge fund hitting it big are slim. "Half of them that survive the first six months are dead two years later," says Stephen J. Brown, a professor at New York University's Stern School of Business. With mutual-fund managers turned hedge-fund managers, the chances of success are even slimmer. "These former mutual-fund managers tend to fall in love with their positions and stay too long on the down side," says Charles J. Gradante, managing principal of Hennessee Hedge Fund Advisory Group. "More than half end up failing."
Hedge funds, which tend to carry six-figure minimums, cater to wealthy and institutional investors and try to make money in both bull and bear markets. It doesn't matter which way the stock market is headed because hedge-fund managers have the flexibility to employ strategies, such as buying put options and selling short, that pay off when a stock's price falls. They also use leverage, or borrow money, to boost returns, or make concentrated bets on a single stock--all risky tricks of the trade that standard-issue mutual-fund managers are neither trained nor allowed to do. "The mental set that allows you to be short, and the conviction to get your portfolio closer to market-neutral or even net-short, is very, very difficult," says Robert I. Schulman, president of Tremont Advisors Inc., a hedge-fund consulting firm. The CSFB Tremont Hedge Fund Index is up 2.1% as of July 31 (the most current date available), vs. an 8.1% loss in the average equity mutual fund and an 8.3% decline in the Standard & Poor's 500-stock index.
There are no hard numbers on how many mutual-fund managers shifted to running hedge funds--or how many of those funds have folded. The industry is unregulated, and players shroud themselves and some 8,000-plus funds in secrecy. Advertising is against the law, and returns are not public information. One thing, though, is for certain: New money from investors seeking refuge from the falling stock market has been rushing in--some $8.4 billion in the second quarter alone. That's more than in all of 2000, according to TASS Research Inc., a unit of Tremont. The rush has attracted more newcomer funds, which now outnumber top-notch talent.
Even industry veterans have failed to brave the market storms. Since the Long-Term Capital Management bust in 1998, Julian Robertson of Tiger Management--once the world's largest hedge group at $22 billion--shut down in March 2000 after investors fled his poorly performing funds. George Soros was forced to liquidate most of his Quantum Fund to meet redemptions, and Jeffrey N. Vinik, a former Fidelity Magellan manager, also quit, returning $4.2 billion to clients. And former mutual-fund managers who have decent track records with hedge funds have hit the skids, too. Ken Londoner spent a dozen years in retail funds with J. & W. Seligman & Co. and State Street Research Investment Services Inc. before starting Red Coat Asset Management, a New York-based hedge fund. The $375 million fund earned a compounded annual return rate of 29% for three years, until 2000: The startup was a near-casualty by concentrating on too few media and telecom positions. Losses wiped out 75% of the fund's assets.
Many of the newest hedge-fund managers got into the game at the height of their mutual-fund careers--and the bull market. Emmy Sobieski and Aaron Harris--former co-managers of the Nicholas-Applegate Global Technology Fund, up 494% in 1999--both left to run separate hedge funds last year. Sobieski joined Palantir Capital Management in New York, while Harris hooked up with NationsBank's asset management arm, Villanova Capital. Harris, who concedes he'll "never look as smart as I did" in 1999 has managed the new $10 million Villanova Global Tech Long-Short Fund for three months. Spending about 30% of his time picking stocks and the rest managing his risk, he says: "I'm learning."
OUT OF THE NEST. But not all newcomers have the backing of a financial powerhouse, and so they're disappearing from sight. "Their phone is disconnected or they've got some horrible story to tell you," says Jeffrey F. Kuchta, chairman of Chicago's Hedge Advisors Inc., which invests only in hedge funds with five-year track records and $100 million under management. In 1998, James "Chip" Otness left J.P. Morgan Chase & Co. to launch his own hedge-fund firm, Dolphin Asset Management. The startup failed, and he's back managing mutual funds for someone else--Goldman, Sachs & Co. Another superstar, Erin Sullivan, whose $17 billion Fidelity Aggressive Growth Fund earned a 103% return in 1999, may have fallen off the map, too. Sullivan, who launched Spheric Capital Management in Boston, would not return phone calls for this article. "Erin won't speak to anyone," says Michael Ocrant, editor-in-chief of MAR Hedge Fund Report, who adds that she declined to speak at an industry conference last year. "She's having a real tough year," says James H. Lowell, editor of Fidelity Investors' newsletter, who has contact with her investors. "I would assume by now a lot of these managers are having to go begging for money."
The mutual-fund managers who are likely to attract big money are those who align with pedigree hedge-fund names. David Felman, former partner of the $7 billion Fidelity Mid-Cap Stock Fund, recently joined Daniel C. Benton, former partner of the renowned Pequot Capital Management. Benton's new Andor Capital Management will launch a fund on Oct. 1 with about $10 billion, sources say. Grady Durham, president of Denver's Monticello Associates, which advises on $30 billion, doesn't invest in startups. But he's watching this one closely: "The best of breed usually comes out of the blue-chip [hedge-fund] shops," he says. "They don't come out of any mutual-fund company."
Others agree. Capital Z Partners LLC not only invests in hedge funds, but also takes a stake in the fund's management company, if it spots potential. Partner Sharissa Y. Jones has interviewed 500 startup hedge-fund managers in the last year, some of whom came from mutual funds, but only five made her cut to receive up to $55 million in seed money.
With the markets treading water and a rush of cash continuing into hedge funds, buy-and-hold mutual-fund managers' hands are tied. Their exodus, therefore, is likely to continue, even though they face the high risk of failure.
By Mara Der Hovanesian in New York
Source: businessweek.com
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