SAC has a reverse Midas touch with spin-offs
BOSTON/NEW YORK (Reuters) - If you are starting a hedge fund, the easiest way to gain an edge is to secure an initial investment from an industry superstar who is also your former boss.
Money from Julian Robertson, George Soros or even Harvard Management has long been considered a seal of approval that can make pension funds and endowments take notice of a newcomer. And many such funds, from Lone Pine Capital to Blue Ridge Capital to Highfields Capital, have gone on to greatness, doing their forebears proud.
But when it comes to spin-offs, Steven A. Cohen's SAC Capital Advisors has produced a surprisingly consistent string of duds.
Funding from Cohen, who oversees $12.9 billion, is particularly rare, bestowed on only a few of the hundreds of traders and portfolio managers who have worked for the billionaire investor over his firm's 17-year lifespan.
As selective as Cohen has been, many of the portfolio managers who have spun out of SAC with a financial boost from their old employer over the past half-dozen years have either shut down completely or have seen so much money leave that they stopped reporting their data to would-be investors, industry analysts and investors said.
"You would think that the records of people who spin out of SAC should be better," said one investor who has money with one of the firm's spin-offs and has watched the progress of many others.
"These people worked for one of the world's most consistently profitable hedge funds, and when some of them flop it makes you wonder what happened," said the investor, who asked not to be named because the investments are private.
Although no statistics exist, some investors and industry consultants say SAC spinouts fail more often than those of other big firms.
THE SAC WAY
Why do so many former top SAC traders have such a hard time replicating their feats after striking out on their own? One possible answer, according to these industry analysts and investors, is the way Cohen runs the firm.
"The biggest difference between spinning out of SAC and some of the other big hedge funds probably is that at SAC you were paid to be a top-notch trader and you didn't learn how to set up a business," said a person who asked not to be named because he is currently considering putting money with some SAC spin-offs.
Another potential explanation is that without a big supporting cast of analysts and assistant traders around them, a one-time star trader at SAC can look a lot more ordinary if he has to research stocks himself. But that would seem to apply to the progeny of other big firms as well.
The most recent example of a Cohen disciple falling down is Forrest Fontana, who left Cohen's Stamford, Connecticut-based SAC to set up his own firm in 2005.
Initial buzz about Fontana Capital, which invests mainly in financial stocks, was strong. Boasting a business degree from Columbia University, stints at Boston-based mutual fund giants Putnam Investments and Fidelity Investments, and a $50 million initial investment from Cohen, Fontana quickly saw his new firm grow to $325 million by November 2006.
But sometime in 2007, Cohen pulled out SAC's money. And by March 1, 2009, Fontana's fund's assets had shrunk to $16.1 million, despite losing only 7.69 percent last year, far less than the Standard & Poor's Financials Index 57 percent loss.
Fontana told his neighbors in March that he managed his own "successful investment" firm when he campaigned for and won a seat as selectman in Winchester, a wealthy suburb north of Boston. At the same time, Fontana abruptly stopped sending his performance reports to potential investors, several said, sparking talk that Fontana Capital was going out of business, with Fontana himself possibly returning to SAC.
Late last month, Fontana was still at work in a corner of his fund firm's largely empty office in Boston's financial district. He declined to answer questions about the firm's or his own professional future.
A succession of people who worked for Julian Robertson and then received money from him to build their own businesses now rank among the world's most prominent hedge fund firms: Andreas Halvorsen's Viking Global Investors, Steven Mandel's Lone Pine Capital and Lee Ainslie's Maverick Capital.
Stanley Druckenmiller, a key player in George Soros' famous bet against the British pound that earned him $1 billion, now runs his own successful fund, Duquesne Capital Management.
Richard Perry, a protege of former Treasury Secretary and Goldman Sachs executive Robert Rubin, and Paul Leff, a former Harvard Management Co executive, co-founded still thriving Perry Capital.
And Jack Meyer, who helped quadruple Harvard's endowment in 15 years as head of the university's investment arm, continued to manage money for the school when he set up Convexity Capital Management, the biggest new hedge fund ever, launched with $6 billion.
Pedigree, however, does not always guarantee long-term success. Jeff Larson, who had worked for Meyer at Harvard and counted the university as his principal investor when he launched Sowood Capital, sunk the $3 billion fund in 2007. The fund's collapse still ranks among the industry's biggest, even though it did not set off industrywide panic.
Starting a new fund under any circumstances is far from easy. Hundreds of hedge fund managers who quit Wall Street banks' trading desks, Connecticut-based hedge funds or even Boston-based mutual funds with high hopes for success ended up failing, according to data from Hedge Fund Research. The data show 858 funds liquidated in the first three quarters of this year after 1,471 funds shut down during 2008.
It's also true that some of the SAC alumni have done very well on their own, although they tend to be the ones who did not get funding from SAC. Healthcor, a healthcare industry focused fund, had raised $3.2 billion by June 2009 since launching four years ago. The fund returned 25 percent in 2006, 18 percent in 2007, and was up 4 percent last year, when the average hedge fund lost 19 percent. In the first 10 months of 2009, Healthcor was up 7 percent.
Healthcor, founded by Arthur Cohen and Joseph Healey, opened without any financial support from SAC. In fact, soon after Cohen and Healey struck out on their own, SAC sued the pair, accusing them of breaching their employment contracts. The matter ultimately was settled. (Healthcor's Cohen is not related to SAC's Cohen).
The story of Stratix Asset Management, launched in 2004 by SAC alumni Richard Grodin and Ian Goodman, is fairly typical of what happens to SAC spawn -- after a strong start, the fund began to falter.
Grodin and Goodman opened shop as a telecommunications and technology focused fund in March 2004, with a $60 million investment from SAC.
But the fund wasn't in business long. When it closed in 2007, Total Alternatives, a trade publication, reported that Stratix had $530 million under management and had returned 17 percent for investors that year.
Since then, Grodin and Goodman have gone their separate ways, with each opening new, much smaller funds -- neither of which got any money from SAC. Goodman's latest fund is GCore Capital. Grodin's latest offering, Quadrum Capital, shut down this summer, around the same time federal authorities asked the fund to provide information in connection with the Galleon insider-trading investigation, according to a person familiar with Quadrum.
The SAC sprout Steven Cohen may be best known for helping to get off the ground is also the one with the most spectacular flameout. Prentice Capital, a fund started in May 2005 by former SAC manager Michael Zimmerman with an initial $400 million investment from SAC, prospered for a while by placing big, often illiquid bets on consumer and retail stocks. And for a time the fund did quite well.
But last year Prentice fell on hard times as the financial crisis began to take a toll on the consumer sector. One big investment the fund made that went sour was KB Toys, which went out of business in 2008. The hedge fund froze redemptions and began returning money to investors -- a process that is nearly complete, say people familiar with Prentice.
In October, Zimmerman relaunched Prentice with a new long/short fund that has raised a little more than $100 million. The new fund, which SAC has not invested in, will also focus mainly on consumer stocks.
Even some firms that were not aided by Cohen directly but cultivated their skills at his shop seem unable to deliver the consistent long-term results for which he is known.
Cedar Hill Capital Partners, founded by SAC alumnus Emil Woods and Charles Cascarilla, delighted investors with a 198 percent gain in 2007. In 2008, when the average hedge fund lost 19 percent and SAC suffered its first annual loss, Cedar Hill was up 85 percent. People familiar with their strategy said the team delivered its returns by betting against the subprime market, a smart call.
This year, their returns have been awful. One person familiar with the fund said the pair was down 42 percent by midyear. Then Cedar Hill, like Fontana Capital, stopped sending its performance numbers to potential investors.
"So many of the ex-SAC people seem to have this model where they attract you with fantastic returns in the first year but in year two or three or four you get annihilated," said a person who is familiar with several former SAC employees' records.
Will the latest SAC spawn buck the trend?
These are the two to watch: Dorsal Capital Management, a California hedge fund launched this year by SAC alumni Ryan Frick and Oliver Evans, secured money from Cohen recently. And in October, SAC sunk some cash into London-based RWC Partners, where former SAC trader Mike Corcell is selecting large U.S. stocks.
(Reporting by Svea Herbst-Bayliss and Matthew Goldstein; editing by Jim Impoco and Claudia Parsons)