ENRON-- John Green - Marshall Capital-- The Profitable Stock trading hedge Fund that Enron had as one of their myriad profit centers.
I had dinner with John Green last night, he has an interesting approach for the focus of his hedge fund. Half of the fund will be a bottom's up fundamentally driven approach that will focus on the Oil service sector equities, which have a tremendous cyclical aspect to their price performance over a 3 and 5 year time period.
This is seen in the tremendous bull market the OSX (oil service sector) stocks had during 1995, 1996 and going into Q3 of 1997. The stocks, as well as the underlying driver of Crude prices itself, then fell in a major way into Q1 of 1999. We then saw another major advance into Q 3 of 2000 and another big plunge in the following 4 Quarters. In the value half of the fund he'll be taking long positions in companies selling at better valuation metrics and short companies where valuations have gotten too high. That was a significant part of the focus at Enron.
The other half of the fund will focus on implied volatility options strategies and look for volatility mismatches, which can then be arbitraged.
A good example of that is the Options in the OSX index itself. These OSX index options often have a lower implied volatility than the implied volatility of the component stocks, such as SII, SLB, WFT.
OSX components and weightings.....
phlx.com
So the idea is to go long volatility of underlying OSX index options, while shorting volatility of the component stocks. This is done with weightings to create a delta neutral exposure.
Both the OSX index options and the component equities have a volatility range over time, similar to the VIX. When the VIX reached 57 on October 8th of 1998 and Sept 21 of 2001, it was time to put on long equity positions. When the VIX has hit 17-18 in the past 5 years, it's been time to be net short stocks and also buying option volatility.
This same type of broader range trading consideration applies to The Oil Service sector, OSX Equities, Equity options and Index options.
Volatility mismatches should also diminish as time premium decays the Volality disparity as the options get closer to expiration. Maximum Time premium decays during the last 45
days of an options life.
There are a range of options strategies, he's planning on using. I just wanted to give one example that is hopefully not as complex as some vertical and horizontal calendar spreads and straddles and strangles etc. Also what is compelling about this stategy is that it's not being focused on and exploited to the degree that man other strategic options focuses are. You usually can get better trades in a market that is not as heavily watched and observed. That's a great point that was raised by Hedge Fund Manager Bruce Kovnar in the first "Market Wizards" book. Kovnar explained that there are usually better foreign exchange cross rate trading opportunities than in straight dollar directional trades due to more market focus on the later trades.
Back to Marshall Capital, Green is looking to make a very reasonably 15% to maybe 20% return a year and very interesting point John made was that this type of fund focus is very uncorrelated to other assets classes and thus an asset manager can put money to work with Marshall Capital and broader his exposure diversification profile, while at the same time looking to get a very nice rate of return.
With the negative returns in equities over the past 3 years,
and with the 10 year Treasury note now on a Monthly Sell Signal, thus suggesting minimal and possibly negative bond returns over the next year or two. Investors and Asset managers are increasingly scanning their universe for positive investment performance and also for asset exposure that has as little correlation as possible to the other major asset classes.
Here's the article.....
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QUESTIONING THE BOOKS
FROM THE ARCHIVES: April 11, 2002
Enron Quietly Ran Risky Hedge Fund
That Turned Over Millions in Trades
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
In the wake of Enron Corp.'s collapse, more than one critic has said the firm looked more like a Wall Street trader than an energy company.
Turns out, those people were at least partly right.
In the months before Enron filed for bankruptcy-court protection late last year, the company had been quietly trading tens of millions of dollars in stocks through an internal hedge fund -- among the riskiest forms of financial trading.
According to former Enron executives who helped manage the hedge fund, called ECT Investments, the Houston-based group was trading about $145 million of Enron's money before the company filed for bankruptcy protection in December -- all under the radar screen of most Enron stockholders.
The size of the internal trading operation underscores once again how far Enron had strayed from its roots as an energy provider and trader -- into unproven, and often risky, business territory.
Hedge funds are loosely regulated investment vehicles that can take risks by using leverage, or borrowed money, to boost returns. Like most hedge funds, ECT used borrowed money to boost the size of its investments, at times increasing the company's exposure to almost $600 million.
The hedge fund, the brainchild of Enron's former chief executive officer, Jeffrey Skilling, did quite well, averaging annual returns of more than 20% after it was launched in 1996, according to former members of the group. In that period, the Dow Jones Industrial Average had returns of 11%. The hedge fund's gains amounted to as much as 8% of Enron's overall earnings in recent years, according to these people.
Enron, of course, isn't the first company to use investments and hedging to buff up its balance sheet. Many companies, from banks to technology giants such as Microsoft Corp., invest in start-ups or even established businesses, often in their own field.
Enron, too, had long been an active investor in a range of companies, usually within the energy and telecom industries. The hedge-fund business was different, though, because it actively traded stocks, and used plentiful leverage to amplify the returns. And Enron was buying stocks that often were far afield from its core energy business.
While ECT was known among some in the hedge fund world, it clearly wasn't well understood by many Enron investors. "They didn't hide it, but there was not a lot of financial disclosure about the hedge-fund group," says Jeff Dieter, an analyst at Simmons & Co., an investment bank in Houston. "There was not a lot of difference between the Enron group and other hedge funds."
ECT INVESTMENTS
Enron's hedge fund
Base: Houston
Number of employees: 25
Size of porftolio: Up to $600 million, including leverage
Some stocks traded: Microsoft, Sun Microsystems, Cisco Systems, Sycamore Networks
Average return: Just over 20%
Sources: former ECT employees; other hedge funds
Although the hedge-fund trading was unorthodox and risky for an energy company such as Enron, ECT seemed to be working. Enron's hedge fund scored substantial gains on big bets on energy, technology, telecom and even bank stocks. In fact, about 40% of ECT's trades were outside the energy business, in stocks such as Microsoft and Sun Microsystems Inc., according to people who worked there.
For its part, Enron disputes the notion that the hedge-fund investments were a stretch for the company, saying that most of the trading at ECT was in companies that had some connection with the energy industry. "Their technology typically had something to do with energy," says Eric Thode, a spokesman for Enron. Enron executives declined to comment further on the group.
Former Enron officials say the hedge-fund operation -- which grew to include 20 traders in Houston and another five in London -- was launched in April 1996, after Enron made investments in utility, energy and telecom companies, as part of a push to expand its business.
Enron executives were looking for a way to hedge Enron's exposure to these companies. Mr. Skilling came up with the hedge-fund idea in the hope that expertise developed in the unit could later be applied to other Enron businesses as well, according to people familiar with the matter.
But ECT's mandate from Mr. Skilling also was to take aggressive positions in various stocks to make as much money as possible. The original goal, initially backed by about $25 million in capital, was to profit by actively trading utility and telecom stocks, to take advantage of the deregulation in those industries.
"They loved having the internal expertise we developed, but they also loved the money we were making," says a senior trader at ECT. Mr. Skilling couldn't be reached for comment.
From the start, ECT was set up as an autonomous trading unit, though later it became a subsidiary of Enron Capital & Trade Resources, Enron's trading and financing arm.
"Skilling would come by to see what's going on, and get our view of the market, but he wasn't involved much day to day," says John Green, who ran trading at ECT.
Within three years of its launch, the group was hugely successful. After receiving an additional $15 million in capital, the hedge-fund unit doubled its money in 1999, generating profits of about $50 million, according to people who were at ECT. That money flowed into other Enron business units as profit, but wasn't broken out separately in Enron's financial statements, analysts say.
"We were one of the most profitable groups, in terms of return on investment, within Enron," says Patrick Lewis, who managed ECT's tech and telecom portfolio.
As the stock market tumbled, and Enron shares themselves weakened, ECT continued to score by buying stocks it viewed as undervalued, and by selling short -- or borrowing and selling to bet on a fall in price -- those seen as overvalued, often in the same industry. In the last year, for instance, the unit bought shares of Cisco Systems Inc. while shorting Sycamore Networks Inc. and other, smaller competitors, one former trader says. Cisco shares fell 53% last year, but Sycamore dropped 86%, making such a trade a success.
With the hedge-fund racking up winnings, members of ECT began pushing senior Enron executives to expand the hedge fund by accepting money from outside investors, such as pension plans, which traditionally invest in hedge funds.
But the executives refused, because they didn't want to share the huge gains, according to one person close to the situation. The executives also were worried that Enron's image might suffer if it emerged that the company was running a large hedge fund, according to people who worked at the company.
Traders say the ECT portfolio was structured to limit its one-day loss to $10 million, a limit that was never reached. Still, some experts say it was inappropriate for a company to be running a hedge fund, given the losses that were possible.
"It just doesn't make a lot of sense" for a company to set up an internal hedge fund, because if it runs into losses "it can come back to bite you, and shareholders are left holding the bag," says Patrick S. McGurn, a vice president at Institutional Shareholder Services, a proxy-advisory firm in Rockville, Md.
Now, the Enron hedge-fund traders and stock pickers are being courted by some of the best hedge funds on Wall Street, even as other Enron employees find their reputations tainted.
Mike Bradley, head portfolio manager at ECT, and Eric Scott, an analyst, have joined Catequil Asset Management, a hedge fund run by two former executives of Tiger Asset Management. Michael Towarek, a senior ECT trader, now works for Goldman Sachs Group Inc. in London. Mr. Lewis, the tech and telecom specialist, is now at Carlson Capital LP, a big Dallas hedge fund. Mr. Green, the head of trading, has begun his own hedge fund, Marshall Capital LP in Houston.
"The Enron hedge fund had a reputation for hiring good, smart people," says Jacob Navon, managing director at Warren International Inc., an executive-search firm specializing in investment-management firms. "There certainly have been some bad apples at Enron, but that shouldn't taint thousands of employees."
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com2 |
