The Investor's Consigliere

Reuters Article on Hedge Funds and Family Offices

Read it here.  It quotes Greg Coules and Adam Herz of Hunter Advisors.

Coules and Herz make an excellent point (and a courageous one for a firm whose business is recruiting for hedge funds):  In the past ten years or so, the talent followed the money, and the money was in hedge funds, but the majority of hedge funds are not an ideal vehicle for managing long-term money, as this blog has argued.

The ideal vehicle for managing money is long-term oriented, patient, and thinks like a principal, not an agent.  In otherwise, something like a family office.  Coules and Herz are betting that the market will move this way.  Hunter Advisors, as far as I can tell, is the only recruiter shifting their thinking accordingly.  I've been looking for a job for the better part of a year, with a specific focus on family offices, and all the other recruiters I spoke to have given me a litany of reasons why family offices are a terrible place to work.  We'll see who has the last laugh.

I see only one countervailing trend: The goal of any money manager of great talent is to maximize both the quantity and the quality of the money he has under management.  By starting your own hedge fund you can get the former, but often at the expense of the latter.  At a family office it's vice versa, as most family offices are pretty small.  Plus at a family office you're an employee.  So there is a tension there.  One way to resolve it is for family offices to pool their resources and create entirely in-house hedge funds and give autonomy to their managers.  Another way is for hedge fund manager to do so well that they can fire their investors, as Soros has largely done.  Another way is for hedge fund managers to convert their LPs into shareholders, a la Berkshire and Leucadia and (maybe) Steel Partners.  Finally, we've started to see hedge fund managers like Value Act try to improve the quality of their investors by forcing them to behave more like family offices, with longer lock-ups.  So I don't think hedge funds are completely going away.

 

My Job Search Statement, Part II, plus a Request

Many thanks to everyone who replied to my last job search statement--especially to SF.  I really appreciate it.  As promised, here is an updated statement:

I'm looking for a position with a firm that allocates capital to outside money managers.  Briefly, what I offer is the ability to evaluate value investors, as I define the term.  To me value investing is not simply a way of investing in stocks, but a way of thinking about capital allocation in general.  Below is an excerpt from an earlier post in which I tried to define it:

What do I mean by a value investor?  Everyone has their own definition of the term.  My definition is essentially "the kind of investing Warren Buffett has done throughout his career," by which I mean the following:

• You invest in businesses, not pieces of paper.  Your job is to understand a business and predict its future, not to predict the macroeconomy or short-term price movements of securities.
• You want to buy something for less than it's worth, i.e. less than its intrinsic value, the sum of all its discounted future cash flows.  If you're shorting, do the opposite.
• You look for a margin of safety.  Avoiding permanent capital loss is the first consideration.
• You're long-term oriented.  The idea is to increase purchasing power measured over a period of years and decades, not weeks and months.
• You're not too diversified.  There is a scarcity of good investment ideas out there, so concentrate your bets on them when you find them.
• You think like a principal.  Returns after taxes and fees are what you care about.

By my definition, a value investor need not be restricted to investing in publicly traded securities.  So you don't have to be a hedge fund or mutual fund.  A private equity fund can be a value investor, as can, I will argue in a future post, a venture capital investor.  Value investing is not confined to equities, private or public.  A distressed debt investor can often be a value investor (when I worked at a hedge fund I did mostly distressed debt).  A value investor can be a completely passive minority owner of securities, or a 100% owner-operator of a business.  He can invest in "good businesses" like Buffett does now, or "bad businesses" like he used to do.  A publicly traded investment company like Berkshire Hathaway or Leucadia can practice value investing, but so can a "regular" company that does only one thing: to me Sam Walton was one of the great value investors--his only investment was "build more Wal-Mart stores" but the returns on those investments have put most hedge fund managers to shame.

If you or someone you know may be interested in buying what I'm selling, please do let me know.  Thank you.

On a related point, even if I don't find a job for awhile I'm very interested in pretending I already have one and behaving accordingly (not only is this good for morale, but it makes me more employable in the first place).  In other words, I want to meet as many professional value investors as I can, with an eye towards eventually investing with them (but not for blogging purposes, unless you'd like to do an on-the-record interview).  If you think you meet my broad definition of a value investor and are raising capital now, or thinking of raising capital in the future, I'd love to meet you.  Have yellow pad, will travel.  I believe that not all "investors in investors" are created equal, and that a good one can make an investor's job easier, independently of the amount of capital he allocates.  I strive to be a good (limited) partner, and hope one day to have the capital to allocate (Think of me as an  undervalued stock with a high future intrinsic value).  So please let me know if you're interested.

My Job Search Statement

I am searching for a "real" job.  I am posting this in the hopes that one of my readers may be hiring or know someone who is.

I am looking for a position as an institutional investment manager selector, someone who helps to allocate capital to hedge funds, long-only managers, PE funds, and VC funds.  Ideally it would be for an institution that acts as an investment principal, like a family office, endowment, or large pension fund, but I am also looking at firms with clients, like a fund of funds, pension consultant, or hedge fund consultant.

I will send my resume to anyone who requests it.  Briefly, I graduated from Yale and worked for over four years at a large event-driven hedge fund in New York, where I focused on distressed investing.  I have been managing money for a small group of friends and family since 2006 in a concentrated long-only value style.  I look at this blog as a kind of extended resume, or extended job interview in which I'm trying to answer the question "How do you think about investing?"  As far as I know, this blog is one of a very few focused on manager selection. 

I will re-post some version of this post at regular intervals, until I find a job or all of you stop reading this blog in disgust, whichever comes first.  I apologize in advance.  Thank you.

A Little Self-Serving Lament

(Note:  Read only if you care about my job search and can tolerate a little whining)

Yesterday's WSJ had an article about the investment success of the little-known Kresge Foundation.  I don't particularly recommend it, but one sentence caught my eye:

Ivy League and other elite-college endowments use their prestige and large asset size to gain access to the most exclusive private-equity and hedge funds, which often have been a boon to their overall returns.

For the past several months I have been engaged in a job search/client search.  My goal is to work for a family office, hedge fund consultant, fund of funds, or endowment as an evaluator of PE and hedge funds, either as an employee or consultant. 

I've interviewed with quite a few firms, without success.  When I've been told "no thank you" the reason I've heard most often is some variation of "We're looking for someone who already has relationships in the industry . . . this industry is all about relationships."  Although I worked for one of the best-known hedge funds for four years, and I keep a very close eye on the world of value investing, nevertheless I must confess that I'm not a deep networker, if you know what I mean. 

In other words, I don't have the "access" referred to in the quote above.  My observation so far suggests that most institutional investors that allocate capital to outside money managers seek to "win" not by being smart enough to identify the best investors (something I claim to be good at), but by having access to those investors who have already been validated as the "best" (something I'm not good at).  In the others, the celebrities of the hedge fund and PE worlds. 

I'm whining about this for two reasons:

1)  A world in which access matters most doesn't do me much good in my job search.

2)  If your goal as an institutional investor is to achieve the best risk-adjusted return, which is what it should be, then the "access matters most" strategy is not likely to get you there, for the following reasons:

• The hedge fund and PE celebrities, the ones everyone wants access to, manage way more money than they used to, and size will inevitably hinder their future performance.  John Paulson may be a genius, but managing $28 billion and charging hedge fund fees puts his investors at a huge disadvantage.  I'd point out, however, that it does not put Mr. Paulson at any disadvantage.

• Money manager celebrities can often be like Hollywood celebrities--famous for one or two years and you never hear from them again.  If you can't tell the difference between the John Waynes and the Jean-Claude Van Dammes of the investment world, your superior access won't help you.

That's the bad news for me.  The good news is that I have to believe that, somewhere over the rainbow, there exists an institutional investor that either can't or chooses not to play this game.  Maybe it's a family office that's too small and unprestigious to matter to the big funds, or an endowment that, like David Swensen's Yale, understands that you can't simply invest where everyone else is investing and hope to get a superior result. 

I just have to find them.

(P.S.  I'm interested to hear what my readers think.  Am I correct in my view of the world of institutional investing, or am I just shell-shocked from rejection?  Do my "over the rainbow" investors exist or am I kidding myself?  If they do, how do I find them?  Thanks)

Could you please explain . . . CDS?

A good deal of what I do as an investment advisor is try to explain to clients certain finance-related concepts that they might read about in the paper but, because they're not in the business, don't completely understand.  I didn't think I would do much of this but to my surprise I've found I enjoy it, and am pretty good at it I'm told.

I believe part of what I could offer a family office client/employer is the ability to explain investing to the non-expert.  At the risk of "talking my own book," in my experience most finance professionals are actively bad at this.  Maybe they have no patience to explain things, or they think it's beneath them to have to deal with such simple things, or, worst of all, they don't understand what they're doing well enough to explain it to someone else.  Or maybe the ability to teach well and like it is independent of your underlying motivation.

My philosophy of explaining things is as follows:  Leaving aside the benefit others get, from a purely selfish POV your ability to explain a complicated subject to a non-expert can only help you.  As Vince Lombardi or Peter Lynch demonstrated, (who if I'm not mistaken both received a Jesuit education, which stresses the ability to explain from first principles.  Maybe a topic for another post.) the ability to teach something so that everyone can understand it is a mark of your own ability to understand and think.  Plus it tests your ability to discard the jargon that all priesthoods set up "as a conspiracy against the laity."  Warren Buffett is the king of this.   However, like Einstein, I believe that everything should be made as simple as possible . . . but no simpler.

On that note, and in the hopes of advancing my career prospects, I will be posting some of my answers to the "Could you please explain . . .?" questions I get from clients and friends.  Starting with the following question from my law school friend:  "Could you please explain CDS (credit default swaps)?"

1)  A credit default swap (CDS) is a form of insurance
for bondholders.  Anyone who holds a bond is exposed
to the risk that the bond will default, in which case
the bond either becomes worthless or worth only a
fraction of par, depending on its recovery in a
bankrputcy or restructuring.  

2)  The idea of insurance simply means that in
exchange for a payment to someone else, the person
exposed to the bond's default risk transfers that risk
to someone else.  

3)  Mechanically, in a CDS there are two parties: the
buyer and the seller (or writer).  Back in Garden of
Eden days, the buyer was a bondholder worried about
the likelihood of his bonds defaulting, and the seller
was a Wall Street bank with a good enough credit
rating to ensure performance.  Today CDSs are used for
hedging and speculation, so the buyer can be anyone
and the seller can be anyone.

4)  Just about all CDS contracts state the security in
question (e.g. the unsecured debt of General Motors)
and the two initial counterparties (buyer and seller).
  The buyer of protection agrees to pay an annual fee
to the seller.  This fee is usually stated in terms of
basis points of par.  Think of it as an insurance
premium, no different than a car insurance premium.

5)  If all goes well and the bond pays off at
maturity, the premium payments are "wasted":  the
bondholder's total return is whatever interest and
principal General Motors paid him, muinus the CDS
insurance premiums paid to the CDS writer.  The writer
of the CDS, on the other hand, is a winner to the tune
of whatever CDS payments he received during this
period, just as GEICO is the winner when your car
doesn't crash.  Neither the CDS writer nor GEICO has
to do anything else.

6)  If, however, the bond defaults, the writer of CDS
protection is now on the hook.  The buyer of the CDS
is entitled to be made whole.  There are two ways to
do this.  The first is physical settlement:  the
holder of the defaulted bond physically delivers it to
the CDS writer, and in exchange receives in cash the
par value of that bond.  Now the CDS writer is the
holder of a crappy defaulted bond and will try to get
whatever it can for it.  The second way is cash
settlement:  Both parties wait to see what the
defaulted bonds recovers in bankruptcy or
restructuring, let's say 40% of par, then the writer
of the CDS pays the buyer an amount in cash equal to
the difference between par and the recovery amount. 
So in this case, the CDS buyer keeps his bond and gets
40 cents on the dollar for it, then receives cash
worth 60 cents on the dollar from the CDS writer, for
a total of 100 cents total value, making him whole.

7)  Note that General Motors is not a counterparty to
the CDS contract.  It just issues the bonds to the
market and goes about its business, while others
create contracts among themselves that reference the
GM bonds (called the "reference security" in the CDS
contract).  

8)  Also note that the buyer of the CDS is not
required to be an actual holder of the bond in order
to enter into a CDS contract.  He can just be a
speculator willing to make a few premium payments to
someone else in exchange for that someone else's
promise to pay him 100 cents on the dollar if some
reference security out there defaults.  Today there
are many more CDS contracts written than actual
reference securities out there.

9)  Finally note that the writer of the CDS is just
selling a promise:  a promise to pay some value in the
future if certain events happen.  Therefore the CDS
contract is only as good as the ability of the CDS
writer to keep its promise.

10)  Why is this all becoming so important now that
the WSJ is constantly writing about it?  Basically two
things are going on:

     a)  Many of the bonds that had CDS contracts
written on them long ago are starting to default, or
threatening to default.  Not so much the vanilla
corporate bonds like GM, but rather the complex
mortgage-backed bonds, especially those tied to
subprime mortgages.  Bondholders who used to be happy
to receive their coupons and wait for maturity are now
saying "sh-t, these bonds I own will default. 
Fortunately I have insurance and can be made whole. 
Unfortunately the person who promised me the
insurance--MBIA, AMBAC, AIG, etc.--made the same
promise on billions of dollars of other bonds.  So
maybe my insurance is worthless, which would suck.  I
thought these bonds would be worth 100 cents come hell
or high water, but now I may have to mark them down on
my balance sheet."

     b)  The writers of these CDS contracts put them
on their balance sheets as "assets."  Actually, they record
the premiums they receive as assets, and the fair value
of their potential obligations are recorded as liabilities.
If the fair value of these liabilities goes down, the 
corresponding increase in shareholders' equity represents 
the "profit" from writing the contract.  It's complicated.  
Think about it this way:  If you're party to a contract 
that entitles you to receive regular payments (CDS premiums 
in this case) and only under certain circumstances to pay out
to someone else (CDS settlements), then the fair value
of the liabilities depends on the probability you'll 
have to make your settlement payments in the event of a default, 
the magnitude of those payments, and the time value of money 
(prevailing interest rates).  The market now perceives that 
the first of those variables, the probability you'll have to keep
your promise to make the CDS buyer whole in the event
of default, is way higher now.  So all CDS writers are
having to mark up the liabilities associated with 
their CDSs, sometimes very painfully--MBIA and AMBAC 
are in danger of going under, AIG just took a multi-billion 
dollar hit.