By Irwin Speizer
Stanley Druckenmiller took the investment world by surprise in August when he announced he was shutting his New York–based Duquesne Capital Management and returning money to investors. Sure, he was having an off year, reportedly down about 5% at the time. But with $12 billion in assets under management and an enviable record dating back to the firm’s founding in 1982, the decision to fold rather than try to sell the firm or pass it along to successors came as a shock.
Druckenmiller’s departure highlights the challenges facing successful hedge fund managers as they confront issues of succession and institutionalization at the businesses they created. Many of today’s largest fund firms remain tightly controlled by founding managers, often now in their 50s and 60s, who find themselves trying to figure out how (or whether) to keep their operations running in their absence and how to dispose of the equity they have in those businesses.
Managers are trying to deal with the issue through a variety of strategies, from taking their companies public, to selling stakes or their entire firms to other companies, to ceding power to newer top-level managers who might be capable of running the firms. Underlying it all is the question of how to value equity in the firm that the founder controls—and what to do with it once the founder decides to step aside. While there is no clear blueprint for setting up a succession strategy, one point seems clear: It is becoming harder to avoid the subject, particularly for large, established fund companies controlled by aging founders. Some of the big names who have been drawn into the succession debate recently include Paul Tudor Jones, Steve Cohen and Mark Kingdon.
“In a lot of cases, the founder has taken a reduced role over the years and brought on other people to run the business for him,” says David Efron, a partner in the law firm Schulte Roth & Zabel. “In cases where the founder has remained very much in control and involved in the business, it is much, much harder to turn it over to a group of partners.”
Efron says managers are starting the succession process by elevating others and adding new layers of management depth and structure. The goal is to move toward a point where firms can operate and produce solid returns without the active, constant participation of the founder.
But the complex equity questions are often left for later.
The challenge can be especially daunting for managers who have attained star status in the hedge fund game. As one investor noted after the Duquesne announcement, “For the most part, these hedge funds are not going concerns. When the key guy is done, the firm is over.”
That’s particularly apt in describing what happened at Duquesne. Druckenmiller, 57, never warmed to the recent move toward more institutional-style operations and fretted about today’s more restrictive operating environment. Rather than try to mold Duquesne into an institution that could be passed along or sold, Druckenmiller opted to give himself a pink slip. He will continue managing his own considerable fortune, but outside investors will have to put their money elsewhere.
The star-manager issue cropped up more recently at Gartmore Group, the London-based asset manager and hedge fund operator. Gartmore had hired a stable of crack managers to run its investment operations. But when two of its top managers, Roger Guy and Guillaume Rambourg, decided to leave this year, investors headed for the exits, causing such a significant drain that the firm’s viability was put in jeopardy. In November, Gartmore announced that it had hired Goldman Sachs to advise it on “strategic options,” a move that suggests the company is up for sale.
At some other funds where well-known founders have sought to cede some measure of authority to others, performance suffered or other difficulties arose. George Soros has tried to step back several times, only to find he had to return to a more active role after performance at Soros Fund Management suffered or other problems cropped up. Jones, founder of Tudor Investment Corp., had to return to a command position at his firm in 2008 after his designated heir, Jim Pallotta, left and the firm struggled in the financial crisis. When Druckenmiller closed his fund this year, Jones issued a statement to AR assuring his investors he would stick around at Tudor for at least five years.
David Rocker ran Rocker Partners for 21 years before retiring in 2007 and ceding both control and equity to Marc Cohodes, his longtime co-managing partner. Cohodes renamed the firm Copper River Management. But Copper River barely made it a year, liquidating in 2008 after it got hammered during the market crisis when the government imposed a temporary ban on shorting and Lehman Brothers, which was a counterparty to Copper River on CDS trades, collapsed.
And then there is Steve Cohen, the founder of SAC Capital Advisors. After his fund lost 27.56% in 2008, he had to push aside top managers he had previously installed and resume control. Cohen is once again trying to retreat and claims to manage the investment of just 10% of the firm’s $12 billion in assets (about 70% of which is reportedly Cohen’s own money). But the normally reclusive Cohen has also had to reassure investors lately that he has no intention of leaving the company any time soon, following a July profile in Vanity Fair in which he talked about how he was setting up the firm to be able to trade and function without him so he could stop trading in a year’s time, if he desired.
The historical importance of the founding managers is reflected in the widespread use of key man clauses, which give investors the option of a relatively quick withdrawal in the event a hedge fund loses a manager viewed as vital to the fund’s performance. Key man clauses can complicate the process of setting up a succession plan, since any hint that the central figure in a fund is contemplating his departure can trigger a run.
The key man clause likely came into play at Shumway Capital Partners, which was founded in 2002 by Tiger Cub Chris Shumway and which managed $8.5 billion as of July. Shumway recently announced that he would hand the role of chief investment officer to another firm executive, Tom Wilcox, while remaining chief executive and chairman of the firm.
But the switch, along with some other management shuffles, prompted the firm to give investors until December 3 to submit redemption requests. The changes came after the firm’s equity vehicle, the SCP Atlantic Fund, was down an estimated 3.55% through September.
Managers tend to clam up when asked about succession, so exactly how much planning is actually taking place in the hedge fund industry is somewhat of a mystery. The succession issue recently slipped into the open at Mark Kingdon’s $4.6 billion Kingdon Capital Management. After Marjorie Kaufman, the firm’s investor relations manager, was let go recently, she released a letter explaining what happened as well as some comments about the firm’s succession planning prospects. “Kingdon is now grappling with issues regarding its future viability,” she wrote. “The firm faces difficult and sensitive challenges pertaining to succession.”
Kaufman’s observations on Kingdon’s succession prospects come despite efforts undertaken by the firm. Founder Mark Kingdon, 61, has told investors he plans to transfer control of the firm by his 70th birthday. In March 2010, he created a four-person committee of top firm executives to address the issue. But he has not discussed how he will deal with the equity in the firm.
In its annual review of trends in the asset management business, Russell Reynolds Associates, the talent search and consulting firm, found that established hedge fund managers were more focused than ever on trying to devise ways of passing on their firms to the next generation. “This is a teenage industry growing into grown-up status,” says Lynn Tidd, managing director of the hedge fund practice at Russell Reynolds. “They have to start thinking about what they leave behind.”
Some observers believe that despite the recent rise in chatter about hedge fund succession, not enough real planning is actually taking place. Mike Hennessy, co-founder of Morgan Creek Capital Management, says his firm now routinely asks about succession planning as part of its reviews. The discussion is almost always uncomfortable for managers, who are reluctant to reveal much even if they have a plan, Hennessy says. “It is surprising how many haven’t thought about it,” he says. “It’s worrisome.”
When the New York accounting firm Rothstein Kass surveyed 349 senior partners at U.S.-based hedge fund firms in 2008, 75% said they did not have a formal succession plan for ownership and control, and those who did said their plans had not been updated in three years or more. Howard Altman, co-CEO at Rothstein Kass, says he is not sure much has changed since the survey was taken. “I think the issue of succession in a hedge fund is much more difficult than in most businesses,” Altman says. “You need the internal talent and the investors almost to form a triangle of trust that will allow the founder to be able to get it to the next generation.”
Still, there are a number of examples of hedge funds that have embarked on the succession path, including a few in which successful founders have left or retired and whose firms continue to operate. The job of transitioning to the next generation tends to be toughest for firms with star managers and narrowly defined strategies closely associated with the trading savvy of the founder.
An exception appears to be Renaissance Technologies, where founder James Simons retired as CEO at the end of 2009, leaving behind his protégés Peter Brown and Robert Mercer as co-CEOs. Simons remains chairman and principal shareholder of the company that he built into a pioneer of computer-driven trading, but the investments are now run by his successors. After a couple of years of pretty miserable returns, the two institutional funds appear to be turning around. For example, Renaissance Institutional Futures Fund won AR’s managed futures fund of the year award for 2010.
One of the earliest attempts at a succession was engineered by Harlan Korenvaes, who founded HBK Capital Management in 1991. When he decided to retire in 2003, Korenvaes relinquished control of the firm—including equity—to those who remained. That gesture of giving up any claim to equity, which is rare in the hedge fund business, made it easier for him to step aside and for his successors to take the reins.
Korenvaes says one of the biggest obstacles to hedge fund succession is the concept of permanent equity that founders can either sell to successors or retain after their retirement so they can continue to share in the firm’s profits. He argues for a partnership system in which there is no transferable permanent equity. That would promote a system of meritocracy and remove what he calls “free ridership” by managers who can get rewarded for passive equity ownership in their firms instead of solely for active investment management. “This industry is very skewed toward a hedge fund manager’s permanent ownership,” Korenvaes says. “I knew from day one what I would do with it: I would give it back.”
Today, HBK is run by 10 partners who effectively own the firm and have the power to hire and fire the president. They share in the profits of the firm only as long as they actively work there. HBK points to its ownership structure as the foundation of its succession planning. “It is not practical to let the key man retire and be a significant drain on the firm,” an HBK spokesperson says. “If that drain is big enough, it could make it difficult for the firm to succeed.”
But HBK’s transition following Korenvaes’s departure has been a bumpy ride, characterized by years of sometimes tepid performance and structural changes. The management committee that ran the firm after Korenvaes left morphed in 2004 into a board led by a chairman, Laurence Lebowitz, who was one of Korenvaes’s first hires at HBK. Lebowitz aggressively sought to expand, growing the firm to $14 billion in assets by July 2007. But returns began to sag. HBK had an annualized return of 16% in the decade before Korenvaes’s departure in 2003. Over the next five years, annualized returns were a little less than 9%. After 2007, bad investments in CDOs resulted in losses and a redemption run that drained billions from the firm’s asset base. Lebowitz retired in 2009, and a second succession took place, resulting in the revised management structure that exists today. As of June 30, HBK was a shadow of its former self, with only $4.8 billion in assets under management.
Hedge fund advisers and consultants note that few hedge fund managers are willing to follow the lead of managers like Korenvaes and walk away without seeking some compensation for equity in the firms they created. Hedge fund founders are no different from other successful small-business owners who expect to be able to sell their businesses when they are ready to retire. “Everyone is struggling with this issue. People have realized they did create something of value,” says Dean Barr, who previously was CEO of Citigroup’s Tribeca Global Management.
Barr recently launched a new company, Foundation Capital Partners, which offers to buy equity stakes of less than 20% from founders of hedge funds with more than $5 billion in assets. Foundation is in talks with several managers to make its first investment. Barr figures that about 50 of the 150 largest hedge funds may be candidates for its brand of investment.
While Foundation represents a new twist on the equity issue, it is not alone in seeking to buy stakes in hedge fund firms. Several equity sales have taken place over the past few years with Wall Street banks as buyers. One of the biggest recent acquirers is Credit Suisse, which agreed in September to pay $425 million for an estimated 30% of Jamie Dinan’s York Capital Management (see “Jamie’s Dream”), then followed up in October with a deal for a 25% stake in Daniel Stern’s Reservoir Capital Group.
Hedge fund D.E. Shaw, which had $17.8 billion under management as of July 1, sold about 20% of the firm to Lehman Brothers in 2006, a stake that remains tied up in the Lehman bankruptcy. Meanwhile, founder David Shaw, 58, has become the firm’s chief scientific officer—an unusual position at a hedge fund firm—and spends most of his time on a cancer research project. He has handed over management of the firm’s hedge fund business to a six-member committee.
But the firm remains closely held by David Shaw. He is listed in the firm’s Securities and Exchange Commission registration as owning between 50% and 75% of the equity, with the rest divided among the other managers and the Lehman stake. The company declined to discuss what plans exist for transfer of Shaw’s interest if that becomes necessary.
In another large equity transaction, JPMorgan completed its staged buyout last year of Highbridge Capital Management, which had $16.46 billion in assets as of July. The buyout process began with an initial purchase in 2004. Co-founder Henry Swieca left the firm in 2009, but his founding partner, Glenn Dubin, remains CEO of Highbridge. Dubin points to the Highbridge deal as a model of how hedge fund ownership can be institutionalized and passed on.
“Highbridge doesn’t look and feel like a hedge fund trying to figure out what to do with rest of its life,” Dubin says. “It looks and feels like an institutional asset management organization.”
One element that eased the transition at Highbridge was the fact that Swieca and Dubin always functioned as business managers who hired others to do the actual investment. That setup avoided the star-manager syndrome that complicates succession for many other founders. In addition, Highbridge ran a multistrategy collection of funds rather than focusing on one strategy closely linked to the investment savvy of the founder.
“There are a lot of founders of hedge funds who have decided to close their funds or retire and stop trading, and they didn’t leave much behind them,” Dubin says. “We built an organization that we felt would outlive both of us. You have a couple of options. You can go public, but the jury is still out on whether or not that is a successful model. The other model is that you merge with a large institution that will be around for hundreds of years. We chose the latter.”
Similarly, York Capital Management’s decision to sell a stake to Credit Suisse and spread equity beyond founder Jamie Dinan is a way to deal with the succession issue. (See “Jamie’s Dream” in this issue.)
Dan Och is among those who have placed a bet on the public model. His Och-Ziff Capital Management Group, which had an estimated $25.3 billion under management as of July, went public in 2007 at $32 a share, giving founder Och, 49, a market to dispose of his equity while also providing a way to reward his stable of top managers through stock awards. But the stock price quickly dropped and was trading in the $15 range in November.
According to an Och-Ziff proxy filed with the SEC in May, not much of the company is actually owned by the public. Och himself still owns 49.8% of the class-A shares, while three other executives own 20.6%, giving Och and his team 70.4% of the public shares. Och controls all of the company’s nonpublic class-B shares, which, together with his class-A shares, gives him control of 77.4% of the voting shares of the company he founded in 1994.
SEC filings offer a peek at the Och-Ziff succession plan, although the details remain sketchy. According to the proxy, the Och-Ziff CEO must file an annual report on his succession plans with the board of directors, including his recommendation for a successor CEO if he is unable or unwilling to continue. Och is both chairman of the board and CEO. He declined to comment on the succession plan or whom he has recommended to succeed him. His top lieutenant is David Windreich, 52, who is head of U.S. investing.
A succession plan popular in small businesses that rarely comes up in hedge funds is the family model, in which the founder passes the business along to an heir. That process is complicated by the reliance of hedge funds on talented asset managers. But there are a few sons taking on larger roles in the firms of their fathers.
Elliott Management, the firm founded by 65-year-old Paul Singer in 1977, announced in October that it granted promotions and equity rights to three of its top managers, including the founder’s son, Gordon Singer, who was added to Elliott’s risk management committee. Brian Miller was promoted to chief trading officer, while Jon Pollock moved even closer to the top, being named co-chief investment officer, a role he will share with the founder. In announcing the moves, Paul Singer indicated he had no intention of stepping aside any time soon, saying he planned to continue as CEO of the firm, which had $16.9 billion in assets as of July 1.
In another familial move, hedge fund icon Julian Robertson has promoted one of his sons to a top position in his firm. Robertson is now working on reconfiguring Tiger Management, his seeding platform, either by raising new money or selling part of the business.
In July, the 78-year-old Robertson announced that he had promoted his youngest son, Alex, to managing partner to help run the business together with newly hired operations chief John Townsend, who was recruited from Goldman Sachs. The senior Robertson remains CEO and chairman of the company.
Despite all the talk of institutionalization, much of the hedge fund field is still run by micromanaging founders who often are as keen on their own self-interest as on the future of the companies they create. The atmosphere fostered by that type of management can be difficult to control, much less pass on to successors.
“It is almost medieval,” says one hedge fund veteran. “If there is a strong king, the baronies stay in line. If the king gets hit by a bus, either one baron exerts hegemony or you have the War of the Roses.”
So far, the all-powerful kings of the hedge fund world have managed in large measure to keep their baronies in line. But as they reach retirement age and begin to consider what to do next, succession questions will no doubt become more urgent, forcing founders to consider future options that many would rather avoid.
“Founders are unwilling to face their own mortality, ” says one insider. “After all, they are masters of the universe.”
