| William Ackman, Pershing Square (Bloomberg) |
By Michelle Celarier
Last year was a bruising one for many of the biggest names in hedge funds, among them William Ackman, David Einhorn, Leon Cooperman and Larry Robbins. All but Einhorn have continued to lose money this year.
But as some of the industry’s most famous managers have shown, it is possible to recover from staggering drawdowns. John Paulson, David Tepper and Lee Ainslie III have had several steep drawdowns, yet all three made last year’s list of all-time greats published by London-based fund of funds LCH Investments, a subsidiary of Edmond de Rothschild Capital Holdings.
That said, bouncing back from steep losses can require managers to make hard decisions about how they manage their portfolios and their businesses. While not all of them made big changes to their practices, a number of managers who suffered huge losses in the past beefed up their risk management and financing capabilities or at least tweaked their investment strategies.
One such firm is Kenneth Griffin’s Citadel, perhaps the poster child for recovery from a near-death experience. Citadel’s 55 percent loss in its flagship funds in 2008 kept it on tenterhooks for years, with the firm’s assets plummeting from its 2007 heights to $9.6 billion in 2009, and its flagship fund didn’t hit its high-water mark until 2012. But today Citadel is once again a powerhouse hedge fund firm, with $26 billion, and Griffin himself is worth $7 billion. Last year Griffin topped Alpha’s Rich List with a $1.3 billion payday after Citadel’s flagship Kensington and Wellington funds gained 18 percent.
One reason for the dramatic turnaround: Citadel made significant changes to its investment strategy. As a multistrategy firm, Citadel was able to move into other, more liquid assets. While Kensington and Wellington were known for the convertibles trades that Griffin started in his Harvard dorm room, they pivoted to liquid assets, like equities, that quickly took off in 2009. The firm continues to emphasize liquidity in its underlying investments.
Another firm that changed its investment practices after a steep downdraft is Ainslie’s Maverick Capital, which lost 11.7 percent in 2011. Other Maverick portfolios lost more, with Maverick Levered down more than 30 percent.
To improve performance and win back investor confidence, the firm implemented its long-planned MavRank quantitative system, which uses fundamental inputs to rank stocks, enhancing its research process. It appears to have worked: In 2015, a tough year for hedge funds, the Maverick Fund returned 16.5 percent, making it one of the year’s top-performing hedge funds. Maverick Levered returned 26.7 percent, and the Maverick Long fund gained 6.6 percent.
Stability of the capital base is also a key factor. Tepper’s Appaloosa Management is known for its volatility — and its dynamic portfolio shifts, which have also benefited performance. Over the years, Tepper has changed his portfolio’s emphasis from what had previously been focused on distressed debt to just about anything that classifies as “distressed,” including stocks. But Tepper can afford to swing for the fences, because more than half of the fund’s capital is now his own money. Tepper’s net worth is now $11.4 billion; Appaloosa runs $20 billion.
Moreover, Tepper’s annualized return of 26 percent since 1994 is possibly the best long-term record in the business today, which is unusual for a firm that size. And that’s despite several down years and a maximum drawdown of nearly 50 percent during eight months in 1998. Tepper isn’t trying to lock investors in, either. He has been giving money back to them on a regular basis in recent years. Having a stable capital base is proving critical for Pershing Square Capital Management CEO Ackman this year. Half of Pershing Square’s capital is permanent, including that raised in the biggest hedge fund IPO in history in 2014, and employee money (primarily Ackman’s own). But even though Pershing Square is facing a 30 percent drawdown now — its biggest ever — only one eighth of most of the nonpermanent capital can be withdrawn each quarter. So far this year only 2 percent of firm capital has redeemed, largely as a result of the fund structure designed to weather the volatility of Pershing Square’s activist portfolio. That’s crucial for Ackman, as he isn’t able to pivot quickly, nor is he likely to change his highly concentrated, activist approach.
That’s also true of Glenview Capital Management’s Robbins, who likes to make big, concentrated bets and doesn’t part easily with his favorite investments. The firm’s funds have gained and lost on a major bet on health care stocks, with its flagship Glenview Capital Partners funds rising more than 14 percent in 2014 and more than 44 percent the previous year but falling more than 19 percent last year. Even though Glenview’s funds are still struggling — the flagship lost another 12.15 percent in the first quarter — investors are sticking with Robbins and even asking to allocate more to the funds, which are technically closed to new investment. (Last November, Robbins raised a cool $2.5 billion from his most fervent admirers for a long-only, limited-life vehicle that doesn’t charge fees.)
Of course, it helps to run a multibillion-dollar firm to begin with. All of the big funds with double-digit losses last year have one thing in common: Their firm’s size is north of $5 billion. The compensation structure of hedge funds means that a $5 billion fund with a 2 percent average management fee has $100 million coming in to keep the lights on and hold onto talent, even if it has to wait years to earn performance fees.
But ultimately, one of the most important factors when it comes to recovering from a major drawdown is clearly communicating to clients exactly what you’re doing and why. A big part of both Citadel’s and Maverick’s success was their active communications with investors. Says Marjorie Kaufman, a veteran hedge fund marketer who is now a partner at activist fund Barington Capital Group: “Investors who know what they are getting into when they sign onto a hedge fund can take some lumps along the way. The most important factor is validity and repeatability of the investment process.”
