Stock Market and Investment Losses and Investing and Investment Advisers and Banking & Finance

SKARBECK: Hedge fund superstars take it on the chin

September 19, 2009

Lauded as “masters of the universe,” the star investment managers overseeing the largest hedge funds built huge firms.

Many followers believed these managers, with their ability to go long or short and hedge their portfolios, could consistently produce positive returns, uncorrelated to the ups and downs of the broader securities markets.

The auras surrounding many of these financial titans have faded, though, shattered by the market meltdown. Huge losses have driven some out of business, while others have been left severely wounded.

Upon further review, many of these funds were not properly hedged portfolios, but instead were pools of money run by cowboy capitalists, making huge bets with borrowed money. That was the eventual source of their undoing.

On the heels of massive losses, waves of investors have requested withdrawals. Unfortunately, some funds employed tactics to delay or block those demands since their portfolios were chock full of illiquid and hard-to-value investments. As a result of the losses and illiquidity, investors such as pension funds and endowments have been rethinking the significant allocations they have made in alternative investments.

The endowments of Harvard and Yale universities had achieved excess returns for more than a decade from alternative investments, yet both sustained 30-percent losses last year.

Among the once-esteemed alternative managers, Cerberus Capital, run by Stephen Feinberg, has been trying to placate investors who want to withdraw $5 billion. That amounts to 70 percent of the firm’s assets after a 24.5-percent loss in 2008. Cerberus sustained huge losses investing in Chrysler and GMAC.

Ken Griffin, the wunderkind of Chicago-based Citadel Investment Group, had generated 26-percent annualized returns the past 17 years, but almost destroyed his firm with a 55-percent loss last year.

Citadel took out loans worth nine times more than its assets, and spent much of last year trying to raise cash to pay back lenders.

You may withhold your sympathy for Timothy Barakett, who earned $675 million in 2006, but closed Atticus Capital after losing 30 percent last year.

Then there is John Meriwether, who presided over the collapse of Long Term Capital Management in 2008, and was forced to close his second hedge fund after losing 44 percent from September 2007 to February 2009.

Elsewhere, Pequot Capital, at one time the world’s largest hedge fund under Art Samberg, liquidated in May after being cited by the Securities & Exchange Commission in 44 cases of potential insider trading and market manipulation.

We once noted—back in 2007, when the private-equity funds Blackstone and Fortress were going public—that those transactions were signs of investment hype typically seen at peaks. Yet, predictably, the consultants to pensions and endowments were at the time advising large allocations into alternative assets.

Now, ironically, as alternative investors seek to extricate themselves from their illiquid investments, they are likely to cut deals to sell to vulture investors at bargain prices.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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