The Fearless First Mover: David Tepper, Appaloosa Management
In 1997, David Tepper was scheduled to meet Russian investor Boris Jordan at the Renaissance Capital offices in Moscow, but when he arrived, Jordan was not there. Tepper and a colleague somehow ended up in the basement facing five men with machine guns. Tepper had learned some Russian in high school and managed to say, “We’re going upstairs!” He later received a call from Jordan’s assistant cancelling the meeting because there was a bomb scare in the building. “I was like, are you kidding me? Why didn’t you tell us before bringing us into the middle of a death trap?”
In retrospect, Tepper was just too long in Russia going into 1998. He had made a lot of money in 1996, but then miscalculated the risks. The Russian ruble had been devalued and the country defaulted after an IMF deal. Tepper had thought that bond prices would go up, which it did for about a day and a half before going straight down. Appaloosa hadn’t realized how fast the markets were becoming illiquid, as Russia’s default brought on a near global financial meltdown. The firm was about $1.7 billion in assets at that time, and lost approximately 29 percent on the whole and $80 million on Russia.
“It was the definitely the biggest screw up of my career,” says Tepper. “We had huge emerging market and junk positions that we sold down to avoid disaster, so we were able to act fast. Our biggest mistake was not realizing how illiquid markets could get so quickly. Many firms went out of business at the time, and at one point, I wondered if we would be able to survive. That was kind of an interesting lesson for a lot of people,” he says.
But Tepper bounced back in 1999 — and with a 61 percent net gain no less — as he bought back the Russian bonds post-default. The banks couldn’t get the bonds off their books fast enough and so Appaloosa was able to swoop in and collect the debt at 5 cents on the dollar. “It was like minting money,” he recalls. “It was almost worth all of the hell we had to go through,” he says with a laugh.
The Global Macro Maven: Ray Dalio, Bridgewater Associates
Ray Dalio began to write his Principles—roughly 200 life, management, and investment guidelines—in the mid-2000s after observing that the employees at his growing firm were straying from the company’s basic tenets. He didn’t originally want to give out this “advice” but found that his friends and colleagues were struggling with issues that were all related to them, and he wanted to help.
Dalio says the principles for successful investing are the same as those for becoming a successful manager or leading a successful life. “You have to be assertive and open-minded at the same time. This is true in the markets; this is true in almost everything. You have to learn from your mistakes to keep getting better. And it’s through learning from those mistakes that you learn what reality is and how to deal with it, which is called principles. Knowing what’s true, whether you like it or not, is a tremendous asset. There’s no sense in fighting reality.”
The principles permeate everything Bridgewater does. Employees are encouraged to constantly ask themselves and their colleagues, “Is this true?” New hires are handed the text even before reporting for their first day of work on campus. Earlier this year, all employees were given iPads preloaded with Principles.
Dalio thinks it’s the fastest route to getting people where they want to be. “I learned that being totally truthful, especially about mistakes and weaknesses, led to a rapid rate of improvement and movement toward what I wanted,” Dalio says in the Principles.
Dalio has observed it takes about 18 months for a new employee to get used to the radical truth culture, and the firm publicly acknowledges that the culture is not for everyone. On its website’s career page, Bridgewater asks potential applicants to ask themselves, before applying for a job there, if they want to: discover their strengths and weaknesses, work to get better fast, put aside ego barriers to learning, and demand others to be truthful and open and whether they are prepared to do the same. In Dalio’s Principles he supports this by saying, “There is nothing to fear from truth. Being truthful is essential to being an independent thinker and obtaining greater understanding of what is right.” That, in essence, is what Dalio hopes everyone that comes to Bridgewater will eventually learn.
The Poison Pen: Daniel Loeb, Third Point
Call it confidence, call it aggressiveness, or call it a passion for risk. There is a theme running though the life of Daniel Loeb, the founder of the $9 billion hedge fund Third Point. You see it in the boy on the surf board challenging the waves off Malibu Beach (whose legendary break inspired the name Third Point); in the 12-year-old who fought the bullies at Paul Revere Junior High School in Los Angeles with his allowance, hiring a classmate as his bodyguard for a quarter a day; in the college student who precociously amassed $120,000 in profits from playing the stock market then lost it all on one bad trade; and in the hungry young junk bond salesman at Jefferies & Co., who late in 1992 heard that David Tepper was planning to leave his job as the head trader on the high-yield desk at Goldman in order to launch his own firm. Loeb promptly called Tepper at home. “I want to cover you,” he told Tepper.
“Unfortunately, I don’t have a need for you; I’m unemployed,” Tepper responded. Or anyone else, for that matter; Tepper’s hedge fund Appaloosa was not yet formed.
“That's okay,” said Loeb, “If you want to buy 50 bonds or something for your ‘PA’ (Personal Account), I just want to cover you. I'm sure you're going to end up someplace.”
Daniel Loeb smiles at the recollection of his confident younger self. “Note to the salesmen out there—be aggressive,” he says. “I literally cold-called him at home, when [Tepper] had no job. So by the time he started Appaloosa, I had established the relationship with him. He became my biggest client. I was his biggest salesman.”
You can also see this attitude in what has become a signature of Loeb’s investment style and what he is perhaps best known for — the letter to the executive. Dan Loeb’s frank, insightful missives to the officers of the companies in which he is invested have made him feared in underperforming boardrooms and companies, and created a new literary art form. Call it the Blast. Since he started Third Point in 1995, Loeb has periodically shared with the delighted public candid, direct letters he has written to the top brass at companies suffering poor results brought about by management’s missteps. His assertions attract attention and his criticisms run the gamut from accusations of incompetence (“To ensure you a dazzling place in the firmament of bad management,” he writes to one recipient), to laziness (“I saw the crowd seeking autographs from the Olsen twins just below the private box that seemed to be occupied by Mr. Dreimann and others who were enjoying the match and summer sun while hobnobbing, snacking on shrimp cocktails, and sipping chilled Gewürztraminer.”), to lame corporate governance (“I must wonder how in this day and age, the company's board of directors has not held you...responsible for your respective failures and shown you both the door long ago – accompanied by a well-worn boot planted in the backside.”)
As much as Loeb’s investors love him for his returns, the public loves him for his rabble-rousing. In 2011 Loeb announced that he would no longer author the lively quarterly letters to his investors (which inevitably became public) where so much of what The New Yorker called his “hedge-fund populism” was expressed. Until late 2011, Third Point had shied away from high-profile activism for four years.
The Risk Arbitrageur: John Paulson, Paulson & Co.
John Paulson wasn’t afraid of the challenge of building his own business. “People kept saying that if you start your own business you’re going to fail,” he says, “but I never thought I would. I thought that in order to do well, all I needed to do was compound at above-average rates of return and I thought, ‘Why shouldn’t I be able to do better than average?’ That seemed to be the easy challenge. So all you had to do was minimize losses and make more than average. If you can do that, you could be successful. And I already had the skills to do that in risk arbitrage, mergers, and bankruptcies.”
So he launched Paulson Partners in 1994. He started with $2 million of his own money and waited for the phone to ring. He sent out 500 announcement cards to potential investors saying, “We’re pleased to announce the formation of Paulson Partners” and told his lawyer he expected “to open” with $100 million.
But raising money was tough. “Although I had a lot of contacts,” he says, “I didn’t have a lot of money. I sent those announcement cards out to everyone I knew and I thought the phone would ring and everyone would be calling to invest. Well, the phone never rang. I got only one card back from Ace Greenberg offering congratulations.” So Paulson picked up the phone, and was met with a mix of indifference, skepticism, and occasional curiosity. “Some did provide a sliver of encouragement and said, ‘John, you know, I like you but you don’t have a track record so come back when you do.’”
Paulson knew he had to build a track record. But this was a daunting task given the small capital he had and it took not a small amount of effort to stay positive. He recalls: “It was so very tough coming to work every day, making calls, having meetings and then getting rejected. People would avoid my calls or make appointments and then cancel. Some of the junior analysts at Bear when I was there were now partners. I’d call them and they wouldn’t see me—guys that worked for me!”
That arduous process took an entire year before Paulson & Co. finally landed its first investor. Paulson had grandiose expectations that weren’t quite met. “I was like, okay, here comes $10 million! And then it was…$500,000,” he said shrugging.
The allocation came from Howard Gurvitch, a friend and former associate of his at Bear Stearns. Gradually some other friends began to pile in and Paulson built up his investor base. Then one day he got his first $5 million investor. “This was a very wealthy guy; he had at least $200 million and he sent me $5 million,” Paulson recalls.
“That more than doubled my capital. I was so excited—I was finally at $10 million. He was reading all of these letters and thought that from the way I spoke that I managed more than $100 million. He later told me that if he knew I only managed $5 million, he would never have put in $5 million, since he has a policy against being more than 5 percent of any manager.”
Barely raising enough capital to run his tiny fund took a toll on Paulson. “I had to swallow my pride, buckle down the hatches and just be patient. I ran the firm professionally in terms of research, portfolio management, monthly reporting and audited results and doing all the work you needed to do even though the position size was small,” he says.
Distressed Debt’s Value Seekers: Marc Lasry and Sonia Gardner, Avenue Capital Group
The Robert M. Bass Group, later called Keystone, Inc., had been known as a breeding ground for some of the world’s top private equity investors, including David Bonderman, who went on to found Texas Pacific Group (TPG), and Richard Rainwater. When Marc Lasry and Sonia Gardner joined the Bass Group, they were given a portfolio of $75 million to invest in trade claims, bank debt and senior bonds. They reported to Bonderman, then the Bass Group’s Chief Operating Officer. Lasry was 30; Gardner was 27. From the beginning, Bonderman recalls how Lasry came onto the scene and blew the guys at Bass away. “He didn’t always speak up,” Bonderman says. “But when he did he always had a vision for the investments that no one else saw. He always brought fresh perspective to the table.”
The siblings wanted to call the entity “Maroc” after their birthplace, Morocco, but a Bass colleague advised them to pick a name starting with the letter “A” so they would be on top of all the distribution lists. They flipped the first two letters and settled on Amroc Investments. Aside from Amroc’s flagship $75 million fund, they also had a drawdown for another $75 million, giving them access to $150 million in capital, which made them one of the largest distressed funds in the U.S. at the time.
“I met all these exceptionally smart guys at Bass,” says Lasry. “David Bonderman, Jim Coulter, Tom Barrack and many others. It was a phenomenal period and I quickly realized I was dealing with guys who are off-the-wall smart and really good guys—nice, smart people.”
Even though they were doing very well under the Bass umbrella, after about two years, the siblings were ready to really strike out on their own. “I think it was a little bit of hubris probably,” Lasry admits.
Lasry and Gardner opened their own boutique distressed brokerage firm in 1990 with $1 million of their own capital, keeping the name, Amroc Investments, and their affiliation with the Robert Bass Group. Gardner remembers the pride she felt in building a business. “It was just the two of us and a secretary when we started - we were both working 14 hour days, seven days a week. We slowly built one of the largest private distressed debt brokerage firms that existed at the time, and expanded Amroc to more than 50 employees. “
Lasry was keeping up a grueling schedule, meeting with clients and bankers establishing relationships, and brokering billions of dollars of debt for their clients. “At the same time, for five years, we also ran our own money, just my sister and me,” says Lasry. They stuck to their winning formula, managing Amroc and continuing to invest their personal capital, and generated compound annual returns in excess of 50 percent.
MAN vs. Machine: Pierre LaGrange & Tim Wong, MAN Group / AHL
Observing the peerless dance duo Fred Astaire and Ginger Rogers glide across the screen, the actress Katherine Hepburn reportedly decoded the duo’s brilliant chemistry saying, “He gives her class and she gives him sex appeal.”
Those may not be the precise adjectives that come to mind when thinking about the Man Group’s 2010 blockbuster acquisition of GLG Partners, but they’re not far off; in creating the world’s largest hedge fund organization, with $69 billion in assets, each partner brought unique characteristics. In the Man Group, a company so old school, it’s where the old school went to school, shareholders get the hardnosed quants who note every price fluctuation in every trend in order to patiently profit from the long term trends. In GLG Partners, they get a star culture of investment gurus whose collective reputation for success attracted $30 billion in assets. Not class and sex appeal exactly; more like grit and glamour, patience and spark.
Opened as a sugar brokerage by barrel maker James Man in 1783, the flagship of the company’s operation, with $23.6 billion in assets, is AHL. This unit was founded by Michael Adam, David Harding, and Martin Lueck, three analysts who studied physics at Oxford and Cambridge Universities, who eventually sold the firm to Man in 1994. Rigorous in its study of long-term trends, AHL has achieved an annualized return of 16.7 percent from its inception in March 1996 through September 2010. But as Man Group CEO Peter Clarke told Institutional Investor in 2011, “clients, especially those in Asia, wanted exposure to a discretionary single manager.”
Enter GLG, which has single managers by the score. Established in September 1995 by Noam Gottesman, Pierre Lagrange, and Jonathan Green, a trio of erstwhile Goldman Sachs private-client executives, GLG quickly became home to nearly 200 elite fund managers, each of whom is free to pursue his or her own strategy. Though enormously successful—along with substantial growth and profits, the firm has won numerous accolades and awards—a system so dependent on star power has proven to be unstable; the departure of the highly successful trader Greg Coffey a couple of years ago triggered an outflow of several billion dollars.
With their needs and assets so obviously complementing one another, Man and GLG began exploring a merger in 2008. Those talks were abandoned amid the turbulence of the financial crisis, and were resumed with a new urgency in the aftermath.
In the face of significant losses, Man’s CEO Peter Clarke began the search for new assets. GLG was the first place he turned, and he found receptive listeners. Between the market turmoil of 2008 and Coffey’s departure, GLG’s stock price tanked, and the amount of assets under management fell to $17.3 billion, reportedly threatening to put GLG in breach of a covenant on a $570 million loan from Citigroup. Although the company rebounded rapidly, Clarke’s call came when the smell of disaster was still fresh in the air. Suddenly, each side saw itself looking at a partner who not only addressed its problems, but promised attractive synergies. With the allure of becoming the first $100 billion hedge fund too sparkly to pass up, the acquisition was announced.
Observers fully expect the new Man Group, with the quants designing new products for the gurus, to become not only the first hedge fund to surpass $100 billion in assets, but suggest that -- if hedge fund growth continues as analysts predict and that if big successful funds continue to take advantage of their scale to keep attracting new assets -- the Man Group could reach the $200 billion mark in the not too distant future.
Two of the Man Group’s key executives, Tim Wong, the CEO of AHL, and Pierre Lagrange, one of the three founding partners of GLG, each had very different paths they took to the Man Group, but now work hand in hand to run one of Europe’s biggest, and most complex, hedge funds.
The Activist Answer: William A. Ackman, Pershing Square Capital Management
“What motivates people to succeed?”
That was the question posed by the 45-year-old hedge fund manager Bill Ackman to a roomful of students in a real-estate entrepreneurship class at Wharton Business School. It was a sunny afternoon in October, the last class of an eight-lecture series and the students had prepared by reading Christine Richard’s book Confidence Game, which details Ackman’s six-year battle with bond-insurer MBIA. But even after a few hundred pages on that struggle, and the subsequent fight with then-New York Attorney General Eliot Spitzer, the students were still not prepared for Ackman’s answer.
“Sex,’’ he told them. “People don’t like to admit it but it’s the primal driver.”
There was pin-drop silence. Slowly a few chuckles began to break out from the back of the room. Ackman took off his suit jacket, rolled up his sleeves, and glanced up at the clock. Perpetually overcommitted, the founder and CEO of $11 billion fund Pershing Square Capital Management had been in meetings in surrounding Pennsylvania all day and, by then, was running low on energy.
Pershing Square’s goal is to work closely with the companies in which it invests to make their businesses more valuable by improving operational performance, selling or spinning off non-core divisions, recruiting new management, or changing the company’s strategic direction or corporate structure among other approaches.
In time, these changes should be reflected in the stock price. “We buy 8, 9, 10 percent of the company when we see long-term value in the investment, when the pieces are worth significantly more than the entire business or an operational change needs to take place,” he said. “We don’t predict when the stock market is going up and down or what’s causing that,” said Ackman. “So we’re not in a rush to get out.”
After taking a sip from the water bottle beside him, Ackman propped himself up on the desk at the front of the class and glanced at the clock once more. There was an hour and a half to go. “Fundamentally,” he continued, “what drives most human behavior is basically foreplay.” The students began turning to look at each other, not quite sure how to react. He trailed off as the room erupted in laughter and Ackman smirked goofily, sporting a slight blush.
Always energetic, Ackman morphs from aggressive, when dealing with stubborn executives of underperforming companies, to charming and benevolent when dealing with his partners and employees, whom he considers like family. But Ackman understands the dynamic between him and the embattled executives of the companies he targets. He likens a company’s board of directors to a club, to which he’s been reluctantly invited. “Do you really want to invite in the outsider who's barging his way in the door because he bought a bunch of stock in your company? That's how some directors think about it,” he explains. But that doesn’t stop him from doing his job with laser-like focus.
“Raising money for a start-up hedge fund is a lot like blind dating,” Ackman says. “You meet someone you’ve never met before, you have a limited time in which to make the pitch and then you try to close the deal. Charm matters,” he says with a chuckle. “And sometimes people with the best ideas aren’t very good at blind dating. When I decided to run a hedge fund out of school, I’d meet with a hundred people before one or two would finally agree to invest with me. In order to be successful, you have to make sure that being rejected doesn’t bother you at all. So for example, in college when I was dating and a girl didn’t like me, I didn’t get upset. I thought that if she didn’t like me then she clearly wasn’t right for me. You should surround yourself with people that believe in you in life and business.”
The Derivatives Pioneer: Boaz Weinstein, Saba Capital
Over the years at Deutsche Bank, as Boaz Weinstein’s team increased its scope, it more closely resembled a hedge fund, and began to be treated as one by the investment banks that provided salespeople to service the team’s trades. It was only natural that Weinstein began to think about launching his own hedge fund. By 2005, he was sharing these thoughts with his bosses at Deutsche.
Highly reluctant to lose Weinstein, they gave him wider authority and responsibility within the bank. By 2006, Weinstein was running junk bonds, corporate bonds, convertible bonds, and credit derivatives globally. At the same time, Deutsche encouraged his entrepreneurial ambitions within the bank structure, and, in a significant concession, allowed him to brand his proprietary trading group, to facilitate an eventual lift-out from the bank. And why not? Weinstein’s earnings were certainly extraordinary. In 2006 the proprietary unit alone was managing $3 billion and earned $900 million for the bank. The following year, it managed $5 billion, and earned $600 million for the bank. “I loved working at DB,” Weinstein says. “I was very happy there for a long time. I got to be part of a firm that was very entrepreneurial and that gave me responsibility and the opportunity to build businesses at an early age.”
And yet Weinstein remained eager to be on his own. When he finally told Rajeev Misra, his boss, of his decision, it came at a time when Misra himself had just negotiated his own exit from the bank; if Weinstein were to leave immediately, Deutsche would find itself uncomfortably thin at the top. Anshu Jain, the head of the investment bank, offered to let Weinstein spin out into a hedge fund on the condition that he stay one additional year to transition his responsibilities… Weinstein agreed.
That year turned out to be the turbulent 2008. Sensing a period of difficulty, Weinstein’s group was positioned cautiously. Consequently, says Weinstein, “all through the Bear Stearns collapse and into the summer, we were slightly ahead for the year, which was a decent result.” Then came the collapse of Lehman Brothers. “That in itself wasn’t the problem for a fund that is both long and short, but it was the secondary effect, where people actually thought Goldman Sachs and Morgan Stanley could go under. That was stunning.”
As part of Deutsche’s senior management, Weinstein spent that dramatic “Lehman Weekend” at the Federal Reserve Bank in New York, in the company of senior government officials and the top executives of the other large banks, attempting to work out contingency plans. Weinstein worked in the credit group. Their assignment was to try to figure out what sort of transactions the banks would need to do with each other to reduce their exposures to Lehman if it failed. “The counterparty exposures between banks were immense,” says Weinstein. “The Fed wanted us to focus on how we could reduce those exposures on a Sunday assuming that Lehman would default the next day. But the exercise was really like moving deck chairs on the Titanic. Because collectively there were over a million trades between Lehman and the banks.”
Weinstein’s fund at Deutsche Bank lost 18 percent in 2008, his only losing year since he began investing in the credit markets. Per his pre-existing agreement with the bank, he soon went out on his own. The fund has been a spectacular success. Given Weinstein’s long record, it quickly attracted many investors, and has amassed over $5 billion of capital. Of that, $700 million is invested in a separate Tail Hedge strategy, which aims to protect client assets against significant market declines. And since inception, Saba Capital has had a 12 percent per annum net return.
What accounts for Weinstein’s great returns, even in years that have generally been tough for hedge funds? For one thing, the fund hit the ground running: As a result of the preparatory work done throughout 2008 on the planned spinout, Saba was able to begin investing only six weeks after the team’s departure from the bank, and the speedy transition meant that Saba kept current on the markets and maintained continuity. Then there are the qualities that have sustained Weinstein throughout his career – intelligence, discipline, pluck, enthusiasm for his work, and a distinct ability to stay calm even under the most trying of circumstances. A colleague at Deutsche Bank recalls that even during the difficult period of the Lehman crisis, you couldn’t tell from looking at Weinstein whether he was up or down that day, and that his leadership was steadfast.
The Cynical Sleuth: James Chanos, Kynikos Associates LP
Jim Chanos founded Kynikos, who were the cynics in ancient Greece, in 1985, just five years after he graduated from Yale University with a degree in economics. Chanos had grown up wanting to be a doctor but destiny had other plans. He stumbled into short selling by accident when, while working for Gilford Securities as an analyst in Chicago, he issued his first stock report in the summer of 1982. The company was Baldwin-United Corporation, the piano maker turned financial services company. Chanos found that the company had a hefty debt load and what he called “liberal accounting practices,” a red flag that would come up throughout his search for investment opportunities time and time again. The stock kept climbing from $24, when Chanos first wrote the report, to about $50, before the inevitable tumble in early 1983, as Chanos’s thesis proved correct down to the T. The stock was trading at $3 by September 1983.
Eventually, industry legends Michael Steinhardt and George Soros, wanted to know what other ideas Chanos had to short. He could see where the opportunities were and had the stamina to stand by his convictions. “I knew the problems inherent in being on the short side, but even when a stock was running up, it didn’t bother me much. I knew I was right,” says Chanos. It was a trade that few analysts could master so Chanos decided to strike while the iron was hot. If he could do institutional research—well documented and well researched—on flawed Fortune 500 companies, he realized, “people will pay me for this.” So he moved to New York to broaden his exposure at Atlantic Capital, a unit of Deutsche Bank. He quickly attracted clients like Fidelity Investments and Dreyfus Corporation. Chanos left Atlantic Capital after a “ridiculous” article in the Wall Street Journal, in which he had naively agreed to be quoted, had angered his bosses in Germany. The article painted short sellers as evil speculators “specializing in sinking vulnerable stocks with barrages of bad-mouthing” wrote Dean Rotbart, then a reporter for the newspaper. “They use facts when available, but some aren’t above innuendo, fabrications, and deceit to batter down a stock.”
At twenty-seven, Chanos decided to strike out on his own, getting backing from two venture capitalists, who wanted him to run a short portfolio for a wealthy family. Because it was relatively virgin territory, the playing field was very lucrative. “There wasn’t a lot of capital in the strategy,” Chanos recalls. The majority of the investors at Kynikos were wealthy individuals. Pension funds found it too risky even though the strategy was perfect for tax-exempt investors because profits from short selling are treated as ordinary income. Short exposure also allowed clients to mitigate risk by giving them investments that weren’t correlated to the stock market. David Swensen, head of Yale University’s Endowment, was the first tax-exempt client to put money with Kynikos, and stayed with the fund for five years. Kynikos’s Ursus Partners fund returned 35 percent before fees in 1986, compared with 18.6 for the S&P 500 Index. In 1987, it rose 26.7 percent while the benchmark index rose 5.1 percent.