Joel Press fell in love with hedge funds in his first job more than a generation ago at a Wall Street accounting firm called Oppenheimer, Appel, Dixon & Co. The year was 1968, and Press landed a small hedge fund client that was part of a then-tiny industry. Over two decades, Press, who came from modest beginnings (he has a bachelor’s degree in accounting from Long Island University), became a sought-after specialist in counseling hedge fund managers on the rules of the road: “I gave advice on how to work within the law.”
He was an accountant-doctor of sorts, whom clients would call for a checkup whenever they began to wonder whether they had put their fund together properly. As it happened, the rules on hedging were still in flux, so Press ended up helping to shape some of the budding industry’s standards on audits, due diligence and succession planning and in such arcana as how to merge one hedge fund with another and how to create and use side pockets (a mechanism that favors some investors over others by isolating certain assets from others).
Today, Press is a senior adviser at investment bank Morgan Stanley, where he brings his considerable industry connections to bear, counseling some of the firm’s biggest hedge fund clients. He came to Morgan Stanley after retiring in 2006 from a long leadership stint at accounting firm Ernst & Young.
“Joel’s unique experience advising hedge funds on all aspects of their business has made him an invaluable resource to our clients at the highest level,” says Stuart Hendel, global head of the firm’s prime brokerage business.
“He really is the guru of the hedge fund industry and also one of its early students,” adds Arthur Tully, co-head of Ernst & Young’s hedge fund practice, who has known Press since 1981, almost a decade before the two worked together. “He founded the Ernst & Young practice and dealt with everyone and anyone who was a leading hedge fund. More important, his knowledge of the industry — especially in terms of when he began working in it — helped him define what are the best practices.”
One of the doubts Press, now 62, had about joining Morgan Stanley was his age. “How does a 60-year-old fit into a firm of lots of younger people? And an outsider, no less,” he recalls wondering just before he met with Richard Portogallo, who was then head of Morgan Stanley’s prime brokerage unit (he is now co-head of institutional clients and services) and one of several top investment bankers who were recruiting Press. Portogallo’s reply, as Press remembers it: “We’ll figure it out. Do whatever you want. Just be here for us. Introduce us to clients. Do whatever you did at Ernst & Young. Just do it here.”
Press hasn’t always had so smooth a transition. In 1989, confident of his ability to operate independently, he left Oppenheimer to start his own fund-consulting business. It was a short-lived endeavor that ended when he realized he needed a bigger platform to deliver the services he wanted to offer. He saw his opening in the merger of Ernst & Whinny and Arthur Young & Co. that same year. “I told them I thought hedge funds would dominate the financial services business.”
During his 17 years at Ernst & Young, Press helped build the biggest hedge fund accounting practice in the world; it controlled 40 percent of the global market as recently as 2006, according to the firm, well ahead of its nearest competitor, PricewaterhouseCoopers, which Press estimates had about 35 percent of the market. More than 1,000 employees reported to Press, and his group was the company’s second-most profitable, its success fed by a fast-growing industry as it advised existing hedge funds, funds of hedge funds and start-ups. Some of the best-known hedge fund names became clients, including Louis Bacon’s London-based Moore Capital Management, which manages $20 billion. Press was the accounting adviser to Daniel Och when Och left Goldman, Sachs & Co. in 1993 to launch Och-Ziff Capital Management, the $33.4 billion New York–based hedge fund firm that started out with a comparatively paltry $100 million.
In 2006, when he reached Ernst & Young’s mandatory retirement age of 60, Press was out the door, though he was a long way from being ready to retire. His first move was to team up with David Berkowitz, the former co-manager of Gotham Partners, a fund that was forced to close in 2003 in a flurry of redemptions. With a $100 million seed investment from Reservoir Capital, a New York–based group that finances hedge funds and private equity firms, Berkowitz and Press launched a small hedge fund called Festina Lente (“make haste slowly” in Latin).
“Our view of the world here is superconcentrated, long-duration investing,” Berkowitz said in October 2006 at the launch of Festina Lente. But it didn’t take long for Press, the firm’s chief operating officer, to realize that he enjoyed being a consigliere more than a manager: “I decided that I liked to give advice.”
That’s when the prime brokers started calling. Press met with top executives at 11 firms and went with Portogallo, a longtime acquaintance. “I told Rich that I was being courted by prime brokers, so he said, ‘Hell, why don’t you come here?’” Upon taking the Morgan Stanley job in January 2007, Press stepped down from Festina Lente’s day-to-day operations.
Despite the recent slowdown in asset flow into the nearly $2 trillion hedge fund industry, Press says that he’s convinced it is a long way from peaking. “It’s in its mid-20s,” he says. “I lived with it at infancy. I lived with it at its adolescence and its teenage years. There’s a long way to go for this industry before it becomes really mature.”
In fact, Press believes that hedge funds will end up being a more durable asset class than mutual funds. “The mutual fund industry is clearly in its middle age, and it’s an industry that has had issues for the past few years,” he says. Press argues that amid the market’s current volatility — volatility that may increase — hedge funds have outperformed mutual funds in their ability to respond to the market and deliver alpha.
Press recently sat down at Morgan Stanley’s offices in New York with Alpha Contributing Writer Udayan Gupta to talk about where he thinks the hedge fund industry is headed.
Alpha: How would you say the hedge fund industry has responded to this roller coaster of a year?
Press: When the dynamics change, you have to be prepared to help your organization solve the new puzzle. In August 2007 the markets imploded — liquidity dried up. More hedge funds went out of business in 2007 and at the beginning of 2008 than at any other time. But they were a relatively small percentage, and they were firms with a specific style. For the most part, the rest of the industry had a phenomenal 2007 relative to indexes, because compared to the indexes, the hedge funds had less volatility. No one talks about that. And in 2008, hedge funds continue to do better than the indexes.
When the dynamics change, you have to be prepared to help your organization solve the new puzzle. In August 2007 the markets imploded — liquidity dried up. More hedge funds went out of business in 2007 and at the beginning of 2008 than at any other time. But they were a relatively small percentage, and they were firms with a specific style. For the most part, the rest of the industry had a phenomenal 2007 relative to indexes, because compared to the indexes, the hedge funds had less volatility. No one talks about that. And in 2008, hedge funds continue to do better than the indexes.But they’ve still lost money.
That will happen. But was it within the tolerance range for particular strategies? And if the losses were outside the tolerance range of strategies, did they learn from it? The fact that there was a double effect — brokerage houses were losing money and the hedge funds were losing money — didn’t help. Everyone was trading credit. Hedge funds lost money trading credit. And people started to realize that the valuations of the assets they had and the valuations they thought they had weren’t there. But what happened is not unusual. Go back to the savings and loans crisis and the RTC bailout: same kinds of issues.
It didn’t trouble you this time around?
Most of the losses have been concentrated over a short period. The question is whether they were in the tolerance range of the type of market and was it anticipated that it could be down that much. There’s nothing that’s happened that requires a change in laws.
Do you think hedge funds are in danger of increased government regulation?
Most government officials recognize the benefits of hedge funds: providing liquidity, creativity, innovation, in some ways helping deal with volatility. When markets move disproportionately to what is expected and what is logical, hedge funds are stepping in and risking capital. That was proven in many other examples, such as the Malaysian currency crisis of 1997, where hedge funds were initially blamed. Hedge funds actually helped stabilize the currency, and I think people realized that. I do think governments are going to try to deal with disclosure and transparency issues and try to understand what kinds of reporting are necessary to avoid unanticipated dislocations. So there will be large-trade reporting, but I don’t see government restricting the trading and creativity and innovation of hedge funds. That would be a mistake in either the U.S. or in Europe. I don’t see increased government control as a trend.
Are activist funds a source of concern?
Activists have existed forever. They’ve had different names. In the ’80s they were called raiders. But activists serve a role. There’s a place for everyone in the market.
What’s your take on the current extent of globalization of hedge funds?
Real hedge fund markets haven’t fully developed in any major cities other than New York, London and Geneva. There are pockets of hedge fund activities in other U.S. cities. Most people don’t realize Minneapolis is a significant hedge fund city. San Francisco, people do realize, is. You can’t say that Beijing is a major hedge fund city. There are a number of hedge funds in Japan, mostly in Tokyo. There are a number of hedge funds in South Korea, in Taiwan, in Singapore. There are pockets everywhere, but they don’t have the breadth and depth that London and New York have, that’s for sure.
But globalization is going to continue. The sovereign wealth funds, as they grow, will start to bring some business in-house, first by trading, then by running hedge funds. They will run their own money, as Harvard did for awhile. I think that’s going to be a trend. Will it develop in India and China? Yes. As the markets mature and the people get more knowledgeable, you will see the spin-outs of hedge funds from the banks in those countries. I could see them starting in Mumbai and then Beijing or both. But it’s going to take a long time, probably ten to 15 years. London developed ten to 15 years behind New York. The rest of the world will take a lot longer.
Where else do you see the hedge fund industry blossoming?
Brazil will likely develop into a market, as I anticipate will Argentina. Chile will develop into a market. I don’t see Mexico yet developing into a hedge fund market. Whether it will happen in Africa, I don’t know. There are a lot of hedge funds in South Africa and also a number of funds of funds. I am going to guess there are as many as ten large hedge funds centered in South Africa.
Has the typical investor profile changed?
Hedge funds, when they started, were almost 100 percent supported by wealthy individuals. Wealthy individuals still participate, but they are dwarfed now by the institutional market — the pension, endowment and foundation markets and the sovereign market. The very distribution of wealth is changing. There’s new wealth in China, new wealth in India.At some point these economies will invest in alternative products like real estate, oil and gas, and alternative energy. But there will always be the wealthy individual looking for innovation. Institutions also are becoming more entrepreneurial as they look at the percentage of allocation to alternative investments, not just hedge funds but commodities, energy, alternative energy, real estate, oil and gas, private equity and venture capital.
Are hedge fund investors more sophisticated today?
The “high net worths” are quick, and their due diligence is spot on. Within every category of pensions and endowments, there are different levels of sophistication. It takes a long time for endowments and pension funds to make their decisions because their due diligence processes take much longer.
What’s driving the prime brokerage business?
What drives prime brokerage is technology and the ability to deliver finance and great service. Prime brokerage is about relationships. The pricing is not the key factor. It is delivering great service and being there for your clients when they need you. Anyone can provide finance. But it’s much more about understanding a client’s business and needs.
Deep pockets don’t matter?
Deep pockets help. The banks, for example, have different kinds of pockets than investment houses, and banks have different tolerances for different kinds of leverage. As the industry has grown, the needs for finance have changed. Now it’s almost impossible for anyone to have just one prime broker, because you should have two or three, depending on your size and how you use leverage. You have to go with those specialists according to your needs. BNP just bought Bank of America’s prime brokerage business, I suspect, to grow it. JPMorgan took over Bear Stearns’ prime brokerage business. I believe they bought it to grow it. There’s a whole bunch of prime brokerage firms that have been started in the past four years to specialize in smaller hedge funds that the bigger firms may not have the ability to service. I still see the prime brokerage business as robust and vital and as a growth business.
Are spectacular hedge fund returns sustainable?
I cannot predict returns, but I do believe that hedge funds are the best of breed and that they will figure out ways to do the best rates of return. Do I think they will beat the normal markets — whatever that means? Yes, because they are unique in what they do.
