| Illustration by Renaud Vigor. |
When Deimos Asset Management announced in September that it would close its doors, co-founder Loren Katzovitz blamed the small hedge fund firm’s shutdown on a “challenging” fundraising environment coupled with the high cost of doing business. While not false, that statement doesn’t do justice to the complexities encountered by the firm and its founders as they navigated the hedge fund start-up world.
The fund had original backing from prestigious Guggenheim Partners, an anchor investment from the highly regarded Ontario Teachers’ Pension Plan, and a slew of portfolio managers with experience at such big names as SAC Capital Advisors and Citadel. But despite this gold-plated backing, Deimos failed to make further inroads with institutional capital, say former employees.
The demise of Deimos shows that big backers, stringent risk management, known talent, and a fee structure investors love aren’t necessarily a recipe for success these days. Indeed, ticking what seemed like the right boxes likely contributed to Deimos’s failure.
Katzovitz and co-founder Patrick Hughes, who had run a fund-of-funds business at Guggenheim between 2002 and 2010, persuaded the financial behemoth to finance an internal hedge fund called Guggenheim Global Trading (GGT), which launched in 2011. The two believed that with the Guggenheim brand behind the fund, they could invest in the best risk management technology systems and talent and be able to build an institutional business, former employees say. Guggenheim was flirting with going public, adding to its allure for those joining the new fund.
Guggenheim promised to put $2 billion into GGT, say former employees, but contributed only $500 million, internal documents show. It spent millions to build state-of-the-art infrastructure in the firm’s Purchase, New York, office, including a huge trading floor and partners’ suite (with its own conference room, bath, and lounge area), miles away from Guggenheim’s office in New York. Meanwhile, the partners persuaded Ontario Teachers’ to sign on to a managed account, but it was for only $100 million, according to former execs.
“Ontario liked the platform because of its transparency and intense focus on compliance and oversight,” says a person familiar with the pension plan’s thinking. Ontario, known for striking a hard bargain with hedge funds, agreed to pay only a performance fee above a hurdle rate and “little or no” management fees, say people familiar with the terms. “Guggenheim was basically managing the money for free,” says one. (Ontario did not return Alpha’s request for comment.)
Cut-rate fee deals for big investors in new funds is becoming common, but it can be risky. “Significant management fee discounts may pose a problem if the manager lacks sufficient working capital to fund its operations,” according to Ted Seides, managing partner of Hidden Brook Investments, an adviser to asset managers and allocators.
Additionally, GGT was hamstrung by tight risk guidelines that made it hard to make money when markets turned volatile, as they did in the middle of 2014.
“They took down leverage, closed positions, and failed to redeploy capital, so they monetized the loss,” says one of GGT’s veteran hedge fund employees. The firm was so maniacal about risk control that it even built the infrastructure to allow risk managers, portfolio managers, and senior management to remotely monitor exposures via “iPad technology,” according to a confidential marketing document Alpha has obtained. The fund was developing an app that would allow investors access to various levels of performance metrics and risk measures.
GGT was running a market-neutral strategy, which requires leverage. The firm’s three products, all focused on equities, were levered between 2.5 and 5 times, according to the marketing document. Managers were routinely fired for blowing through their risk levels, say two former GGT employees, who also note that portfolio managers struggled under the firm’s tight risk parameters.
By the third quarter of 2014, GGT had assets of $591 million and a sizable staff of 68, according to the marketing document. It was also losing money — and had never made that much, even during the bull market. GGT gained 3 percent in 2012 and 7 percent in 2013, and lost about 6 percent in 2014, say individuals with knowledge of the performance.
Meanwhile, Guggenheim had its own problems. The firm got into trouble with the New York State Department of Financial Services, which regulates insurance companies, when it tried to use annuity assets to fund its private equity unit’s purchase of Dodger Stadium in Los Angeles in 2013. DFS’s then-chief, Benjamin Lawsky, reportedly didn’t like annuity money going into risky assets. Guggenheim eventually spun off the private equity unit.
By 2014 the firm had had enough of its hedge fund progeny. It pulled the plug on GGT at the end of the year, only two and a half years into what employees had been told was a long-term, locked-up, “permanent capital” commitment, former execs say. (Guggenheim declined to comment.)
Katzovitz and Hughes were left scrambling. Along with Mark Standish, who had worked with the two at Royal Bank of Canada, they inked a deal in early 2015 with alternative-asset manager Ares Management, which made an equity investment, and renamed the firm Deimos (after a small satellite of Mars).
By that time, the firm had fired about 90 percent of its staff. It had shrunk to four portfolio managers covering industry sectors, and a quant team, says one person who stayed on.
But the new incarnation failed to take off. When it announced its closure in September, Deimos said it had seven teams of money managers. At the end of March, it reported regulatory assets under management, which include leverage, of $348.9 million. Deimos planned to return capital to Ontario and said Ares would inherit the infrastructure and technology, as well as some staff, according to a statement made to Bloomberg by Katzovitz, who didn’t return calls from Alpha requesting comment.
“The current fundraising environment has been one of the most challenging in history for hedge funds overall, and there is little visibility as to when conditions will improve,” Katzovitz told Bloomberg. “Due to these factors, the overhead for running an institutional-quality fund like Deimos has simply become too high, so we have decided to return capital to Ontario Teachers’ and stop managing funds.”