By Irwin Speizer
Photographs by Mackenzie Stroh
Nearly four years ago, Ross Margolies suddenly found himself out of work, having just shut down his hedge fund business, Saranac Capital Management, before it ever really got off the ground. Margolies had planned to spin out Saranac, a group he had been managing at Citigroup, but he got sideswiped by an internal scandal in the bank’s Japanese operation that touched off a redemption run just as he was getting under way. Saranac’s swift demise left the then 48-year-old wondering how his long career on Wall Street had so suddenly jumped the tracks—and whether he would be able to get it back on again.
“I was emotionally drained,” Margolies says of the experience, which tarnished an otherwise stellar reputation. Margolies had distinguished himself as a top-rated mutual fund stock picker and portfolio manager before building what became a $3.2 billion multistrategy and long/short hedge fund operation within the big bank.
Margolies sought advice and guidance from friends, acquaintances, people he had met at conferences—anyone he thought might help him put his career back together. The soul searching eventually paid off. Armed with cash from a loyal following of investors, Margolies launched Stelliam Investment Management in 2007 and was up and running by August.
If his first bid to become an independent hedge fund manager was a flop, his second act has enjoyed a much more auspicious debut. Its success has demonstrated that the Wall Street veteran long regarded as an ace stock picker hasn’t lost his touch.
It didn’t take long for the new firm to find its footing: The Stelliam Fund’s main class B shares returned a whopping 49.78% in 2009, about double the rise in the S&P 500. It also won AR’s award for U.S. equity performance last year.
“Ross would have never had a degree of satisfaction the rest of his life if he had not bounced back,” says Peter Wilby, general partner and chief investment officer of Stone Harbor Investment Partners, a New York investment firm that focuses on high-yield, emerging market and investment-grade debt. Wilby, who has known Margolies for more than two decades, is an investor in Stelliam. “After family, this is everything to him,” he says.
Stelliam’s big 2009 return followed an impressive 2008, when savvy short plays helped Stelliam to post a 2.86% rise—despite the beating equities took that year. Stelliam finished its first, partial year of trading in 2007 with a 6.47% gain. Stelliam has now produced an annualized return since inception of 22.73% and a Sharpe ratio of 1.79.
By the end of 2009, Stelliam Fund had $339 million under management, with another $115 million in a separate Stelliam long-only fund. Margolies was a net buyer of securities in 2008, with the fund’s net exposure rising from 26% to 57% during the year. Long exposure jumped from about 51% at the start of the year to 95% by year-end, while short exposure peaked at 54% in mid-Sepember before settling back to 38% by the end of 2008. At that time, the fund was 95.4% long and 38.4% short.
While the surging stock market of 2009 clearly helped Margolies, his portfolio points to a nuanced strategy. His core strategy in the Stelliam Fund revolves around long equity investments, but he also places short bets and invests in convertibles.
Stelliam’s stock picks span a diverse range of companies, many of them underappreciated names. Among his top holdings at the end of 2009 were Coca-Cola Enterprises, Gamestop, Pfizer, JPMorgan Chase, ExpressJet Holdings, Microsoft and Navios Maritime Holdings. One of the most frequently repeated compliments that investors bestow on Margolies is his ability to find winners—particularly long-term winners—where others don’t.
“He is the best company selector I have ever known in my career,” Wilby says. “He is a brilliant investor.”
Margolies’ stock-picking ability derives from a combination of skills learned during a lifetime spent on Wall Street in a variety of roles, from credit analyst to convertibles manager. He has never been keen on short-term analysis, preferring to look for companies that he can hold profitably for periods of one to two years.
“Investing based on consistently predicting if a company will beat the quarter is a hard thing to do,” Margolies says. “By investing based on a company’s business strategy, and following them for long periods of time, you can tell if their strategy is correct. We are not trying to get an edge on anybody. We are trying to understand things so we can make a better judgment.”
One key to Margolies’ style is his reliance on credit analysis—a skill he picked up early in his career—to inform his view of a company’s prospects. Wilby says that these credit smarts give Margolies an advantage over the crowded field of equity analysts who tend to focus mainly on company-specific business fundamentals like quarterly earnings, sales and stock price movements—but who often have a limited understanding of balance sheet issues that drive credit analysis.
“Most equity guys I know are clueless as to credit,” Wilby says. “Ross has a much broader view.”
Margolies figures that can help him divine important hints about how banks and lenders perceive a company’s prospects—particularly a company that others think is in financial trouble. “Banks get companies’ internal projections and plans,” Margolies says. “Look at how banks are acting. What are they doing with the extra data they get? Are they working with a company, or are they fighting with it? Are they squeezing a company or giving them room? The worst thing you want to see is a bank wanting its money back. When markets panic, for many companies we can figure out who will go bankrupt and who will likely not.”
Margolies has used this type of analysis to guide a number of investments. One recent example is Macy’s, which he started aggressively buying in 2008, when the stock was in the high single digits and on its way down. While a number of other analysts decided that Macy’s would have trouble generating enough cash to stay out of serious trouble in the economic downturn, Margolies thought the company’s finances were solid enough to weather the rough conditions.
The divergent views were clearly evident in reactions to the company’s finances. The downturn had put a squeeze on the ability of companies like Macy’s to meet immediate credit terms, and Macy’s creditors responded by offering some relief in exchange for higher fees. Most equity analysts saw this as a sign of trouble for Macy’s because debt covenants had been breached. Margolies viewed it as a clear indication that creditors believed Macy’s would survive and were giving Macy’s a little more room to maneuver.
Margolies’ view proved prescient when Macy’s announced in November 2008 that it had generated enough cash to pay down $950 million in debt. The stock shot up to a high of nearly $21 by September 2009. Margolies expanded on his debt analysis methods in a 2009 investor letter. “In today’s skittish markets, pronouncing the words ‘this company is going to violate a bank debt covenant’ is the financial equivalent of yelling ‘fire!’ in a crowded theater... Tripping a debt covenant is not synonymous with going bankrupt, although if you look at the reactions of equity investors lately, you would think it is.”
Before he could make those types of bets, Margolies had to restart his career after the demise of Saranac. He says that during his down time, he got advice on how to build a new hedge fund from a competitor, whose name he declines to reveal. Margolies recites the advice with delight, as if he were telling the story for the first time. “He said to me, your problem is you built a house without a strong enough foundation. A storm came and blew your house down. The next time, you need to build something that will be standing regardless of what storm comes by.
“The second thing he said was to create a firm around your own personal traits and investment style. Don’t change it to suit someone you want to hire. Create an environment that you want to work in, and hire people who also want to work in it.”
Adds Margolies: “His parting words were to start small and have a very exclusive fund. I have lived by his advice ever since.”
In building his new firm, Margolies assembled a small team, later adding people he had worked with at Saranac, and he gave all of them a stake in the company to insure that their interests and the company’s were aligned. He kept the fund’s strategy simple and based it around what he knew and loved best: buying stocks.
For Margolies, the most important lesson gleaned from the competitor’s advice was to create the job he wanted, which for him meant focusing almost exclusively on analyzing and picking stocks. He also wanted to create a work environment in which his team had enough input in the decision-making process to reap the psychological, and not just economic, rewards of winning investments.
Margolies called on previous investors who knew him and respected his past work, and he encouraged them to sign up under longer-term lockups to prevent unraveling from a sudden redemption run. The longer lockups provide him with more time to work out his long equity positions.
By offering lower fees for those who took such lockups, he convinced almost all of his new investors to take him up on the offer. Most opted for three-year lockups that charged a 1.25% management fee and an 18% performance fee, a slight discount to the standard 2% and 20% for those who took one-year lockups in Stelliam.
Margolies recently cut his one-year fees to 1.5% and 20% and added incentives for those who opt to switch from shorter to longer lockups once they are invested. He also honored high-water marks for Saranac investors who moved to Stelliam. Only some of those investors’ portfolios were below their high-water marks, and those were all in the low single digits, Margolies says.
Margolies named
the fund Stelliam, a combination of the first names of his mother and father, Stella and William, with the invented word serving as a constant reminder to him of his desire to create a workplace reflective of the family environment he remembers fondly. Margolies says that what characterized his home life growing up was an abiding sense of fairness and equality.
“There are two extremes in hedge funds,” Margolies says. “There is the mercenary model, where you eat what you kill, and if you don’t kill something every month, you are dead. The other extreme is the collegial approach. The latter is my business model.”
Those who know Margolies say the collegial atmosphere doesn’t mean an absence of interpersonal friction. One longtime acquaintance describes “screaming matches” he has had with Margolies in the past. But he says Margolies also understands and appreciates contrary investment opinions and has an ability to incorporate other views into investment decisions. Another longtime acquaintance says Margolies is a perfectionist who can be “abrupt and demanding” at times, causing tension between him and his team. But the same person also notes that Margolies is very good at choosing people who can ultimately work with him.
Rick White, managing partner at Minot Capital, a global investment adviser managing about $1.5 billion, has invested with Margolies for years, including in Stelliam. Margolies may be intense at times, but he stands apart from much of the high-flying hedge fund world, says White.
“Ross is not remotely similar to your stereotypical hedge fund diva,” says White. “He leads a relatively simple life. He is just a guy who loves stock market investing. It is what he lives for. He has the bug.”
Margolies lives in New Jersey with his wife and three children, and commutes by train into the city each day. That he ended up on Wall Street was something of a surprise to him.
The manager grew up in Rockland County, New York, in the 1960s, the eldest of four children. His father was a middle school principal, his mother a dietician. A decent student who was active in sports, Margolies decided that he would become a doctor so that he could have an interesting career and help people at the same time. The first hint of an interest in finance came after he did a school report on the stock market and became so intrigued that in high school he would often go down to the local brokerage house to watch the electronic ticker. He started reading business publications for fun, and he began investing in stocks with money he earned delivering newspapers and from other summer jobs.
He enrolled at Johns Hopkins University as a chemistry major, figuring that if he got decent grades in the undergraduate program he would have a better chance of getting into the vaunted medical school. But he was stumped by an organic chemistry course and found himself reading the newspaper business section in class. Outside of school, he continued to dabble in stocks with his stake of a few thousand dollars. In his sophomore year, Margolies switched majors from chemistry to economics and never looked back.
One of his college pals, Jeffrey Aronson, says Margolies was obsessed with stocks and company news even in his student days. “The rest of us, we didn’t care,” says Aronson, co-founder and managing principal of Centerbridge Partners, a New York firm that invests in private equity and distressed debt. “But that was what he wanted to talk about,” adds Aronson, who was one of the first investors in Stelliam.
Margolies graduated in 1981 with a bachelor’s degree in economics and immediately took a job with Guy Carpenter & Co., a reinsurance broker. His job was collecting on reinsurance claims after disasters. In 1984, he switched jobs and became a corporate valuation analyst for KPMG.
Throughout this period, he took night classes at New York University’s business school, commuting into the city each day from Hoboken, N.J., and often staying late to attend classes. He finally got his master’s of business administration degree from NYU in 1987 and used it to land a new job as a high-yield credit analyst with Prudential Insurance. From there Margolies moved to Lehman Brothers in 1989 in a similar role and then to Salomon Brothers Asset Management in 1992 as an equity analyst in a newly acquired mutual fund operation. He started out covering sectors that he had watched at Prudential—food and beverage companies and supermarkets—and quickly worked his way up to portfolio manager, then head of the equity team and eventually head of a newly formed hedge fund operation at the firm.
Margolies first gained national recognition as head of the Salomon Brothers Capital Fund, the mutual fund he took over in 1995. He posted an average 28.36% annual return over five years, putting him in the top 10% of mutual fund managers. He also displayed two traits that later hedge fund investors would find particularly attractive: He picked different stocks from those most favored by other analysts, and he displayed a knack for continuing to make money even during periods when the overall market was down. For his efforts, he was named one of the original Morningstar Five Star managers and became a regular on the Barron’s list of top 100 managers, rising as high as third one year. He left the Salomon Capital Fund in 2004 to launch a hedge fund for Salomon, departing with a record of 18.14% annualized returns during his tenure, compared with an 11.75% rise for the S&P 500.
While at Salomon, Margolies also ran the long convertibles portfolio, posting 14.25% gross annualized returns during his tenure from March 1, 1993, to November 30, 2001. By comparison, Merrill Lynch’s convertibles index posted an annualized gain of 10.33% for the period. Unlike the index, which showed three years of losses, Margolies posted gains every year.
In 1998, Travelers Group acquired Salomon Brothers, and then Travelers merged with Citigroup. Margolies became part of a global financial conglomerate, and the new corporate culture didn’t suit him. He found the layers of bureaucracy increasingly difficult to navigate, and the distractions infringed on his time to do financial analysis.
“By August 2003, I’d had my fill of Citi,” Margolies says. He was running $3.2 billion in hedge fund assets, raised primarily from Citigroup’s private client bank and much of it coming from Japan. Margolies gave Citi two options: He could transfer the hedge fund business to someone else at Citi, or he could spin it out and continue to run money for Citi clients. Citi agreed to the second option.
In November 2004, Margolies opened Saranac Capital Management, taking his 42-member team with him. He left with an agreement to continue managing the Citi funds. But the timing of the spinout could not have been worse. Citi had become embroiled in a banking scandal in Japan, with regulators there leveling a host of charges, including failing to advise some investors of true risk levels and making loans that were used to manipulate stock prices. Japanese regulators ordered Citi to close its private banking group there. Much of the hedge fund money that Citi was putting into Saranac came from Japan. Of the original $3.2 billion, about $300 million was redeemed before the spinout process even began. Margolies tried to raise new money, but the redemption run continued, aggravated by some investment losses posted in early 2005.
The withdrawals drained more than two-thirds of Saranac’s assets by the end of 2005, and the seemingly endless delays and complications made it difficult for Margolies to raise new money. In May 2006, he conceded defeat and closed Saranac.
“We were down to $600 million in assets,” he says. “I didn’t see any way of turning it around without unacceptable risk for my investors. I decided to give back the money and start my career over. One of my biggest clients advised me not to do it, to hang on. But it wasn’t viable.” Margolies viewed his position as a bad stock play, where the smartest move is to accept the losses and move on.
“In hindsight, I was wrong to do a spinout,” Margolies says. “I should have started over at that point in time.”
Aronson says that part of the problem for Margolies was that by spinning out Saranac, Margolies was taking on the job of running a fully staffed, operating company with dozens of employees, and that meant focusing on a range of operational duties that a parent company like Citigroup had provided for him. Instead of ditching the distractions, Margolies carried them over to Saranac.
“This started off day one as a fairly large organization,” Aronson says. “The challenges of that and the need to focus on one’s portfolio was really a hard balancing act. I candidly think the need to run the business cut into his ability to manage the portfolio the way that he likes to.”
Stelliam, by contrast, began as a stripped-down version of the hedge fund operation Margolies ran at Saranac. He brought a handful of his most trusted team members from Saranac with him to launch the new company. He never bothered to relocate and still occupies the same offices he did when he ran Saranac, although he gave up most of the space. Today he works out of a small office on the 16th floor of the same building.
Flush with outsize returns in 2009, Margolies says he is ready to start courting institutional investors (his initial fundraising focused on wealthy individuals and longtime friends and associates). While he does not have a hard target for future asset size, he says he would like to manage at least $1 billion of assets between the Stelliam Fund and the Stelliam Offshore Long Fund. He can see himself bulking up again in the future, although he does not anticipate ever getting above $3 billion to $4 billion.
It remains to be seen how Margolies’ fund will respond to market conditions in 2010, with equity markets having endured a rough start to the year. But Margolies says the fund’s positioning now is not radically different from how it was positioned in 2009, because the firm takes a fairly long-term view when it comes to long positions.
And while the fund’s exposures can change with market fluctuations, Margolies says it mostly adheres to a ratio of long to short positions that ranges from 2:1 to 4:1. The fund’s net exposure is expected to range from 50% to 100%, while gross exposure is expected to range from 125% to 175%. Margolies notes that when comparing Stelliam’s portfolio from December 2008 to that of December 2009, 59% of the long positions were from the same issuers. The fund declined by 1.73% in January 2010.
Stelliam, Margolies says, will remain a “boutiquey” fund closely tied to his personal interests and skills. He is determined not to repeat the Saranac experience. “I learned a lot of lessons,” he says, but they dealt primarily with the business aspects of running a hedge fund. As far as investment techniques, he continues to ply his trade just as he has for decades.
As Margolies puts it, “I am the same investor I was.” AR
