Candor can be tough to take, but Donald Putnam has a tell-it-like-it-is impulse he can’t resist, a trait that’s probably won him more respect than friends.
His Boston-based merchant bank, Grail Partners, is one of the elite mergers and acquisitions advisers in the U.S., with offices in New York and San Francisco. Grail is relatively new, but Putnam has been at the M&A game since the 1980s, and over the years his clients have included heavyweights like Chase Manhattan Bank, Pacific Investment Management Co. and Wellington Management. Among the recent deals Grail has advised on: the 2006 acquisition of $5.5 billion hedge fund firm FrontPoint Partners by Morgan Stanley and State Street Corp.’s 2007 purchase of Palmeri Fund Administrators, a Fair Lawn, New Jersey–based firm that specializes in serving the private equity industry.
Putnam remains one of the go-to guys on big deals. Although the economy continues to struggle, he thinks the M&A business is strong, and he expects a burst of consolidation, especially in the financial sector, over the next year. He predicts that hedge funds, which he likens to the carnivores at the top of the food chain, will go through a makeover like everybody else.
Putnam, 58, came of age in the 1960s with the rise of computers and worked in quantitative investment in the 1970s at Bankers Trust Co., where he specialized in pension fund “performance attribution,” or “what we used to call risk management,” he says, “before it was the highfalutin thing it is today.”
Later he joined SEI Investments and was founder and president of SEI Financial Services Co. and its various mutual funds, responsible for assets in excess of $15 billion. He established Putnam Lovell Securities in 1987, building it into a mergers and acquisitions force before selling it to Canada’s National Bank Financial in 2002, though he stayed on as chief executive for three years. In 2005 — “sort of late in life” — he founded Grail as a clearinghouse for unvarnished advice to investors.
“He’s notoriously blunt, which can be very positive and incrementally useful — or it can be kind of a flagrant foul, but we know where he comes from so it’s okay,” says William Thompson, the retired chief executive of Pimco.
In fact, Putnam seems to delight in playing the contrarian, and his point of view has sometimes proved prescient. He foresaw the depth of the subprime crisis as it began to unfold more than a year and a half ago. “If a rising tide lifts all boats, a sinking ship sinks all ships,” he told the New York Times in October 2007. “There will be many more losers than winners when this is through.”
Putnam is an avid reader of history, using it as a guide to the future. He cites Six Frigates: The Epic History of the Founding of the U.S. Navy, a 600-page tome by Ian Toll, as one of his favorite reads. “History is something you have to absorb,” he says. “You can’t skim it; it’s dense and requires you to be thoughtful, and you’re forever comparing what you’re reading with what you thought you knew.”
Putnam travels constantly. He left San Francisco on a recent Sunday, for instance, for Monday morning meetings in Chicago and then flew to New York that afternoon. He was in Los Angeles on Tuesday and Boston on Wednesday. A lot of his time in the air is spent poring over hard-copy research. “I like reading in its physical form — I do three hours a day in front of a computer, and that’s plenty,” he says. Home is San Francisco, but Putnam also owns an estate in the Napa Valley, where he likes to spends time with his family.
He posts his views on the world online in essays with titles like “Adapt or Die Trying: Darwinism and Intelligent Design in the Hedge Fund Industry.” In one particularly scathing piece this year, Putnam took on hedge fund managers for promising absolute returns and “aligning” fee structures — and delivering neither. “Portfolio managers, especially hedge fund managers, misrepresented both the risks inherent in their portfolios (a forgivable error) and the real efforts they were undertaking to mitigate risk (an unforgivable fraud),” he wrote. “The language of hedge portfolio managers beguiled rather than informed the clients and their smug and lazy agents.”
Angry?
“No,” Putnam insists. “Bearish.”
He met recently with Alpha Senior Editor Karl Cates to talk about the value of forthrightness and the shape of investor expectations to come.
Alpha: Is your reputation as a painfully plainspoken personality deserved?
Putnam: Yeah. I’m extremely direct. If what you want is facts without advice, we are not the people for you. I give advice, and often it’s hard to take, although I try to make you laugh when I tell you what you might not want to hear. I try not to be insulting, but there’s instance after instance of clients who have been offended.
Comfort is not a prized quality with us because we’re less interested in making you feel good than in making you feel better. CEOs and portfolio managers as masters of their universe are used to being treated with deference, and I don’t do that very well.
Doesn’t utter honesty come with a price?
When I got to be over 40, I decided that I had to select my clients based upon people who wanted to hear the truth as I saw it. If they wanted to hear their own truth reflected back at them, they could deal with the large investment banks and they could deal with the consulting community and they could hire their lawyers — there’s a kiss-ass function in all advisory businesses. But we don’t do it that way. I can’t do it that way. So I have ended up with a community of friends and clients in the industry who are always a little braced for my frequently-wrong-but-never-in-doubt kind of way.
What were some of your favorite deals?
Taking Pimco public [in 1994] through a reverse merger and then the subsequent sale five years later to [German insurer] Allianz, because those were difficult and interesting transactions full of brilliant people. Another one would be the purchase [in 2000] of [British investment bank and asset manager] Robert Fleming Holdings by Chase Manhattan because it was a truly global and intricate transaction. What I found fascinating about that [deal] was the extreme competence of the Chase Manhattan team. You typically think of the individual brilliance behind something, that there are a bunch of drones behind them, but the truth of the matter was the Chase Manhattan team was 200 of the brightest and best-tempered people I’ve ever seen.
Recently, you’ve made some dire predictions on the economy and markets. Do you stand by them?
I believe we have a whole ’nother wave of credit crisis [ahead]. I believe we will hit 11 percent unemployment. I believe we will see the Dow at 6,000 before the end of the year. I’ve said it for two years, in postcataclysm equity, it’s going to rotate around 6,500. Rotate around it — yes, up to 7,500 but then down to 6,000. And yet in the White House — by the way, I’ve been an Obama supporter from way back — but even he is falling into the trap of thinking that, by changing the mood of the nation, we can change the economic outcome. There’s only really been one person in history who could change an outcome by changing the mood.
FDR?
No, Christ. But good guess. FDR was a total failure for five consecutive years. The problem was vastly more difficult than he imagined. As an economic historian, I am here to tell you that we actually have serious, serious problems to be solved. They will not be solved with $8 billion in pork; it will take every penny of the trillions we are prepared to spend. We just can’t afford the distraction of all of this stuff that is premised on the idea that we have a six-month problem or a nine-month problem.
What the optimists are trying to do is get America borrowing again. That is the quickest route to disaster. What we have to do is actually navigate our way through the storm to safety. It takes focus, and it takes truth. If you really think we’ve got a passing squall, then, hey, let’s enjoy the rain. But if you think we’re facing the first of 40 days, you better damn well build an ark. There’s too much talk of the sun will come out tomorrow and not enough talk about how to build an ark.
How do you build an ark?
You rebuild the savings system. You don’t raise taxes, you lower them. You take serious action on mortgages, not populist-nonsense action on mortgages.
Are you advocating a government program to reduce the principal on residential mortgages?
I don’t actually believe in reducing principal, I believe in having a government-guaranteed, 3 percent, 40-year mortgage. Now, that appears to reduce principal because it reduces the carrying costs and so on, but if we have a 30- or 40-year, 3 percent government mortgage that can be used to replace existing principal of any mortgage, we will recapitalize the base. But, more important, we will not give a free gift to any idiot that overleveraged. We can handle the failure of the idiots if we can reduce the burden on the less idiotic.
Beyond unemployment and the Dow, what evidence do you see that things are as bad as you say?
We’ve got a worldwide export collapse. There are literally tens of thousands of empty containers sitting in Singapore harbor. And we have a trillion dollars of debt to roll over in the commercial sector — commercial debt, commercial paper — that has no chance of being refinanced.
You’ve been very critical of what you call hedge fund arrogance. What big changes do you see coming?
We’re now seeing a die-off of fund groups, and the larger ones are proposing more-rational fees for their institutional clients. There’s a change going on to what amounts to either 75 basis points plus a 5 percent performance fee or, on the other hand, a flat 100 or 125 basis points for supervising the assets. Both of those are rational. We’re also going to move to a managed-account structure. From a regulatory perspective, we’re going to need third-party marks on all the positions, third-party custodians for all the positions, third-party administrators. And those are good things. Telling the client every day what positions he has is pointless: It’s transparency with no risk management. Being sure that the positions you can’t see every day are actually at a custodian, that, by golly, is risk management. Bernie Madoff was prepared to send you confirms all the time, he just was making them up in the back room with some sealing wax and a big quill pen.
You see a shift of power from manager to investor?
Because almost every investor was disappointed in 2008, there will be a huge amount of turnover in 2009 and 2010. What we call client rage. That creates a tremendous amount of opportunity. We see a lot of new entrant potential in the next couple of years. We think we’ll do two or three or four years’ worth of market share change in each of the next two years. In the hedge fund business, it means a dynamic environment for new product and for new packaging. It’s clear there’s enormous investor appetite for things like TARP and TALF.
You recently wrote that the private equity industry “will ruthlessly retool itself.” Could you scratch out “private equity” and put “hedge fund” there?
Yes, although I don’t think the hedge fund industry is in as much trouble as everyone else thinks it is. There were a lot of unforced errors, primarily in a gating of product that was not supposed to have been gated. Those were failures of discipline, and some of them are failures of integrity. But this is an industry that learns from its errors as much as it learns from its successes. Right now, all the big firms feel terribly under the gun. They’re humiliated and embarrassed and ashamed. But they will turn on a dime and find a way to win because their clients will force them to [achieve] a better alignment of interests. The bottom line is, if you look at the vast Serengeti of financial services firms, the hedge funds are the most nimble, they’re peopled with the strongest, they can run the farthest: They are the great predators.
Karl Cates is at www.twitter.com/AlphaBlogging and kcates@iimagazine.com.
