Jones Concedes Errors With Bacon & Griffin in Strategy Shakeout
By Katherine Burton and Saijel Kishan
Dec. 12 (Bloomberg) -- In the close-knit hedge fund community, where confessions of a mistake are rare, billionaires Louis Bacon, Kenneth Griffin and Paul Tudor Jones are retreating from borrowed-money bets, private equity and emerging market debt and championing more transparent stocks, bonds and currencies.
The three trading prodigies, who have earned annualized returns of more than 20 percent in careers of two decades or more, say they aren’t about to lose the cachet that prevented them from ever being compared to ordinary investors.
“We had become disheartened by the complexity of our portfolio given our results and took decisive steps to change our format,” Bacon wrote in a Dec. 3 letter to investors in his New York-based Moore Capital Management LLC. His main fund fell 2.9 percent this year through November.
While record redemptions have helped shrink hedge funds by an estimated 45 percent to $1.1 trillion in the worst year for the industry since 1990, Jones, 54, insists in a Nov. 28 letter to clients that his change of tactics is a necessary adjustment to a period when the leveraged betting is no longer viable.
“Those of you who have visited recently have heard me refer to this return to our roots as back to the future,” he wrote, referring to the macro style of trading stock indexes, bonds, currencies and commodities that he relied on when he began Greenwich, Connecticut-based Tudor Investment Corp. in 1984 at the age of 30. Since starting the BVI Global Fund two years later, he’s more than doubled the average annual return of the Standard & Poor’s 500 Index.
Industry Reset
The $10 billion fund dropped 12 percent between June 30 and the end of November, its worst losing streak since 1992.
“Managers got away from their core expertise as they got bigger and had to put the money to work,” said Brad Balter, whose Boston-based Balter Capital Management LLC invests in hedge funds. “The industry lost its way, and this is a reset.”
It’s a comedown for a business that had enjoyed almost unchecked growth and whose fees -- usually 2 percent of assets under management and 20 percent of investment gains -- were the envy of Wall Street. Investor withdrawals may reach as much as $400 billion this year, according to estimates by Morgan Stanley analyst Huw van Steenis in London. At least 20 percent of the 3,100 hedge-fund firms operating at the end of June, when assets were $1.9 trillion, may shutter by year-end.
“What happened in the early part of this decade is that people looked at ‘2 and 20’ and said, ‘That looks good,’ ” said Richard Sylla, an economic and financial historian at New York University’s Leonard N. Stern School of Business in New York. “Now that bubble is bursting. The industry isn’t dying, but it will take half a decade to recover.”
Fewer Managers
Bacon, 52, has stopped making private-equity investments and is pulling money from most of the external managers that he used to help run his $9 billion Moore Global Investments fund. The fund, like Jones’s, started in 1990 as a macro fund.
He now has concentrated his equity investments among a smaller number of in-house stock-pickers with proven records of generating a return when prices fall or rise, and put more money with his macro traders.
“The combination of a streamlined and liquid portfolio, high cash balances and mostly macro-oriented managers has allowed us to focus on the opportunities in a macro period that is going to continue to be of historic proportions,” Bacon said in his letter. The fund is facing client withdrawals of about 8 percent of assets at year-end. Since the fund started in 1990, it’s produced an average annual return of about 21 percent.
Griffin’s Worst Year
Griffin’s main Wellington hedge fund, which started in 1990 trading convertible bonds, and Kensington fund that began five years later, are cutting several strategies, including investments in power plants, reinsurance and Asian and European companies going through corporate events such as mergers. The funds, which together manage about $10 billion, have fallen 47 percent this year, the worst for Griffin, 40, and his Chicago- based Citadel Investment Group LLC.
The biggest reason clients are abandoning the industry is the investment losses they’ve endured, even though hedge funds fell an average 18 percent this year through November, less than half the decline of the S&P 500, according to data compiled by Hedge Fund Research Inc. of Chicago. Many investors expected the funds to increase their wealth and preserve capital in tough times. Those benefits were worth the higher fees than mutual funds and their commitment to keep money invested for a year or more.
That’s changing.
Not Worth It
Brad Alford, who runs investment-advisory firm Alpha Capital Management LLC in Atlanta, has clients who came to him with all their assets in hedge funds. He’s cutting their holdings by half.
“The illiquidity, the high fees, the gates and side- pockets -- they just aren’t worth it for this type of returns,” said Alford, who’s now steering cash to long-short mutual funds, which both buy and bet against stocks.
Endowments and foundations have pulled out of hedge funds because they needed cash for day-to-day operations or to meet commitments for capital from private-equity firms. Others are trimming holdings because hedge funds had become a larger-than- targeted percentage of their assets as stocks, bonds and other investments plunged even farther.
Putting Up Gates
This year’s net withdrawals from hedge funds will be the first since 1994, when $1 billion left the then $167 billion industry.
To deal with client defections, some managers have opted to suspend or limit redemptions, marking the first time in history that so many funds have put up gates, as the process is called.
As of October, 18 percent of hedge-fund assets -- managed by 5 percent of hedge funds -- were subject to some sort of restriction on withdrawals, according to Peter Douglas, principal of Singapore-based hedge-fund consulting firm GFIA Pte.
“It’s the very large funds who are alienating investors,” Douglas said.
Tudor’s Jones suspended withdrawals from BVI Global after clients asked to redeem 14 percent of assets. The fund plans to put its illiquid assets into a separate fund that will be sold off over time. The $36 billion D.E. Shaw & Co. LP and the $30 billion Farallon Capital Management LLC have also limited redemptions.
Markets Impose Change
In their own back-to-the-future move, clients are using the turmoil to wrest power from managers, who had been raising fees and extending lock-ups as cash piled into the funds.
Sandra Manzke, who runs MAXAM Capital Management LLC, a fund of funds in Darien, Connecticut, is rallying investors to create the Hedge Fund Investor United Forum. She sent a letter to hedge fund managers last week railing against such practices as charging fees on portfolios they are liquidating, and freezing redemptions for unlimited periods.
“Going forward, the opinion of the Investor Forum is that new investment will not be made in funds which allow these type of actions,” Manzke wrote. She has been investing in hedge funds since 1985, when there were just 68 managers from whom to choose.
The beneficiaries of this year’s unrest are the managers with the best long-term records as well as new funds concentrating on distressed investments such as bank loans and convertible bonds, whose prices tumbled as investors dumped securities.
Death & Birth
“We haven’t been scared off from investing in hedge funds,” said Patrick O’Connor, chief investment officer of the $600 million University of Arizona Endowment, which has about 15 percent of its assets in hedge funds. “The current market dislocations aren’t permanent and so we see this as a good time to take advantage of the opportunities out there.”
Funds are forming to meet this demand. The hedge fund brokerage unit at Zurich-based UBS AG reported that at least 10 funds are starting to take advantage of the plunge in convertible bonds, which tumbled by 33 percent since the end of August, according to data compiled by Merrill Lynch & Co.
To attract client money, some of the new funds lowered their fees. The $55 million Artradis Asian Convertible Bond Fund is charging investors just 1 percent of assets and a 15 percent performance fee.
More hedge fund executives will try going it alone this year, since funds that have lost big won’t be able to charge performance fees on investment gains -- or pay big bonuses -- until they recoup their losses. A fund that has dropped 25 percent this year, for example, won’t collect fees again until it has returned 33 percent.
“The prospect of a year or two scrabbling back to high- water marks and therefore performance bonuses will lessen the ties of many investment people to their current firms,” said Douglas of hedge-fund consultant GFIA.
Even though these new managers may only start out with a relatively small amount of assets, if they do well, they will attract more money, and in time, the hedge fund bubble will re-inflate again, said Douglas.
To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net
Last Updated: December 12, 2008 00:01 EST |
