| Illustrations by Michael Kirkham |
By Stephen Taub
While hedge fund managers are famous for their secrecy, the founders of King Street Capital Management have set a new standard for reticence.
The firm’s founders, Ottavio Francis Biondi Jr. and Brian Higgins, have rarely appeared in the press since they launched their global long-short credit and event-driven firm in New York in 1995. The firm, which managed $18.5 billion as of December 1, has never conducted an investor day, an increasingly common practice for hedge funds in which the founders meet with a big group of investors. And several King Street investors contacted for this story say they have never met both founders — only a few have met with even one of them. Though investors say King Street’s investor relations team — which they rate highly — has stocked the firm’s secure web site with detailed information, Biondi and Higgins prefer to communicate through their quarterly letters, which typically run just three pages.
“They don’t meet people,” says an investor in the fund who, like most investors contacted for this story, wanted to remain anonymous. “Not even investors. They believe their job is to manage assets.”
This hands-off style worked for many of the most successful managers in the hedge fund industry’s early days. But after the financial crisis of 2008 hammered returns at many big-name hedge funds and the Bernard Madoff Ponzi scheme tripped up several well-known hedge fund investors, many hedge funds — including Caxton Associates (see cover story), Millennium Capital Management and Och-Ziff Capital Management Group — acceded to their investors’ demands for greater transparency. Investors say these and other formerly tight-lipped firms are more likely now than before to meet with investors, provide more detailed information on a regular basis and even speak at industry conferences.
But King Street may find it difficult to maintain such a low profile for much longer. It just suffered its first-ever losing year — dropping 1.2 percent in 2011 — and has now delivered two straight mediocre years, having gained just 5.7 percent in 2010, well below its historical average annualized return of more than 14 percent since its inception.
This lackluster performance coincides with a period of aggressive fundraising in recent years. King Street has nearly tripled its assets under management since 2006, peaking at $19.9 billion at the end of 2010, raising questions about whether this growth spurt has hampered performance. The firm has also kept a large portion of its portfolio in cash — a savvy move in a bad year, but one that investors may question, given King Street’s 1.5 percent management fee.
“Firms that are in an asset-gathering mode generally should be watched more closely,” says one King Street investor, who is forgiving of its recent performance.
Biondi and Higgins declined numerous requests to comment for this article, as did the firm’s investor relations team.
The co-founders of King Street met in the late 1980s at First Boston and in the early 1990s were part of the group that formed the First Boston Special Situations Fund. Biondi was a member of the research team while Higgins shared responsibility for trading and investment execution.
Biondi has been the more publicly visible of the pair and even placed his wedding notice in the New York Times in 1997. He graduated magna cum laude from Yale College in 1987 and got an MBA from Harvard Business School in 1991. His wife, Jamie Nicholls, was formerly a general partner at private equity firm Forstmann Little & Co. In 2006 the couple bought a 5,600-square-foot apartment on New York’s Park Avenue listed for $21 million, according to published reports.
Higgins is said to be the more aggressive of the two partners. Those who know him describe Higgins as highly opinionated and suggest the characteristic tends to turn some people off. He is also said to be defensive about his non–Ivy League education, having received a BS in business administration and finance from Villanova University in 1987. But some say his scrappy demeanor serves him well.
“He is one of the least pretentious people,” says Bradley Alford, CIO of Alpha Capital Management, an Atlanta-based investment advisory firm that runs two alternative mutual funds, which provide access to hedge fund–like strategies with the fee structure and regulatory requirements of mutual funds. “He is a street fighter. He was not born on third base and thought he hit a triple.”
Higgins joined First Boston in 1987 in its merchant banking group, where he worked on leveraged buyouts, bridge loans and recapitalizations, before joining its high-yield desk, where he met Biondi.
Since they launched King Street, Higgins and Biondi have served as co-portfolio managers. After ceding the trading role for six years to Kieran Goodwin, in early 2010 Higgins took over as head of trading and managing the firm’s team of 24 traders after Goodwin retired.
Today King Street employs about 175 people in five offices, including London, Singapore, Tokyo and Charlottesville, Virginia. King Street has grown its assets rapidly in recent years: At the end of 2006, the firm managed $7.4 billion. Two years later that figure had shot up to $15.9 billion; it grew by another $3 billion over the next year.
King Street invests primarily in equities, bonds, foreign exchange, warrants and options across four funds. It concentrates on stressed and out-of-favor situations, value investing, shorting investment-grade and high-yield debt, capital structure trades, and special situations involving spin-offs, litigation plays or other events.
The firm’s main domestic vehicle, King Street Capital Fund, has delivered a net annualized compound return of more than 14 percent since its 1995 launch and generated double-digit returns in all but one of its first 13 years. King Street Capital Ltd., the offshore version launched in 1997, has not done quite as well, compounding at slightly less than 12 percent only because it did not benefit from the onshore fund’s first two years of strong performance. To their credit, the two funds made approximately 3.6 percent in 2008, when most hedge funds lost money. The much smaller King Street Europe funds have compounded at more than 11 percent since their July 1997 inception. They manage a little less than $1 billion combined.
In sleuthing for global long-short credit and event-driven opportunities, King Street seeks mispriced, out-of-favor, distressed and event-driven situations, including short or long investments in all major industries and asset classes. Unlike many other distressed specialists, the firm prefers to invest passively in a large number of securities rather than taking controlling positions. It is rare for the firm to sit on a creditor’s committee or control a single security of a particular company. The firm typically holds 50 to 250 of what it calls “material positions.” For long positions, the managers choose investments whose upside potential is deemed to be three times greater than their downside. King Street generally is not the first investor in a trade or the last one out. “They are not good at market timing,” explains one investor.
The firm is also more aggressively engaged in short-selling than most distressed managers. “Frank and Brian look at the world differently from other distressed managers,” says one fund-of-funds investor. “They look through a lens that is very bearish.”
This approach came in handy in 2008, as most global markets collapsed. King Street had a large short book and made a lot of money betting on the credit default swaps of individual companies they predicted would become distressed or considered prone to a negative event.
In a confidential document sent to investors, King Street has said its goal is to create a portfolio of inexpensive, optionlike positions. The firm employs three major strategies: directional long, directional short and intercapital trades, which are defined by the firm as event-driven with a near-term catalyst.
Biondi and Higgins are the sole portfolio managers. Unlike some other hedge funds, King Street does not make separate allocations of pools of capital to individual portfolio manager teams. However, investment ideas are sometimes suggested by one of the 62 people on its investment team, including 23 in trading and 37 in research.
King Street emphasizes risk management and preservation of capital. Its risk committee meets monthly, and Eric Jacobs, the director of finance and risk management, independently monitors and oversees portfolio risk. Daily, weekly and monthly risk reports are distributed to the investment team.
The firm’s risk management is obviously not all talk: King Street Capital Fund’s biggest drawdown has been just 5.35 percent, experienced from May through November 2011. Its maximum drawdown of 8.59 percent and 7.88 percent for King Street Europe LP and King Street Europe Ltd., respectively, took place from March to May 2008. What’s more, until 2011 the firm had experienced no down years and only four and five down quarters, respectively, for the King Street Capital Fund and its offshore version. Most of the funds have a one-year lockup, although one class of the European funds has a two-year lockup. The funds allow quarterly redemptions if investors give at least 65 days’ notice.
Over the past few years, King Street has been among the more cautious hedge fund firms. As recently as a year ago, it had about half its assets in cash. However, even while it was well aware of the many warning signs haunting the global economy and markets, in the first half of last year the firm started to deploy a big chunk of this capital. By the time it fired off its second-quarter letter to investors in late July, it reported having pumped an additional $2 billion into many of its existing investments as well as some new ones.
“By remaining patient and disciplined, we have taken advantage of recent negative sentiment,” wrote the two partners. King Street added to key positions it holds in the estate of Lehman Brothers, which went bankrupt in 2008, and also topped up holdings in corporate structured credit and residential mortgage-backed securities (RMBS). As a hedge, it also added to a number of bearish bets.
The firm’s domestic hedge fund was up 2.82 percent net through June and seemingly well on its way to its 17th straight profitable year since its inception. Like many investors last year, however, King Street was caught off guard by the global sell-off in the third quarter and by what it later conceded was a level of uncertainty and volatility in the market not seen since late 2008.
“Favorable market liquidity, strong capital markets and fading systemic concerns that defined the first half of 2011 gave way to fears of heightened European sovereign risks, slower economic growth and potential bank contagion globally,” the firm’s co-founders told clients in the third-quarter letter, dated October 28, adding that sentiment worsened dramatically as the quarter progressed. They noted that a severe crisis in market confidence sent yields on Italian and Spanish government bonds soaring, demonstrating that the European debt crisis was no longer confined to the euro zone’s periphery (Greece, Ireland and Portugal) and causing the S&P 500 to fall 14.3 percent and the Euro Stoxx 50 to plunge 23.5 percent.
This time, the global sell-off impacted even King Street, whose flagship fund lost a net 2.82 percent, only its fifth quarterly loss in its history, putting the fund slightly in the red for the year. Most of the losses — nearly 4 percentage points — came from positions in collateralized synthetic obligations and collateralized loan obligations.
“The implicit leverage embedded in these structures makes them vulnerable to market volatility,” the partners said in their letter. The CSOs and CLOs suffered steep losses as credit spreads widened.
The firm also racked up losses from Lehman’s debt, especially holding company bonds, which the partners said declined “in sympathy” with the broader markets.
In retrospect, King Street may have been too hasty in putting that $2 billion to work earlier in the year. The firm’s co-founders told investors that it was harder to make money last year than in 2008 because it was difficult to hedge their book and the CDS they racked up in 2008 were much more expensive in 2011. “Markets are likely to remain characterized by high levels of uncertainty as we move into year-end and the start of 2012,” they wrote.
King Street also missed the sharp rally in the global equity markets late last year. Still, Biondi and Higgins were confident in their positions. In the third-quarter letter they reported that King Street was still positioned for a highly volatile market heavily sensitive to headline risk from European policymakers. They observed that any resolution will be complicated by politics and conflicting goals among the many participants and that any implementation of various proposals will be a long, drawn-out affair.
The partners were also optimistic about the firm’s Lehman holdings thanks to several positive developments in the third quarter, including settlements of certain claims. They expressed confidence that Lehman’s reorganization plan would be approved by the beginning of 2012. “Other parts of the Lehman capital structure proved more resilient,” they added in the letter, noting that King Street’s positions in the trade claims of the U.S. and UK broker-dealers continued to be aggressively bid throughout the quarter.
For its part, King Street believes that its long portfolio is positioned properly — in bankruptcy liquidations, corporate structured credit, mortgage structured credit and financial hybrids, according to the letter. On the long side, Biondi and Higgins wrote, the firm was looking to take advantage of the market’s sell-off in the third quarter to buy several large single-name corporate distressed situations, but they did not name companies.
“On the short side, the opportunity set of companies vulnerable to cyclical and secular trends is likely to grow in the face of sluggish economic growth,” they added.
“I like how they are positioned,” says a fund-of-funds manager with an investment with King Street. “Barring a complete meltdown in Europe, they should do well [in 2012]. They still have a lot of firepower with their cash.”
The big question, of course, is whether King Street will be able to deliver the double-digit gains the firm has come to be known for. Investors are mindful that it may be more than a coincidence that returns have sagged after King Street’s assets grew exponentially. In fact, at least one investor asked Biondi and Higgins to return $2 billion to investors since so much of the firm’s assets are sitting in cash. (The principals said no.)
But so far, investors are forgiving. “For their type of strategy, big is not an issue,” says Alford. “It is a positive.”
“They are one of our stronger funds,” notes Jason Goeller, who is responsible for hedge fund investments at the Public Employees Retirement Association of New Mexico. “We’re very happy with them.”
Still, how King Street fares in 2012 could determine whether investors finally lose patience with its lack of communication — not to mention its large stash of cash. Says one prominent hedge fund manager: “When they stop making money and assets go from $20 billion to $15 billion, they will be out there meeting investors so fast.” AR