By Irwin Speizer
Photographs Michael Edwards
Brian Taylor had just launched Pine River Capital Management in 2002 and was pitching investors when Brett Barth came calling. A partner in BBR Partners, the New York asset management company that serves a group of wealthy families, Barth had watched Taylor in previous jobs and sized him up as a promising new face on the hedge fund scene.
Barth found Taylor operating out of a remote lake cabin about 150 miles north of Minneapolis, with his business set up in the basement. Because of an unusual noncompete clause from his previous employer, EBF & Associates, Taylor was barred from establishing his firm within 100 miles of his old firm in suburban Minneapolis.
The cabin was a perfect location for weekend hunting and fishing trips. But for a hedge fund firm with ambitions of becoming a global multistrategy operation?
“A group operating out of a lake house 100 miles out of town felt . . . uncomfortable,” Barth says. “It didn’t give us institutional comfort. Plus, to make the trip to see him was a schlep.”
So Barth waited and watched as Taylor built his firm, moving first to an office in nearby Brainerd and then, when his one-year noncompete agreement ran out, to downtown Minneapolis and finally to his current location in the same office complex in Minnetonka, the Minneapolis suburb that housed his previous employer. Throughout this initial growth period, Pine River posted solid returns and began steadily attracting new investors. Ultimately, BBR was one of them. Barth says Pine River has yet to disappoint. “They always seem to perform,” Barth says.
But first the firm had to overcome its humble origins. Taylor’s cabin was in the town of Pine River, population 928. The cabin became the headquarters of the Pine River hedge fund, which began with $5.3 million in assets, one outside investor, and a frat house ambiance where one of the challenges was assigning dishwashing duty. During hunting season, locals would show up at the cabin offering to butcher deer and make sausage. “Every Thursday was taco night,” Taylor says. “It got old pretty quick.”
Pine River has come a long way since then. Today it manages more than $1.8 billion in assets spread among six funds, five of them single-strategy funds and one a multistrategy. All share a common vision of seeking investment opportunities in mispriced assets. The funds invest in a broad range of instruments, including mortgage bonds, convertible bonds and corporate debt and equity.
“We tend to focus on relative value investing, where there is some type of structural relationship between different instruments,” Taylor says. “We like things where we feel there is some convergence or economic process or sense that will force the realization of some value.”
Its strong returns and solid Sharpe ratios have earned the Pine River funds accolades in AR’s annual hedge fund awards. Last December its Nisswa Fixed Income Fund was named top fixed-income fund of the year and top new fund of the year for 2009, while the flagship Nisswa Fund was nominated in the multistrategy category. The Nisswa Fund rose 91% in 2009 and was up another 5.60% year-to-date through April 2010. The Nisswa Fixed Income Fund, launched in September 2008, recorded an annual net return since inception of 78% through April 2010 and a Sharpe ratio for the same period of 6.39. It rose 92.71% in 2009 and gained another 12.06% year-to-date this year through April. Pine River also operates two convertible arbitrage funds, a distressed credit fund and an event-driven fund.
Nisswa Fixed Income is run out of Pine River’s New York office, one of several satellite offices managed through the firm’s Minnetonka headquarters. From its early days in the cabin, the firm has grown into an operation that spans the globe, with additional offices in San Francisco, London and Hong Kong, and plans for a new office in Beijing.
Taylor, who is 45, now spends most of his time on the road, visiting Pine River’s far-flung outposts. In a typical month he is in Minnesota for about a week, plus weekends home with his family. He maintains a second office and an apartment in New York, the firm’s biggest trading operation. The firm’s staff of 80 includes 10 on the information technology team, who design most of the firm’s trading and analysis software themselves. Each fund has its own portfolio manager, with Taylor now a step removed from the day-to-day investment and operational decisions.
“In the early days I spent a lot of time on non investment matters, such as marketing, because we didn’t have that infrastructure in place,” Taylor says. He adds, “For a firm our size, we have always put a great deal of emphasis on client service, operations and administration. Today I have more time than ever to focus on the investment side because we have the people and processes in place to handle the other important aspects of the business.”
Investors who have been with Pine River for a while say the level of infrastructure and back-office detail sets the firm apart from many others of its asset size. One investor notes that hedge fund managers tend to have a bias toward trading and strategy, often at the expense of infrastructure and back-office functions, but Taylor seems to place nearly as much emphasis on things like investor relations and accounting as he does on trading.
Another investor said the management operation Taylor built resembled a mutual fund as much as it did a hedge fund. Taylor says the attention to organizational detail is partly in deference to the type of institutional investors he wants to attract, who have become increasingly demanding of hedge funds in terms of how they manage their businesses.
“He really invested heavily in the beginning to make sure the back office was state-of-the-art,” says Graham Cook, a partner at Chicago’s Copia Capital, an energy and utility hedge fund. Cook is a personal investor in Pine River. “It was a very heartening thing to see. He did not skimp on expenses. He did not skimp on anything.”
The systems and infrastructure Taylor was building were not just to boost the back office but also to provide tools for investment. Thomas Siering, a Pine River partner and head of fundamental strategies, says the firm has developed systems for screening big databases in search of pricing discrepancies, which has proved particularly helpful in analyzing credit instruments.
“A big emphasis in credit for us has been in capital structure arbitrage: buying one piece of the structure, then selling or shorting another,” Siering says. “We can use our systems to filter through, say, credit default swaps versus bonds. We can screen the universe, distill it down to a list of interesting ideas. We dig in and say, okay, is there something here that at first glance we are missing? If we think there is an inconsistent view by market participants, then there is a trade to be done.”
How that plays out is evident in the Nisswa Fixed Income Fund. Steve Kuhn, who runs the fund, says that when he began researching mortgage-backed securities for Pine River in 2008, he determined that he could get an edge by mining the records of individual homeowners. Kuhn proposed buying one of the most expensive databases of loans tied to mortgage-backed securities and then devoting company analysis and technology resources to an exhaustive homeowner-by-homeowner examination. The goal was to try to rank bonds based on key criteria like loan default and refinance rates.
“I told Brian why we wanted it,” Kuhn says. “How it would give us a better chance of finding undervalued bonds. I would be lying if I said the cost was not mentioned. But even though it was expensive, it was the best database. To not have it would have made it more difficult.”
Taylor, who had recognized the potential in depressed mortgage-backed securities and hired Kuhn in early 2008 to run the new strategy, signed off on Kuhn’s proposal. Kuhn was then able to use the firm’s existing computer systems and technical expertise to help his team crunch the numbers, and the results informed a series of highly profitable mortgage bond investments that produced the outsize returns in 2009.
The actual investments tracked the general theme of relative value investment. Unlike managers such as John Paulson, who made a killing shorting residential mortgage securities before the market collapse, Pine River came in later as a buyer of distressed bonds with underlying value.
The database analysis came in particularly handy in one of Pine River’s critical mortgage plays in 2009 that revolved around a pricing disparity between mortgage bonds with government agency backing and privately placed bonds without it. The agency sector that Pine River picked is called inverse interest only/interest only (IIO/IO). At the end of 2008, agency bonds were being priced as if 60% of their loans would be refinanced and prepaid, while private label bonds were curiously priced as if just 5% would be repaid. Pine River thought the first number was too high and the second too low. It analyzed individual bonds to find those that seemed to most support the thesis, then placed bets on both but in opposite directions, figuring that Pine River would be well positioned whichever way the trends moved. Both agency and nonagency prepayment rates moved in Pine River’s favor, and the ability to select bonds with the best profiles helped amplify the returns.
Similarly, Pine River used its Pines Edge Value Investors fund to play the distressed corporate bond market, employing its in-house systems to screen for promising deeply discounted bonds. In late 2008 and early 2009, Pines Edge began buying corporate bonds along with credit default swaps on the same bonds as protection at a combined price that was at such a steep discount to fair value that it created a nearly risk-free trade. Pines Edge, in effect, crafted combination plays that were so cheap to buy that they tended to pay off regardless of whether the bonds defaulted or recovered. That strategy helped the Pines Edge fund post a 58.42% gain in 2009. The fund was up another 5.7% through April of this year.
The flip side of generating strong returns when opportunities arise is responding to adversity. In the market meltdown that followed the demise of Lehman Brothers in September 2008, a host of hedge funds raised gates or otherwise restricted redemptions to deal with the rush of redemption requests at a particularly vulnerable moment. Pine River honored redemptions during that period, even as it was losing money on investments. The Nisswa Fund, for example, fell 26.72% in 2008. The combination of redemptions and trading losses cost Pine River more than half its assets, which dropped from $1.3 billion in the summer of 2008 to around $600 million by January 2009.
“When markets became dysfunctional in 2008, we expected that clients would need liquidity,” Taylor says. “Many of our competitors put up gates or suspensions or created side pockets. We didn’t get into less liquid investing opportunities, and as a result we were in a position to honor any and all redemption requests. Then we were able to take the capital we had left over and aggressively invest in amazing opportunities. You always perform better when you are on offense than defense.”
That they did. Each of Pine River’s funds significantly outperformed the AR index for the corresponding strategy in 2009, and the funds have maintained an edge in 2010. Taylor is hoping to continue the trend by scouting for new trading opportunities that could result in additional strategies.
Despite the firm’s increasing emphasis on its New York trading office, Taylor has indicated no desire to shift the corporate headquarters out of Minnesota, where it was born and where it still has deep roots, and where the firm’s accounting and back-office functions are located. Much of his management team has connections to Minnesota and the Midwest, which has infused the firm with what investors see as a regional flavor that starts with Taylor himself.
“There is the stereotypical New York hedge fund guy. Brian is not that in any category,” Barth says. “He is just plainspoken, down-to-earth, no spin, very intelligent, well balanced. He is your stereotypical Midwesterner.”
Taylor was born and grew up in Palatine, Ill., a residential suburb of Chicago. His father was the controller of a manufacturing company. Taylor attended public schools and then Millikin University, a small Presbyterian-affiliated school in Decatur, Ill., that his parents, grandfather and sister also attended. He graduated with an accounting major and passed his certified public accountant exam in his home state.
But by then he had developed a fascination with mathematics and finance. After taking some courses in his senior year that gave him a glimpse of options trading, he enrolled in business school at the University of Chicago. He took a summer internship in 1987 with Minneapolis-based Cargill, landing in the equity derivatives trading group. The experience gave him a taste of playing international markets with sophisticated instruments, and he was hooked.
Taylor received his MBA from the University of Chicago in 1988 and went to work for Cargill. That same year three of the founders of the Cargill trading operation split off and formed a new asset management firm called EBF & Associates in Minneapolis. Taylor quickly joined them, starting out as a trader and rising to head of the firm’s convertible bond arbitrage strategy and making partner in 1997.
After 14 years at EBF, Taylor left in 2002 to form his own hedge fund. At the time Taylor says he was managing about $775 million in assets for EBF. Trying to protect itself from the possibility of a brain drain if other top managers decided to leave with him, EBF crafted an unusual noncompete agreement. Since Taylor and other managers at EBF had established roots in Minneapolis, EBF decided it might be useful to keep Taylor out of town for a while. The noncompete agreement restricted Taylor from running his new asset management firm within 100 miles of the city.
Taylor was determined to set up shop in Minneapolis and figured he simply needed someplace just outside the 100-mile radius to park his company until the one-year agreement ran out. “One of the things about Minnesota is that it is the land of 10,000 lakes,” Taylor says. “It is part of the culture of Minnesota that in the summer you go north to your lake cabin. We happened to have a cabin.”
Almost immediately after he left EBF, three others left the firm to join him: Jeff Stolt, the former EBF controller who is Pine River’s chief financial officer; Nikhil Mankodi, who traded Japanese convertibles for EBF and now heads Pine River’s London office and oversees international trading; and Aaron Yeary, the head of Pine River’s New York office and of relative value trading, who was an EBF convertibles trader. All three are now partners.
Pine River continued bringing in key personnel as partners as it grew. It now has eight partners, all with equity stakes in the company. “We very much believe in distributed ownership,” Yeary says. “What we are trying to create is a global asset management organization with distributed ownership. That is very important to maintaining an entrepreneurial spirit. A lot of the best people in this industry want to own a piece of the pie.”
After three months in the cabin, Pine River leased space in a small office park in Baxter, just outside Brainerd, and set up a full trading operation. Curious neighbors in Brainerd wondered why the lights at Pine River never seemed to be off. The reason: Pine River was trading Japanese convertible bonds in the middle of the night.
The first fund, the multistrategy Nisswa Fund, was launched in June 2002, taking its name from a nearby town. While building the firm, courting investors and investing capital, Taylor and the other partners also marked time until they could move back to Minneapolis. The moment the noncompete agreement expired in 2003, Taylor moved the firm to downtown Minneapolis.
As new assets arrived, the firm added personnel, drawing now not just from the immediate area but also recruiting in Chicago, New York and elsewhere.
The London office opened in 2004, followed by the Hong Kong office in 2006 and the New York office in 2007. Siering, head of value investing at EBF, joined Pine River as a partner in 2006 to head up value investing and to run the Pines Edge Value Investors fund.
The desire to build infrastructure has lately taken some unusual turns for what is still primarily a hedge fund company. Steve Kuhn, the fixed income manager, was busy in May putting the finishing touches on a new office in Beijing that was being set up to support his mortgage bond effort.
But the office will have nothing to do with trading in China. Instead, it will be a research and analysis office to support trading in U.S. mortgage bonds.
Why would Kuhn need to go all the way to China to get that work done? Kuhn says Taylor asked that same question. Kuhn explained that his idea was not based on anything that other hedge funds might be doing but rather on what Microsoft was up to.
The software maker was among several U.S. companies that had set up successful research and development offices in Beijing to mine talent from local universities; Kuhn, who had spent time in Beijing before his arrival at Pine River, felt he might be able to do the same. The work he wanted done was primarily statistical analysis and computer modeling, which required skills that he felt he could find in abundance in Beijing.
“It was definitely an outside-the-box idea,” Kuhn says. After he explained how he would operate and manage the office from the United States, and the type of talent it might bring to Pine River and how that could help the firm analyze markets, Taylor agreed.
“He was excited about idea,” Kuhn says. “He is willing to take very unique ideas and run with them.”
For Taylor, the China R&D office fits in with his long-range goal of building an asset management company with a variety of investment vehicles to fit investor needs. The latest venture, Nisswa Tail Hedge, is expected to launch in June and has been designed to provide protection from extreme market dislocations. It will charge a flat 2% fee.
Pine River also added a real estate investment trust last year with a new subsidiary called Two Harbors Investment. That new fund will run a relative value strategy in mortgage-backed securities and will be co-managed by Kuhn and Bill Roth, who was previously a managing director at Citi, where he managed a proprietary trading book that focused on mortgage and asset-backed securities.
While Taylor continues to see investment opportunities for his funds, he also envisions continued growth of the Pine River brand, with ambitions to become more than a hedge fund manager. Taylor says Pine River is built to handle investments in more traditional asset management business in addition to the alternative asset line. “Much of what we do requires significant investment in infrastructure,” Taylor says. “I think we can take some of the tools and techniques we have developed on the hedge fund side and apply them to the more traditional investment side.”
Wherever that quest leads, it is certain to be a long way from that cabin in the woods where Pine River started.
