Here's a fascinating story - hedge fund guy, Harvard, making billions, the kind of "never wrong" claims, including shorting stocks against positions in the debt of company, "can't go wrong," etc.
Money man bet wrong -- and lost $1.6b
A roiling market sinks hedge fund
By Christopher Rowland, Globe Staff | August 16, 2007
When Boston hedge fund millionaire Jeffrey B. Larson visited a classroom of economics students at his Midwestern alma mater last year, he picked up a marker and diagrammed a low-risk strategy for maximizing profits when investing in a company's stocks and bonds.
The probability "of success was exceedingly high," remembered professor Karl Egge, who taught Larson in the late 1970s and invited him back to his class at Macalester College, in St. Paul.
And at the time, Larson's investment strategy was working -- a 16 percent return from June 2005 to June 2006, nearly double what stocks returned that period. But a month ago, Larson's supposedly seaworthy $3 billion hedge fund at Sowood Capital Management LP abruptly foundered in turbulent debt markets.
His loss of $1.6 billion of investors' money is the biggest hedge fund collapse this year. Much of it occurred during a few frantic days in July, when a meltdown in the subprime mortgage market triggered a shock wave that caused the values of many debt securities, such as those held by Sowood, to drop sharply. Larson suddenly did not have enough money to repay his lenders, and he was forced to dissolve the fund. He sold off the remnants and closed Sowood on July 30.
Larson's sudden fall has left investors, colleagues, and friends wondering how a prudent Midwesterner from River Falls, Wis. (population, 14,000), -- who came East and starred as a highly paid investment manager for Harvard University until he launched Sowood three years ago -- could have miscalculated so badly.
A former Macalester classmate who stayed in touch with Larson, Minneapolis lawyer David Bolt, said he was shocked Larson's carefully-conceived investment strategy proved to be so vulnerable.
"I've always thought of him as fairly conservative. He was never a risk-taking kind of guy when we were in college," he said. After Sowood succumbed to the markets, Larson's wife, Janet, sent his friends from Macalester, where Larson also served as chairman of the college board of trustees, an e-mail seeking moral support for her husband.
Hedge funds have earned a reputation for making elaborate bets on securities as straightforward as stocks to more complicated currency and commodity trades that can earn their managers amazing sums. The most successful hedge-fund managers earned more than $1 billion in 2005, according to a survey by Alpha magazine. Average pay for the top 25 in 2005 was $323 million.
Because of the risky and sometimes opaque nature of their strategies, hedge funds are off-limits to all but the most sophisticated and well-heeled of investors -- pensions funds, for example, or families rich enough to pony up the $5 million or so entry fee typical at some shops.
Friends and colleagues said Larson, 49, never fit the stereotype of a swaggering hedge fund cowboy or reckless financial raider. A friend said he is the antithesis of the corporate villain portrayed in the 1987 movie "Wall Street."
"Not every hedge fund manager is Gordon Gekko," said one friend, Jonathon S. Jacobson, Larson's former colleague at the Harvard Management Co., which manages Harvard's endowment. Jacobson co-founded Boston investment firm Highfields Capital Management.
"Until the last six weeks, Jeff had an impeccable 25-year career," he said. "Virtually everyone I have spoken to feels horrible for Sowood's clients and employees, but most of all for Jeff. And believe me, no one feels worse about what happened than he does."
Larson has refused numerous requests for interviews and also declined to answer e-mailed questions. He has issued two brief statements in which he apologized to Sowood's investors, but otherwise has not provided a detailed explanation of its collapse.
Sowood's strategies involved exploiting differences in prices between a company's bond, notes and other loans, and its stock. He would buy these debt securities of a company in the hopes those values would rise, and then hedge that bet by short-selling its stock, which would pay off if share prices fell. That way, if he gambled wrong on the bond position, Larson would be able to recover or limit those losses if and when its stock price also fell.
Daniel Koelsch, a hedge fund specialist at Standard & Poor's, the debt-rating firm, said Sowood's investment strategy was neither uncommon on Wall Street nor excessively risky.
Rather, what did Larson in was how he funded that strategy. Like many other hedge funds, Sowood borrowed heavily to finance its investments, Koelsch and other specialists said. By making more money available to invest, such a "leverage" strategy can amplify returns for investors, yielding bigger fees for fund managers.
But in Sowood's case, Koelsch said, it appeared Larson's fundamental problem was not having enough cash or liquid assets in case his bets went wrong and his lenders, as they ultimately did, demanded their money back.
It's a difficult balancing act for hedge fund managers seeking to maximize returns, said Timothy Mungovan, an attorney in the Boston office of Nixon Peabody LLP who specializes in alternative investments, such as hedge funds.
The overreliance on leverage is an echo of 1998, when the $4 billion collapse of the hedge fund Long Term Capital Management prompted federal banking regulators to engineer an unusual rescue plan. In both Long Term Capital and Sowood, the magnitude of losses were caused by the same market phenomenon: a blizzard of bond or debt investments that are in low demand and quickly falling in value.
After graduating from Macalester in 1979, Larson worked as a trader for the agricultural commodities firm Cargill Inc., and was promoted to its London office to trade in foreign securities. There he formed ties to investment brokers who helped him make the leap in 1991 to the rarefied halls of Harvard Management Co., which invests the university's $29 billion endowment.
Working under legendary Harvard endowment manager Jack Meyer, Larson became a top manager. He consistently beat market benchmarks by wide margins and, in turn, Harvard rewarded Larson handsomely.
He made $17.4 million in 2002, putting him in the endowment's top echelon but also making him and other high-paid managers lightning rods for controversy. He was among an exodus of Harvard managers who left the firm earlier this decade amid a wave of criticism from faculty and alumni over the endowment's pay policies.
He started Sowood in 2004, with Harvard staking him to $500 million.
"People thought he must be really good, not only coming out of Harvard Management, but because he worked with one of the great talents in the field, Jack Meyer," said Gregory Curtis, chairman of Greycourt & Co. Inc., a Pittsburgh investment consulting firm for wealthy families. "He was viewed as being trained really well and that it must be a no-lose proposition."
Sowood won other prestigious clients: the Massachusetts state employees pension fund, and the Boston Foundation.
In late spring, the market for bonds and other debts issued by corporations was rocked by a crisis in subprime mortgages. As happens in routs, the market deteriorated in ways Larson failed to anticipate: investors abandoned many forms of corporate debt, not just those related to the mortgage markets, and did so without regard to the underlying fundamentals of specific companies. The careful research Larson and his managers performed to pick strong companies didn't matter once investors made a mass exodus.
As a result, Sowood's bond-related holdings plunged in value. Meanwhile, stocks that were supposed to fall -- the hedge -- didn't fall enough. The lenders who provided Larson with credit to place his heavily leveraged bets wanted their money back. Scrambling to raise money during the week of July 23, Larson could not sell his drastically devalued holdings fast enough. As demand for these holdings dropped and they declined in value, the more he had to sell to raise cash, which in turn pushed their prices down even further.
Within a week, this classic death spiral had claimed Larson's company. After a weekend of scrambling for a bailout he announced Monday morning, July 30, that he was shuttering Sowood and selling its remaining holdings to Citadel Investment Group. Harvard's endowment lost $350 million; the Massachusetts pension fund $30 million, and Boston Foundation close to $20 million.
Larson, who lives in a $2.5 million house in Wellesley, has made two carefully scripted statements since Sowood's failure, each with one overriding theme: I'm sorry.
"You entrusted us with the management of your money, and we lost a lot of it to say the least," he said in one statement, delivered during a conference call with investors Aug. 3. "No apology is sufficient, but I want you to know how profoundly sorry and deeply pained I am about what has happened." Investors listening to the call were not permitted to ask questions.
There are signs that Larson continues to work feverishly behind the scenes, meeting with investors to explain directly what went wrong, and handling inquiries from regulators. And the president of Macalester College, Brian Rosenberg, explained in a note to college staff shortly after July 30 that Larson had resigned as chairman of the school's board of trustees "in order to be able to devote his full attention to his business and personal affairs."
It was by all accounts an extremely painful decision for Larson, whose daughter Elizabeth, is a student there. Larson also gave the school $3.1 million from the Larson Family Foundation in 2005.
According to public disclosure forms, the Larson Family Foundation had about $14 million in assets before the gift. Larson invested most of the foundation's money conservatively, in mutual funds pegged to broad-based market indexes.
Christopher Rowland can be reached at crowland@globe.com. |
