By Stephen Taub
Photographs by Michael Edwards
In September 12 of last year, the six members of Highbridge Capital Management’s executive committee were gathered at cofounder Glenn Dubin’s Rocky Mountain ranch in Colorado, when news of Lehman Brothers’ impending bankruptcy reached the group. Cutting weekend plans short, on Sunday, September 14, they packed their bags and flew back to New York City.
“It was war,” recalls Dubin, who suddenly faced the biggest crisis in the 16-year history of Highbridge, which had about $27 billion in hedge fund assets as of July 1, 2008. “It was the beginning of the world changing.”
Highbridge, headed by Dubin and cofounder Henry Swieca, thought it was prepared. Over the summer of 2008, the firm had deleveraged by selling equities in its flagship multistrategy fund, keeping it flat for the year when the major market indices had already posted double-digit declines.
But the multistrategy firm had used Lehman as one of its prime brokers and that Sunday a team of 23 senior execs regrouped in the firm’s midtown Manhattan conference room to begin disaster planning. They ranked their counterparties into three groups, based on their presumed risk, then they determined the steps that would be necessary to reduce exposures and pursue legal and regulatory options. Highbridge pulled excess capital from broker/dealers and began to contact trading counterparties. Even so, the Highbridge execs realized they could do little but hunker down and endure the pain to come.
Having sold off its liquid holdings, the then $9.7 billion flagship fund had about 40% of its assets in convertible bonds, the firm’s foundational strategy, along with levered loans and high-yield bonds that Highbridge had ambitiously acquired late in the cycle. Soon convertibles went into a tailspin, and loans stopped trading, which would eventually drag the flagship down about 27% for the year.
The losses would lead to a stampede for the exits by investors and exacerbate tensions between Dubin and Swieca. Their childhood friendship and longstanding business partnership had become strained since selling Highbridge to JPMorgan in 2004, in a multibillion dollar deal that would take five years to complete--the first and possibly the only successful hedge fund-bank tie-up.
When the deal was struck, the Highbridge cofounders could hardly have anticipated that JPMorgan would become the strongest U.S. financial institution in the years ahead and run one of the largest U.S. hedge fund businesses. But last year’s losses threatened Dubin and Swieca’s final payout, which was based partly on performance: Net annualized returns for the firm’s flagship since the purchase had shrunk to a paltry 5%. As a sign of confidence, JPMorgan pumped $225 million into the multistrategy vehicle on January 1. The bank later agreed to accelerate the date on which it would take over 100% ownership, allowing Swieca to leave Highbridge on June 30. By that time, convertibles had made a remarkable comeback, leading to a 27% net return for Highbridge’s flagship fund through July and putting Highbridge on track for its best year ever.
Last fall, however, the future looked bleak. Steely-eyed and square-jawed with Clint Eastwood tough-guy looks, the 52-year-old Dubin says he would walk the corridors of Highbridge and feel the eyes of the firm’s 400 employees staring at his back, wondering whether Highbridge would make it. “They were relying on me,” says Dubin, who was widely viewed as the dominant partner and the de facto head of Highbridge--if not the most easygoing boss. “I felt a lot of weight on my shoulders. It was the most stressful period in my 30 years in the investment business.”
For 10 weeks--roughly from mid-September through December 1--the global stock and credit markets entered free fall. Highbridge’s multistrategy fund wasn’t the only one of its vehicles that was bleeding. Its $1 billion levered loan fund, launched only at the beginning of September, had lost a third of its value by yearend, and Asia Opportunities was down 31.3%.
“There was a complete meltdown of the markets,” Dubin recalls. “The markets were not functioning at all. It was a two-headed monster--market risk and volatility and a very dangerous and real counterparty risk environment to deal with. In the depths of the fourth quarter, I did question my sanity because it was so painful.”
Investors, many of whom had allocated to the firm through the JPMorgan private bank, were jittery. Since becoming part of JPMAM, Highbridge’s asset flows had been volatile, billions flowing in and out with performance ups and downs, but that was nothing compared with last year. As the losses mounted, scared and disgruntled investors wanted out. Dubin and other top Highbridge officials held one-on-one meetings with some clients and conference calls with large groups of investors. “At some of the darkest times, they had conference calls with hundreds of clients,” recalls Mary Erdoes, head of JPMorgan Global Wealth Management.
Highbridge’s multistrategy fund ended up with redemption requests for about 35% of its assets, leading to the next problem it had to tackle: The flagship, which typically had no more than 10% of its assets in illiquid securities, was left with a portfolio that was nearly impossible to unload. How would it satisfy investors? Would it let them out or gate their funds? Would it have to lay off employees? How many? And how should the firm compensate those who remained, as well as any potential recruits, given that most of the funds faced high-water marks? They knew that meant they wouldn’t generate the huge incentive fees the firm was accustomed to--and which enabled it to generously reward key portfolio managers, analysts and other professionals.
At the end of 2008, the Highbridge team opted to erect a gate on two of its funds--multistrategy and Asia--which was permitted under both funds’ offering documents. Some investors had quarterly liquidity whereas others had annual liquidity. The flagship’s redeeming investors received 30 cents on each dollar in cash; the remaining 70 cents was placed in what Highbridge called a dislocated pool of assets--illiquid securities such as convertibles, levered loans and privately structured investments. The firm halved the management fee for the dislocated pool.
Crafting the deal was not easy. “The gating process was not taken lightly,” Erdoes recalls. “There were late nights, hours of debate, constant discussions about the redeeming clients and the remaining clients.”
A number of investors weren’t pleased with what was initially offered and negotiated concessions that eventually were accepted for all. “For us, the changes they were making [from the initial proposed plan compared with the agreed-upon policy] were not enough,” says Larry Powell, deputy investment chief for the $16 billion Utah Retirement System, whose experience with redemptions in 2008 led him to propose industrywide changes earlier this year in a widely circulated white paper that called for lower hedge fund fees. Although Powell would not say what Highbridge changed, eventually enough was done to keep Utah happy. “After a two- or three-hour meeting, it became clear to us that we would be able to work out a structure that would be up to Utah’s expectations,” Powell said in an e-mail exchange. Dubin simply says: “Definitely Utah provided input. It was not an edict. It was a collaborative discussion with our investor base.”
Still, redemptions and losses cut Highbridge’s assets by 38%, from $27.8 billion at the start of 2008 to $17.3 billion on January 1, displacing JPMAM from the top spot in the Billion Dollar Club to number two. (Bridgewater Associates took over the lead.)
Inside Highbridge, fear was in the air. Of Highbridge’s nearly 400-person staff, about 60 people, or 15% were laid off, the bulk from noninvestment areas--back office and operations. Executives maintain they had no choice. “It was crystal-clear--as difficult as it was--that the business had changed in front of our eyes,” says Todd Builione, the chief operating officer who joined Highbridge in 2005 from Goldman Sachs, where he had served as a financial institutions group investment banker.
In addition, Swieca, who had historically overseen the firm’s risk management and chaired its investment committee, was on his way out. Ever since the merger with JPMorgan, which Dubin orchestrated with Jes Staley, head of JPMAM, the role of Swieca--more soft-spoken and introspective than his hard-charging partner--had been diminishing. Swieca had been reluctant to do the deal in the first place, and he disagreed with Dubin’s push into private equity, stat arb and loans. While Dubin hired big names from Goldman Sachs and D.E. Shaw, among others, to lead the firm in new directions, Swieca was the day-to-day guy who oversaw the investment process and risk management.
“The partnership swapped from Glenn and Henry to Glenn and me,” Staley says, regarding Swieca’s recent departure. “It is sad. The partnership of many years was ending, however, none of us should cry. They have done well for themselves.”
In recent years, the two childhood friends had rarely socialized. It was a huge change for the pair, who grew up five blocks from each other in Washington Heights, the working class New York City neighborhood in the shadow of the George Washington Bridge. Both attended the State University of New York at Stony Brook, sharing a dorm room for the first two years. Dubin earned a B.A. in economics in 1978 while Swieca earned a degree in economics and French the following year. They both became stockbrokers and both eventually landed at E.F. Hutton. After creating a forerunner to the firm’s multistrategy fund while at Hutton, the two went on their own and, in 1992, launched their own actively managed multistrategy hedge fund: Highbridge, named for the Washington Heights aqueduct.
The fund specialized in convertible arbitrage at a time when it was still in its infancy and providing huge returns. Although the number of strategies was eventually expanded, for most of the fund’s history convertibles were an important source of the investment returns--and losses.
Dubin and Swieca never personally completed a trade at Highbridge, relying on expert managers and their teams to run their strategies. This was by design and the major reason why Swieca felt they could create a firm that would outlast them both. It was also why Swieca insisted that they not put their names on the door. At the time, risk management and asset allocation were informal, determined as Dubin and Swieca shouted to one another between their offices, which were separated by a single pane of movable glass. It worked well. By the time JPMorgan closed on its acquisition, Highbridge had compounded at 15% per year.
Today,Highbridge is a much different firm than the one in late 2004 that JPMorgan paid about $1.3 billion for a majority stake. Since then, total assets have tripled to $22.9 billion from $7.4 billion while the number of investment professionals has doubled. Perhaps more significantly, the firm expanded from a hedge fund business with one multistrategy fund and two single-strategy funds to four main business platforms--traditional hedge funds, including the multistrategy fund and four single-manager funds; an asset management business mostly comprising two market-neutral funds that are considered in Highbridge’s calculation of hedge fund assets; a $3.7 billion private equity and credit business, including a $2.1 billion mezzanine fund, a $1.1 billion levered loan fund and Constellation Partners, a $500 million private equity business in media and telecommunications inherited from Bear Stearns; and a 50% interest in Louis Dreyfus, a merchant energy business.
“The deal has exceeded expectations by quite a bit,” says Staley. “We have created something truly unique. It is one of the most envied transactions in the industry.”
When JPMorgan agreed to buy Highbridge, Staley knew he was putting his career on the line. After all, he had to win over JPMorgan Chairman Jamie Dimon (then president), who feared that Highbridge’s best people, as well as investors, would leave the firm once the deal closed. Staley was mindful that earlier hedge fund luminaries Julian Robertson of Tiger Management, Michael Steinhardt of Steinhardt Partners and Leon Levy and Jack Nash of Odyssey Partners closed down when they packed it in. He did not want the same to happen to Highbridge, and Staley was well aware that banks in general had a reputation for ruining asset management firms.
Dubin and Swieca thought a sale to JPMorgan would accelerate their game plan to institutionalize the firm and eventually create a business that would endure well after they left. And, of course, they wanted a way to cash out.
Staley, however, wanted to ensure that he would be able to retain the principals and key portfolio managers. He shrewdly structured the deal so that money would change hands in three installments over five years--including one when the deal closed--with the payout partly contingent on performance. “Glenn and I spent an enormous amount of time trusting each other,” recalls Staley, 52. “Glenn knew if it failed, he would be the biggest dope in the hedge fund industry; and I knew if it failed, I would be the biggest dope on Wall Street.”
Despite the deal’s potential drawbacks, it unleashed a race among banks to purchase hedge funds, in whole or part. In subsequent years, Morgan Stanley purchased FrontPoint Partners and Citigroup acquired Old Lane Partners, founded by Vikram Pandit, who later became Citi’s chairman. Morgan Stanley also bought roughly 20% stakes in Avenue Capital Management and Lansdowne Partners while Lehman bought similar size stakes in a number of firms, including D.E. Shaw and Ospraie Management. Meanwhile, several firms went public, including Fortress Investment Group, GLG Partners and Och-Ziff Capital Management.
Now, Old Lane has shut down and Lehman is bankrupt. Meanwhile, the stocks of the publicly traded alternative investment firms are near all-time lows. Also, no hedge fund firm has yet been able to prove it could create a business that outlived the founder.
Though the Highbridge acquisition is considered a success, it didn’t look promising at the outset. Immediately after the deal closed, Highbridge suffered about $1 billion in redemptions, or 14% of its $7 billion in assets. Departing clients included philanthropist Eli Broad, who had been a longtime investor in Highbridge through his Broad Foundation. The octogenarian billionaire decided to withdraw his assets from the fund after the deal was announced because he was uncomfortable with the hedge fund being owned by a bank.
“There are always inherent conflicts when a bank owns a fund,” says Peter Adamson, chief investment officer of the Broad family office. “We felt the founders were taking a lot of money out. We didn’t know the incentives. It was a good deal for them. It was not clear [how] it would benefit us.”
What’s more, Highbridge was losing money under its new owner, thanks to a collapse in convertibles. It was the first time the multistrategy fund--down 3% for the year through April 2005--had strung together a four-month losing streak. Dubin was concerned about his new partner, knowing that Staley had put his career on the line; he called the JPMorgan executive daily to make sure he was okay. At the same time, Staley was worried about how his new partners were faring.
JPMorgan put the muscle of its private bank network to work, bringing in investors during this tough period. Staley recalls he was most interested in whether the investment team was stable, especially Mark Vanacore, who headed convertible arbitrage. “They said no one was going anywhere,” he recalls. Vanacore, one of 22 people who made partner and received an equity stake when the deal was struck, remains with Highbridge.
The2005 convertibles downdraft was not Highbridge’s only crisis since the JPMorgan acquisition. With the multistrat up about 23% in 2006, Highbridge was riding high in early 2007, raising billions of dollars in new capital through the JPMorgan network, an unprecedented feat for a hedge fund at the time. That summer, the quant crisis sent Highbridge’s relatively new statistical arbitrage fund plummeting. Highbridge tried to reduce its sizable leverage at the same time as others by dumping securities, but that only added to the pain.
Staley, who had just arrived in Africa for a two-week vacation with his family, turned around and immediately set out for New York City to meet with a group of people that included Dimon, Dubin and Builione. It almost cost him his life. Staley rented a single-engine plane that would take him from Johannesburg to Dakar. Shortly after takeoff, however, the plane--built in 1938--lost power at 4,000 feet. Luckily, the pilot was able to restart the engine. When it landed for 20 minutes to refuel, Staley tried to call Dimon to relay his plan, but the flight crew wouldn’t let him use his cell phone. His seatmate told him to switch to the window seat, draping a blanket over Staley to make it seem as if he was sleeping. This enabled Staley to call Dimon with his important message: Although Goldman Sachs had put capital into its quant funds, Staley did not want to follow suit, figuring it would set a terrible precedent. “Bank capital is not here to insure returns,” he told Dimon. In Staley’s view, bank capital should be used only if fraud were committed or management greatly strayed from its stated mission, neither of which was the case at Highbridge. The stat arb fund ended the year down 14%, and Highbridge’s hedge fund assets fell by $8.9 billion to $27.8 billion in the last six months of the year.
Because Highbridge had raised so much money in the year’s first half, its hedge fund assets actually jumped by 67% during 2007 despite the quant rout. By yearend, the size of its multistrategy fund had grown to $14 billion, and the firm had launched Highbridge Statistical Opportunities--the quant fund-- bringing the total number of funds to five. Most of the new investors were wealthy individuals and institutions instead of European funds of funds, which accounted for most of those who bolted at the end of 2008. From 2005 through 2007, Highbridge’s multistrategy fund compounded at 11.2%, but last year’s losses lowered the annualized return since JPMorgan’s purchase to 5.2% through July (compared with a loss of 2.5% for the S&P 500). Since inception, the flagship is up 14% on an annualized basis. In 2007, the firm’s event driven/relative value fund dropped about 10%; it was closed down last year. The statistical opportunities fund rebounded in 2008, rising about 22%--the only Highbridge fund to make money last year. It was up another 14% this year through July.
In the past few years, Highbridge also started two statistical market-neutral funds. They finished 2008 up 10% and 12%, according to Morningstar. Already this year, these funds have raised more than $2 billion. Highbridge also manages $700 million in long-only equity funds. Highbridge’s other big business is principal strategies, its private equity business, which was developed in 2007 after bringing in Scott Kapnick, then co-head of global investment banking at Goldman, whom Dubin had known for about 10 years. At a breakfast meeting in December 2006, Kapnick recommended to Dubin that JPMorgan develop a mezzanine fund instead of investing in the asset class as a side pocket, as most hedge funds do. Kapnick, who figured Highbridge could draw on JPMorgan’s investment banking business to identify potential investments, joined as a managing partner and member of Highbridge Capital Management’s board and the chief executive officer of Highbridge Principal Strategies in July 2007. “It was clear the credit markets were going to turn, and I felt there was a great opportunity to create a credit platform at Highbridge,” Kapnick says.
Kapnick’s timing was somewhat off. He started raising money in 2007 as soon as he joined the firm as the credit markets were heading into a long downward spiral. Also, he was at a disadvantage because Highbridge had no track record to tout in the private equity business. Even so, in early 2008, he closed on $1.1 billion and recently upped this cache to $2.1 billion. JPMorgan kicked in $400 million of its own money. The fund, the third largest mezzanine fund behind Goldman Sachs and TCW, trades liquid securities, such as bank debt and bonds and, so far, has made direct investments in five companies.
In September 2008, Kapnick created a levered loan fund, which invests in high-yield first-lien bank debt, raising about $300 million in equity through JPMorgan’s private bank. Credit Suisse provided the fund its leverage facility, bringing the fund’s total capital to $1 billion. “We figured it was a great opportunity to buy leveraged loans amid the biggest correction ever,” Dubin says. Again the timing proved terrible. Two weeks later--September 15--Lehman filed for bankruptcy, and the fund lost a third of its value that year. However, it has surged 77% through July, rebounding sharply this year along with the rest of the credit markets.
Twoyears after striking its deal with JPMorgan, Highbridge created a seven-person investment committee, including five professionals who represent a vast majority of the firm’s risk taking. Of the seven, four members are longstanding portfolio managers--convertibles specialist Vanacore, who joined Highbridge shortly after it began operations in 1992; Carl Huttenlocher, senior portfolio manager of the Asian equities and convertibles group who had spent four years at Long Term Capital Management before founding Intelligent Markets, where he served as chief executive from 1999 to 2001; Alec McAree, senior portfolio manager for the long/short equities group, and Alan Sunier, one of the senior portfolio managers for Highbridge’s statistical arbitrage group.
The committee meets formally every Monday and Thursday to decide on the firm’s market exposure, asset allocation and leverage, among other things. Dubin claims this setup enabled the firm to increase its exposure to the equity markets in March, because the credit portfolio managers who sit on the investment committee noticed that the markets for investment-grade bonds, noninvestment-grade bonds and levered loans were starting to improve.
“We felt this was a major turning point for financials,” Dubin recalls. As a result, Highbridge bought financial stocks at the bottom of the market, which turned out to be a timely call. “We wouldn’t have had the courage to make that decision without the market input from our credit team,” he says.
At Staley’s suggestion, Highbridge also created an executive committee, which in addition to himself, includes Dubin, Kapnick, Builione, Clayton Rose, who was former head of JPMorgan’s investment bank and now a Harvard Business School professor, and Bob Goad, who previously worked in principal investments at Goldman Sachs.
Swieca was never on the executive committee and had begun dialing back his involvement in the firm, slowly transitioning from the investment committee in the middle of 2008. As Swieca geared up to leave the firm, Dubin assumed control of that committee. Swieca says he had planned to leave once JPMorgan completed the acquisition of Highbridge at the end of 2009 and his payout was complete--a timetable that was subsequently moved up. About a decade ago, Swieca, who lives in Manhattan and frequently spends weekends in Atlantic Beach in suburban Nassau County, became an orthodox Jew. He says he now spends most of his time in three places--New York, Israel and Florida.
Dubin lives in Manhattan and visits his home in Colorado.
Now that JPMorgan has completed its acquisition of nearly 100% of Highbridge and Swieca has bowed out, Dubin has signed on for five more years. He likes to say that 99.5% of people in his position would have chosen Swieca’s path and that he stayed on because a lot more work needs to be done. Staley thinks that had Highbridge’s flagship risen 27% last year instead of fallen by that amount, Dubin might have left as well. For his part, Dubin emphasizes: “I’m not doing this for eleemosynary reasons. I have a very attractive economic interest to continue building out this business. If the business makes a lot of money for JPMorgan’s shareholders, I make a lot of money.”
Dubin has mapped out a five-year plan, with private equity getting a lot of attention going forward. “There are tremendous opportunities,” says Kapnick, “as much as I have seen in my 25-year career.”
Kapnick figures there will be a Mezzanine II fund after the current one completes its investment phase. This time, there will be a track record to show potential investors, which should make it easier to raise capital. A second levered loan fund is also in the works. Within a year, Highbridge will probably trot out a midsize buyout fund with an industry focus. Kapnick imagines launching an energy or natural resources fund, partly drawing on Highbridge’s relationship with Louis Dreyfus.
Later this year, Highbridge plans to move across the street from its longtime offices on 57th Street, roughly 10 blocks away JPMorgan’s headquarters on Park Avenue.
Dubin also wants to broaden the scope of Highbridge’s flagship hedge fund, developing a macro investing capability, thinking it would serve as a tactical trading engine in the multistrategy fund as well as help the firm incorporate a macro thought process into its capital allocations and risk-taking decisions. Other products are also on the drawing board, says Dubin.
Meanwhile, Highbridge is trying to leave the 2008 fallout behind. Through July, the two hedge funds for which Highbridge erected gates have gone a long way toward returning money to investors. By the end of July, the multistrategy flagship fund had returned 80% of total capital to investors who redeemed. The assets that had been segregated into a separate pool were up 16%. Highbridge Asian Opportunities had risen 42%, withheld assets were up 6%, and the fund has returned 96% of assets to investors who wanted their money back. The levered loan fund had climbed 78% through July. Perhaps the best sign of its return to health is the fact that in August Highbridge began accepting new investors in the multistrategy fund for the first time since it erected the gates. As of July 1, Highbridge had $17.4 billion in hedge fund assets.
Like most hedge funds that lost money last year, Highbridge must reach its high-water mark--it is roughly five percentage points away from doing so--before it can earn performance fees. In in the interim, it has had to work out employees’ incentive pay packages to retain and attract top talent. “If you have one fund and it is down, the management company is in trouble,” Builione explains.
Highbridge was able to benefit from its diversification and ties to JPMorgan as well as its operations that were not hurt last year--the stat arb hedge fund and its traditional asset management business. The firm agreed to pay its professionals a percentage of what they would have received if the funds were not under water. “The diversity of Highbridge allowed us to subsidize businesses that had a difficult time during 2008,” explains Builione. “We knew it was critical to keep key investment people in their seats.”
Now that Highbridge has successfully transitioned despite the retirement of one of its founders, it faces perhaps its biggest challenge. It must make sure it can survive the eventual departures of Dubin and Staley. Dubin won’t say how long he plans to stick around beyond his five-year commitment.
“We have been planning for this for two or three years,” he adds, referring to Highbridge’s ability to survive the departure of a founding partner. “The day Henry announced he was moving on, there wasn’t even a ripple with the investor base, hedge fund community or our Wall Street counterparties. We felt we did it. We institutionalized our business beyond the two of us.” And although Staley and Dubin are satisfied that the firm did not suffer when Swieca left, Staley is not so confident the same would have happened had Dubin left as well. “I think losing them at the same time would have been a lot harder,” he concedes. “Impossible? No, I am close enough to all of the portfolio managers so Highbridge would have survived it.”
Still, he knows that one day both he and Dubin won’t be around to oversee the company but thinks they have time to get it right: “To make this work took five years,” he says. “To make it really work, we need another five years.”
Dubin insists the organization is prepared, stressing that Staley can retire knowing that JPMorgan owns 100% of Highbridge. At the same time, Dubin knows that he must designate his replacement. He predicts that Highbridge’s top four investment professionals will most likely not be the ones to run the business, which means the task will probably fall to someone like Kapnick or Builione, whom he calls the “finest professional services managers.”
Adds Dubin: “My goal is for when I step down, it will be as seamless as it was for Henry.”
