Hedge Hunters E-Book

Katherine Burton

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Bloomberg
• Sprache: Englisch

Seitenzahl: 453

Veröffentlichungsjahr: 2010

Beschreibung

The hedge fund industry's top managers have a penchant for high returns and low profiles. The combination makes them a regular focus of the media, eager to know what makes them tick. Now, thanks to Katherine Burton, who's been covering these noteworthy traders for Bloomberg News for more than a decade, we know considerably more about them. With candor and detail, the industry's most successful hedge fund managers describe the events that shaped their personal journeys, the strategies they use to produce returns even in uncooperative markets, and the attributes that make a smart investor. Hedge Hunters offers a rare look at the industry's top performers and an introduction to some of the most talented new managers, handpicked by the masters themselves.

Leseprobe

Table of Contents

Praise

Title Page

Copyright Page

Dedication

Preface to the 2009 Edition

Preface to the 2007 Edition

Acknowledgements

Chapter 1 - Mark Yusko

AFTER THE CRISIS - Getting Real

Chapter 2 - Michael Steinhardt

AFTER THE CRISIS - No Excuses

Chapter 3 - John Armitage

AFTER THE CRISIS - Assessing the Unknown

Chapter 4 - Marc Lasry

AFTER THE CRISIS - Out of Trouble

Chapter 5 - Craig Effron

AFTER THE CRISIS - Why Size Matters

Chapter 6 - Lee Ainslie

AFTER THE CRISIS - Optimism on the Rise

Chapter 7 - Bernay Box

AFTER THE CRISIS - Moving On

Chapter 8 - Boone Pickens

AFTER THE CRISIS - A Focus on the Future

Chapter 9 - Brian Bradshaw, David Meaney, Michael Ross, and Alex Szewczyk

AFTER THE CRISIS - Expecting the Unexpected

Chapter 10 - Josh Friedman and Mitch Julis

AFTER THE CRISIS - No Worm for the Early Bird

Chapter 11 - Jeffrey Schachter and Burton Weinstein

AFTER THE CRISIS - Smart Accommodations

Chapter 12 - Dwight Anderson

AFTER THE CRISIS - From the Ashes

Chapter 13 - Roberto Mignone

AFTER THE CRISIS - Repairing the Damage

Chapter 14 - Bruce Ritter

AFTER THE CRISIS - Profits and Predictions

Chapter 15 - Julian Robertson

AFTER THE CRISIS - Crisis? What Crisis?

Chapter 16 - Jim Chanos

AFTER THE CRISIS - A Nose for Losers

Chapter 17 - Richard Perry

AFTER THE CRISIS - The Trouble with Truisms

Chapter 18 - Daniel Loeb

AFTER THE CRISIS - Charting a Way Back

Index

About the Author

About Bloomberg

PRAISE FOR

Hedge Hunters

Hedge Fund Masters on the Rewards, the Risk,and the Reckoning

BY KATHERINE BURTON

BLOOMBERG NEWS

One of Amazon.com’s Best Books of 2007

Top 10 Editors’ Picks: Finance & Investing

“A readable, relevant book, with lessons a new generation of hedge-fund managers, in a decidedly less hospitable investment climate, would do well to take to heart.”

—BARRON’S

“A fine introduction to hedge funds for both the interested reader and those contemplating a career in this area of investment.”

—LIBRARY JOURNAL

“Great descriptions of the backgrounds, philosophies, and practices of the best managers, told in a rapid, entertaining narrative—I learned quite a lot.”

—DAVID EINHORN Manager, Greenlight Capital Hedge Fund

“This is a page-turner, with insights from some of the legends of the hedge fund industry. And it’s written in a wonderfully engaging style by a veteran journalist with unprecedented access to these titans of Wall Street.”

—ANDREW W. LO Harris & Harris Group Professor Director, MIT Laboratory for Financial Engineering MIT Sloan School of Management

“Burton . . . break[s] new ground by profiling thirteen up-and-coming managers selected by ten acknowledged ‘leaders and legends.’ Well written.”

—PUBLISHERS WEEKLY

Also available from

Bloomberg Press

Complicit:How Greed and Collusion Made the Credit Crisis UnstoppableBy Mark Gilbert

Confidence Game:How a Hedge Fund Manager Called Wall Street’s BluffBy Christine Richard

(April 2010)

A complete list of our titles is available atwww.bloomberg.com/books

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This book is available for bulk purchase at special discount. Special editions or chapter reprints can also be customized to specifications. For information, please e-mail Bloomberg Press, [email protected], Attention: Director of Special Markets, or phone [phone].

© 2010 by Bloomberg L.P. All rights reserved. Protected under the Berne Convention. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher except in the case of brief quotations embodied in critical articles and reviews. For information, please write: Permissions Department, Bloomberg Press, 731 Lexington Avenue, New York, NY 10022 or send an e-mail to [email protected].

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This publication contains the author’s opinions and is designed to provide accurate and authoritative information. It is sold with the understanding that the author, publisher, and Bloomberg L.P. are not engaged in rendering legal, accounting, investment-planning, or other professional advice. The reader should seek the services of a qualified professional for such advice; the author, publisher, and Bloomberg L.P. cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader.

eISBN : 978-1-576-60245-4

Library of Congress Cataloging-in-Publication Data

Burton, Katherine.

p. cm.

Includes index.

Summary: “A rare look at the hedge fund industry’s top performers that introduces the most talented new managers, handpicked by the masters themselves. With unprecedented candor and detail, the most successful hedge fund managers reveal their personal journeys, their individual strategies for producing outstanding returns, attributes most important to the job, and how they survived the subprime crisis”--Provided by publisher.

ISBN 978-1-57660-363-5 (pbk. : alk. paper)

1. Hedge funds. 2. Investment advisors. I. Title.

HG4530.B87 2010

332.64’5240922--dc22

2009048376

To Colin

Preface to the 2009 Edition

At 11:42 P.M. on December 31, 2008, as the most tumultuous year in financial markets since the Great Depression was coming to a close, I got a text message from a friend in the hedge fund industry: “RIP” was all it said.

The reaction was understandable. Hedge funds, on average, lost 19 percent during the year, their worst annual showing ever. The industry shrunk to roughly $1.2 trillion, down from its peak of $1.8 trillion just six months earlier, as a result of losses and client withdrawals. Funds were shutting down and people were losing their jobs at a record pace. In 2009 and perhaps beyond, compensation would be a fraction of the fat paychecks industry players had received as recently as 2007. Hedge funds had lost their swagger.

The losses in 2008 had been the calamitous denouement to years of easy credit that fueled consumer spending and created the biggest real estate bubble the United States had ever experienced. The first signs of trouble appeared in 2007—just as I was writing the first edition of this book—when the value of mortgages made to people with bad credit started to tumble. Bank CEOs and government officials initially assured the world that the crisis would be contained to these so-called subprime mortgages. They were wrong.

By the fall of 2008, the scope of the damage was plain: Federal officials had engineered JPMorgan Chase’s purchase of Bear Stearns, and the government bailed out insurer AIG (American International Group) and seized Fannie Mae and Freddie Mac. Bank of America bought Merrill Lynch, and Lehman Brothers declared bankruptcy. The government banned short-selling in more than 940 financial stocks. Banks stopped lending. Hedge funds and other money managers rushed to sell their holdings to reduce their level of borrowing, cut losses, and raise cash to meet redemptions of clients unhappy with their performance.

The fallout was a massive liquidation that wreaked havoc in almost everyone’s portfolio. The stocks and bonds that everyone thought were the healthiest fell the most in price because they were the easiest to sell. Securities that managers were shorting because they viewed them as most likely to plummet in value jumped in price as traders bought them to cover their positions.

Although most of the “smart money” knew that credit had been too easy, that the markets were due for some sort of correction, and that the global economy would certainly slow, few investors foresaw the swiftness and magnitude of the move. Call it a matter of myopia or a lack of imagination, but many traders remained too focused on their area of expertise—be it stocks, bonds, or commodities. They failed to give enough weight to the big picture, to contemplate the havoc that would ensue from a triple threat: the possibility that banks would stopped lending, investors would all want their money back, and everyone would try to sell everything all at once.

Experience didn’t help much. Managers who had been in the markets for decades were often even more handicapped because they reacted as if this downturn would be much like those they’d seen in the previous ten or twenty years. Even many of the managers profiled in this book, the majority of whom had never before posted a losing year, faltered. Most of them lost at least 20 percent of their assets in a matter of weeks. About 500 firms shut down in 2008, or about 15 percent of the total at the end of 2007.

Hedge fund managers, for the most part, have been humbled. They recognize that they amassed too much money, which caused them to stray into investments beyond their core areas of competency. As they grew, many hedge funds shifted capital into private companies—investments they couldn’t unload quickly. Because so much of their portfolios had become illiquid, more than 20 percent of hedge fund assets were subject to some sort of limit on withdrawals.

Only three of the seventeen managers profiled in this book—Jim Chanos, Julian Robertson, and Bruce Ritter—made money in 2008. Two, Bernay Box and Dwight Anderson, returned all their investor capital in their main funds. Only one hedge fund group, Canyon Partners, limited client withdrawals at the end of the year.

Despite their troubles, the profiled managers have entered 2009 re-energized. As Daniel Loeb told investors, “After suffering through a year like 2008, the best thing to do is to stand up, take your lumps, and clear the portfolio of dead wood.”

The theme for 2009 is back to the future. Assets of many firms have dropped to levels not seen for three or four years. Managers are returning to the strategies they know best and have made them money year after year. In the wake of the Bernard Madoff’s $65 billion Ponzi scheme, investors are demanding more transparency as to what their managers are doing and how they’re marking their investments. And they’re getting more answers. Overall, hedge funds are more investor friendly. They’re giving clients more opportunities to exit the funds, or offering them lower fees if they agree to stay in the fund for a longer period of time. It’s a buyer’s market.

For hedge fund investors, 2008 was proof that integrity matters as much, if not more, than money-making prowess. The best managers acknowledged their mistakes and learned from them, rather than blaming losses on unprecedented market moves or on government actions. They did everything they could to give clients their money back as quickly as possible when they wanted out. They never forgot whose money it really was.

Former hedge fund manager Michael Steinhardt pulled much of his money from hedge funds in the wake of a disastrous 2008. “I remember myself and others being much more idealistic and caring overwhelmingly about the investor,” he says. “In some respects, the hedge fund industry is not the glorious and ennobled field I thought it was.”

Despite the extreme disappointment of investors like Steinhardt, no one expects hedge funds to go away. After all, hedge fund clients still did better in 2008 than they would have with traditional money managers who bet only on rising prices.

As it turns out, Hedge Hunters came out at the top of the market when what some might say was a hedge fund bubble was ready to burst. Indeed, the lessons that can be gleaned from the managers profiled here may be even more valuable in the context of a difficult economic environment than they were during a bull market. It is the managers who find ways to prosper during these tumultuous times who will surely be considered the masters of their craft.

—K.B. September 2009

Preface to the 2007 Edition

IN THE MID-90S, when I began covering hedge funds for Bloomberg News, and during much of the decade that followed, the people who ran these funds occupied a quirky, little-known corner of the financial services industry. Once in a while, a name like George Soros, renowned as “the man who broke the Bank of England” for forcing the British pound out of the European monetary system, or John Meriwether, who nearly started a financial crisis with $4 billion in losses at Long-Term Capital Management, would make its way into the mainstream press. But most of the time, no one paid any heed to these eccentric sorts who managed money in a way that few others dared.

Unlike the managers of mutual funds and other traditional portfolios—which invest only in securities expected to rise in price—the people running hedge funds would also try to profit by wagering on securities whose value they expected would fall. The goal was to make money under any market conditions. They sometimes borrowed cash to make these bets, and they charged outsized fees—initially, 1 percent of assets under management (now, more often 2 percent) and 20 percent of any gains they made.

Hedge fund managers were considered cowboys, colorful personalities who didn’t fit within the confines of a large organization. They wanted to run their own show by their own rules. The conventional wisdom back then was that size was anathema to performance. Funds routinely returned capital to their investors. By the late 1990s, only two managers, Tiger Management’s Julian Robertson and Soros Fund Management’s George Soros, had ventured across the $20 billion threshold. Neither manager lasted long at that lofty height.

A lot has changed since then. What was once a handful of renegade investment professionals—one early practitioner told me that if he hadn’t become a hedge fund manager, he would have ended up as a bookie—has morphed into a buttoned-down industry of substantial size. Today, in 2007, there are roughly twenty-four hundred single-manager hedge fund firms worldwide, overseeing $1.7 trillion. The two largest fund groups are affiliated with major financial institutions—JPMorgan Chase & Company and the Goldman Sachs Group—and at the beginning of 2007, the seven largest firms accounted for almost $200 billion of industry assets.

As new entrants have crowded the field, performance has suffered. The average annual return for a hedge fund between the start of 2000 and July 2007 was less than 9 percent, a dramatic decline from 18 percent in the previous decade. Finding ways to make money in the markets is harder now, especially because the bigger the firm, the less impact each individual trade has on overall performance.

The hot topic as this book goes to press is the debt crisis and the resulting flight to quality that has caused some significant—and in a few cases, mortal—losses at several hedge fund firms. After years of tight credit spreads and rising stock markets, some funds have suffered what Edward Vasser, chief investment officer at Wolf Asset Management International, calls a “crisis of complacency.” So far, most of the damage has been contained to funds that trade debt using a lot of borrowed money and to quantitative funds that use computer models to make their buy and sell decisions. The managers profiled in this book are not “quants,” and no more than one or two of them use much leverage. Overall, most funds are making it through these tumultuous times, perhaps a little bruised, but still standing.

This backdrop of a maturing industry seems the right time to ask some very basic questions: What makes a great hedge fund manager? What accounts for the ability to thrive under conditions that make mere survival an achievement? Finding that out would go a long way toward uncovering which of the hundreds of new entrants are destined to be management stars—and maybe provide some essential tips for the young men and women who’d settle for a lesser place among this select group of investors.

To find the answers, I sought out the industry’s leaders and legends—hedge fund masters who have all successfully weathered the vagaries of the financial markets for a decade or more and produced returns that far outstrip those of their peers. I chose them because of the parts they’ve played in the evolution of hedge funds. They excel at different strategies and some either honed their investment skills under notable mentors or became mentors themselves, influencing practices throughout the industry. Michael Steinhardt is among the industry’s founders as is Julian Robertson, who is renowned for developing investment talent at Tiger Management. Tiger Cubs Lee Ainslie and Dwight Anderson were with Robertson in the early days before heading out on their own. Kynikos Associates’ Jim Chanos, who makes money solely on stocks he expects to tumble, is the longest-surviving short seller with the most assets and was an obvious choice for the book, as was Boone Pickens, the grandfather of commodities trading. Richard Perry helped build the famed merger arbitrage desk at Goldman Sachs under Robert Rubin, which launched some of today’s most successful hedge fund managers. Canyon Partners’ Mitch Julis and Josh Friedman have created a $16.5 billion multistrategy firm, trading in everything from high-yield bonds to stocks and bank debt. Daniel Loeb still posts some of the best returns around even as his Third Point has grown large enough to float a publicly traded fund on the London Stock Exchange. And Avenue Capital Group’s Marc Lasry, the most institutionally focused of the group, produces resolutely steady returns and has created one of the fastest-growing firms in the business, pulling in billions in assets from pension funds and other relatively conservative clients.

I talked to these managers about their training, their work, the lessons they’ve learned in the business, and the qualities they think are necessary to success. Although they’re among the biggest names in the industry, some of them had never before agreed to an in-depth interview. A few common traits were immediately apparent. They all work incredibly hard, and they all think more about the bets that might sink them than about the trades that can make them a lot of money. “Live to trade another day” is one manager’s motto. How each ensures his survival, however, can be astonishingly different. One went into mind-numbing market minutiae to describe why he put on a particular position. Another told of making an investment call based on a visceral instinct honed from years of decision making. He couldn’t account for the thought process that got him there, but he knew he was right. Their personal styles are equally disparate. Several of these hedge fund mavens care deeply about training and mentoring their employees; others—even some who were tutored by investment greats in their youth—say they simply don’t have the patience for it.

With the goal of turning the spotlight on little-known virtuosos, I also asked the masters to talk about the up-and-coming or undiscovered hedge fund professionals whose skills they admire. I interviewed these lesser-known traders to get a handle on how they had won the respect of the established players. Initially, I expected these new hedge fund stars to be in their twenties or early thirties, with funds only a few years old. Instead, the candidates were all over the map in terms of age and experience: Some of the picks have been in business for well over a decade but have remained under the radar because they’ve curtailed asset growth. Others just opened up shop recently. Their ages range from mid-thirties to late fifties. The variety is intriguing, but, for the most part, the veterans’ explanations for their choices were single-minded and unembroidered: They make money.

In exploring the talents of all these men—whether veterans or young turks—I had hoped to uncover the winning recipe for outstanding performance, to find out what separates investment and business-building geniuses from the average joes. But there is no such recipe. That’s because the approaches to investment management they’ve cooked up are as varied as their backgrounds and personalities. Some of them traded stocks and constructed portfolios while still in their teens. Several earned MBAs. Others took a more circuitous route to stardom: One had spent time in Israel studying the Talmud. Another had practiced law. Their threshold for money-losing pain also varies. One manager uses options liberally as insurance against a market tumble. Another never hedges.

The basic skills of money management—portfolio construction, risk management, company analysis, and research—can be taught. Yet the secret sauce, the emphasis each manager places on these investment tools, is invariably infused with the elements that drive their varied personalities—whether geeky or hip, outgoing or retiring, down-home or academic. Each style is represented in the stories of these mavericks.

Whatever their training, education, or risk tolerance, they share many qualities: they’re skeptical, intellectually curious, and independent thinkers. Passionate about their profession and their goals, they take the long view. With integrity as much of a priority as performance, they built a track record first, a business second. Perhaps the most challenging hurdle they’ve cleared is to balance confidence and conviction with the recognition that they’re fallible. Egerton Capital’s John Armitage puts it most succinctly: “You have to be obsessive, you have to have guts, you have to know when to stick to your convictions and when to walk away.” To make those crucial distinctions, they assemble the facts and question their investment premises. The process can result in sleepless nights and grouchy clients, but these managers don’t waver once they’re convinced they’re right.

And when it comes to what really matters, they usually are.

Acknowledgments

First and foremost, I’d like to thank all the managers who so graciously agreed to be interviewed. Without their generosity of time and their willingness to educate me about how they do what they do, there would be no book.

At Bloomberg, special thanks to Matt Winkler for giving me the opportunity to drop my daily gig for six months to work on this project—and for taking a chance on me fourteen years ago when he hired me for my first full-time journalism job. To Jared Kieling and Ron Henkoff for supporting this project from the get-go, and to Charles Glasser for his keen legal reading of the manuscript. To Tim Quinson and Larry Edelman for so diligently respecting my book leave, and to Jenny Strasburg for pulling all the weight during my absence. To Evan Burton for ensuring that all the interview transcriptions got done in a timely manner and to Dru-Ann Chuchran for her stellar copyediting skills. To my editors Mary Ann McGuigan, who provided excellent guidance and editing, and Sophia Efthimiatou, who took what started as a casual conversation and shepherded the idea into this final product. Without her enthusiasm, encouragement, and counsel it wouldn’t have happened.

To my industry sources—who always prefer to remain anonymous—who helped steer me toward the managers I should interview and provided background and insight into their businesses. Thank you all for so kindly sharing your stories and knowledge with me over the past decade. And thanks to Scott Esser at Hedge Fund Research for providing data on the industry, which are used throughout the book.

Finally, thanks to my family and friends for making sure I remained sane and balanced during the months I was sprinting toward my deadline.

Chapter 1

Mark Yusko

What It Takes to Be the Best

IN 2004, a twenty-one-year-old New York University student named Hakan Yalincak told the world he was going to run a hedge fund. With his mother, Ayferafet, he rented office space in Greenwich, Connecticut, and filled it with computers, fancy furniture, and Bloomberg terminals. They hired temps to man the screens. Wealthy investors paraded through the offices to check out the boy wonder and were told the story of a young stock-picking genius born into a wealthy Turkish family worth $800 million. The mother-son duo raised more than $7 million.

Yalincak never bought any stocks. Instead, prosecutors said he used the money to purchase a Porsche and expensive jewelry and gave $1.25 million—the first installment of what he said would be a $21 million gift—to New York University, where he was then a senior studying history. The young Turkish national was later arrested and pleaded guilty to bank and wire fraud. Yalincak was sentenced to forty-two months in prison; his mother’s sentence was two years in prison, after she pleaded guilty to conspiracy to commit wire fraud.

This sad tale speaks volumes about the world of hedge funds. A con can happen in any industry. But it’s the golden aura of hedge funds, with its promise of unparalleled riches, that made this unlikely scam possible and allowed a kid barely old enough to order a beer to raise millions of dollars from adults with real jobs and big bank accounts.

Everyone, it seems, wants a piece of the hedge fund business. MBA students across the country are eschewing jobs at major investment banks to join the funds, many of which won’t be around in ten years. Managers trying to find an edge have opened funds trading such unlikely assets as art and wine.

The hedge fund world didn’t always garner such attention. One friend in the industry tells of a visit home to his parents during which the mother of a childhood pal asked how his successful landscaping business was going: “Your mother said something about hedges?” The history of hedge funds—private partnerships in which the manager bets on falling as well as rising prices of stocks, bonds, and other financial instruments and then takes a piece of the profits—dates back at least as far as 1923, when Benjamin Graham, the godfather of value investing, opened just such a fund. Yet it’s taken almost eighty years for the trend to become widely known.

Nowadays, the bartender, the massage therapist, and just about everybody’s neighbors all know that hedge fund managers are the new masters of the universe. They make the cover of New York magazine; in fact, just about every kind of publication—from the New York Post to Vanity Fair—runs stories about them. They’re even hip enough for HBO to develop a series about them. The amount of money they manage isn’t huge compared with other large capital pools. Even accounting for leverage, the hedge fund industry’s assets probably come to less than half the $10 trillion that mutual funds control. Yet the biggest hedge fund managers wield power far beyond the world of stocks and bonds. They are the Carnegies and Rockefellers of the twenty-first century: some of the biggest philanthropists, the largest political donors, and the most influential art collectors.

In 1990, there were only a few hundred hedge fund managers, with $39 billion in assets. At the end of 2006, the two biggest hedge fund operators together managed more than $65 billion. In total that year, there were roughly twenty-four hundred managers, with $1.5 trillion in assets. New entrants continue to rush in, and average returns have fallen as competition increases. As the number of hedge funds grows, so do the odds of their having mediocre leadership. Finding the best managers is even harder than it used to be.

But Mark Yusko seems to have the knack. He has been investing in hedge funds for more than a dozen years, first as senior investment director at the University of Notre Dame and later as chief investment officer at the University of North Carolina at Chapel Hill (UNC). In his six-and-a-half-year tenure at UNC, he increased the endowment’s investment in hedge funds to about 55 percent of its $1.2 billion in assets. In 2004, he left UNC to form Morgan Creek Capital Management in Chapel Hill. The firm advises institutions and wealthy individuals on how and where to invest their money and farms out money to hedge funds and other investment firms.

In the years that Yusko has been picking managers, he has invested with most of the established hedge fund managers interviewed in this book and many others in the top tier. He has worked closely with Julian Robertson, who managed money for UNC for almost a decade and who owns a small minority stake in Morgan Creek. Robertson also provided seed capital for Tiger Select Fund Management, a group of funds Yusko runs that invests in other hedge funds.

“I joke that it may take me five years to figure out if I want to invest with someone,” says Yusko, “but I know in five minutes if I’ll never invest with somebody. When they don’t have it, it’s immediately obvious.” The it—that special something that characterizes managers who seem to be divining rods for investment returns—is hard to define. Yusko has not found any one identifiable characteristic they all share that’s central to success, but in some cases, that edge—whatever it may be—is apparent from the first meeting. “The moment I met David Bonderman [founder of buyout firm Texas Pacific Group], I threw my wallet at him and said, ‘Here. Take all my money.’ The guy has it,” says Yusko. “I had a similar experience with Julian and with John Griffin.” Griffin was once president of Robertson’s Tiger Management and now runs hedge fund Blue Ridge Capital in New York.

The essentials for success may be elusive, but in his years of picking hedge fund managers, Yusko has developed some ideas about what constitutes great talent and how it can be nurtured. At its core, it’s all about the people, he says, and mentoring is a vital part of the process. “Money is managed by people, not institutions,” says Yusko. “A lot of people get hung up on the idea that a great manager has to come out of a certain educational institution, or requires a certain credential, or has to have worked at one of the big uglies like Goldman Sachs. It’s exactly the opposite.” The investment business is about craftsmanship, he says, and a craftsman is an apprentice first.

Yusko likens the process of learning how to manage a fund to the way artists learned to paint hundreds of years ago. The master would set up his easel, and the apprentices would set up their easels in a circle around him. They would proceed by copying his palette, his brushstrokes, his use of light. Eventually, great painters—with styles all their own—were born from the great masters. “When Julian ran Tiger, they sat around a big round table,” says Yusko. “Julian was the master and these young guys were there to copy his brushstrokes.” They paid attention to how he made decisions and processed information and wisely followed suit.

Paying attention has always paid off. Before, say, the 1990s, many of the biggest winners were those who knew things before other investors did. But these days, information is much easier to get, and there are many more managers trying to parse it. With such intense competition, having a good mentor to show you the ropes has gone from necessary to critical. “Once the industry shifted into information overload, running a fund became more about process and practices and the ability to synthesize,” says Yusko. “Those are learned skills.”

But whether it’s gleaned from a mentor or a Ouija board, what managers must learn is how to gain the advantage and identify the opportunity. In markets, when one person wins, another one loses. “Ultimately, we buy managers for their edge. You pay those high fees to great managers because they know how to extract alpha, or wealth, from the pool, where it’s a zero-sum game.”

When Robertson launched Tiger Management in 1980, Yusko explains, he believed he had a great advantage over most institutional investors, which were primarily mutual funds or traditional investors who bought and held stocks. “Julian had a great line when he got into the business: ‘It’s me and the patsies,’ ” says Yusko. Robertson didn’t mean that his competition lacked smarts, but he saw that they were rule bound. The fund’s prospectus forced them to stay inside the box. The rules might allow them to own one type of security and not another. They might prohibit short selling or forbid ownership of more than a certain percentage of a company. “These managers were like poker players who can’t hold aces,” says Yusko. “If you can’t hold aces, you’re going to have a tough time winning a poker hand.”

As time went on, a swarm of new players looked to join the fun. “People who didn’t have these rules came into the business,” says Yusko. All the young analysts and portfolio managers wanted to leave the Fidelity Investments of the world and open the next Soros Fund Management. There were more traders with fewer restrictions, yet many of them didn’t know the finer points of the game so the renegade no longer had the advantage.

“Now, with the explosion of hedge funds,” says Yusko, “there is a whole new set of patsies in the game again.” This new generation of pigeons wasn’t trained by the masters; they don’t understand portfolio construction. Many of them presume that because they were talented analysts, they will be superb portfolio managers, says Yusko. In fact, he argues, the personality traits of a good analyst and a good portfolio manager are completely different. “What you need to be an analyst is an attention to detail, a fundamental research mindset, the ability to do active due diligence, and the skill to do financial modeling. It’s very quantitative. Being a portfolio manager is almost the direct opposite. It’s all about nuance and extrapolation and interpolation. It’s about reading between the lines, understanding the elements that aren’t printed in the factual statements, what the management doesn’t say when they make a public statement, what they omitted when they were writing up their notes for the financial statements.”

And ultimately it’s about having the courage to pull the trigger, to put the money on the line.

The right combination of skills is not the set that most people would expect in a fund manager, says Yusko. The best in the business today are not necessarily the finest analysts, and many of them are not even the most quantitatively oriented. “Great portfolio managers are great thinkers,” says Yusko. “They’re smart guys who were drawn to the work and were trained about the markets by great thinkers.”

Robertson is probably the best at spotting that kind of talent. “He has a process for it,” says Yusko. “He is wired that way. He’s a mentor. He guides them. He passes them the tools.” The tools are critical: Managers need a process and a philosophy—a vision. If they don’t have the tools, they won’t succeed.

Some great managers are not so great at cultivating top talent, a deficiency that Yusko says may simply be a function of age—or rather the lack of it. “You cannot have wisdom without age. To be a great mentor, you have to be older, more mature, and wiser.” Yusko believes that the younger the manager, the harder it is for him to command the respect of an apprentice: “ ‘He’s not that much older than I am,’ the apprentice is thinking, ‘Can he really be so much better?’”

Having interviewed and worked with hundreds of hedge fund managers over the years, Yusko has come up with some attributes that he believes are essential to being the best.

Independence. The word contrarian is often linked to investment smarts, but Yusko prefers the term independent thinker. After all, merely doing the opposite of what other investors are doing doesn’t necessarily put you ahead of the crowd. “Sometimes the consensus is right and momentum can work for a period of time,” he says.

Likewise, the modus operandi for some contrarians is to work on the assumption that things like interest rates and stock market returns are mean reverting, a conviction that markets get out of whack but eventually revert back to long-term average values. “The problem, of course, is that markets can remain irrational longer than the rational investor can remain solvent,” says Yusko, quoting economist John Maynard Keynes. Being early, he points out, is often a euphemism for being wrong.

To capture the essence of the true nonconformist, Yusko prefers the definition used by Dean LeBaron, founder and former chairman of Batterymarch Financial Management in Boston: “Contrary thinking is most like intellectual independence, with a healthy dash of agnosticism about consensus views.”

Managers who are independent thinkers are constantly challenging consensus and doing their own research. “You can’t just accept what other people say,” says Yusko, “or accept what other people put in reports.”

Guts. What distinguishes a great investor is the willingness to take intelligent risk, says Yusko. Even for the willing, the odds are intimidating. “A legendary investor like Michael Steinhardt, Julian Robertson, or George Soros is right 58 or 59 percent of the time,” says Yusko. “That’s frightening when you think about it. Most investors are right only about 30 to 40 percent of the time. If you can be right even 51 percent, the odds work in your favor.”

Clearly, without risk, there can be no substantial return. Around 2000, more institutions, like pension funds, began investing in hedge funds, and these institutions demand steadier returns, even if that means lower profits. To meet the needs of their new clients, some managers have tended to reduce the magnitude of the swings in their performance, a tendency that makes for lower gains and smaller losses.

Some managers are inclined to be less aggressive because they focus more on the 2 percent management fee they earn on the assets they oversee than on the 20 percent performance fee they pocket on the money they make. If a hedge fund manager oversees, say, $20 billion, he earns $400 million just for coming to work every day, and only a portion of that goes to keeping the lights on and paying employees. Why take unnecessary chances and risk losing lots of money and clients?

“The people you really want,” Yusko insists, “are the ones who understand intelligent risk and have the guts to bet big.” They have that rare chutzpah depicted in Ocean’s Eleven, the movie about a casino heist, starring George Clooney and Brad Pitt. Clooney’s character, Danny Ocean, is talking about why it’s so hard to win at gambling in Vegas: “ ’Cause the house always wins. You play long enough, never change the stakes, the house takes you. Unless, when that perfect hand comes along, you bet big, and then you take the house.”

To illustrate, Yusko points to Soros and Stanley Druckenmiller, Soros’s chief investment strategist, who bet on a fall in the British pound, loaded up the boat, and earned $1 billion, and to Sir John Templeton, a legendary value investor, who in 1939 bought $100 worth of every stock listed on the New York Stock Exchange that was trading below a dollar, wagering that World War II was about to start and these stocks would soar. Within three years, 100 of the 104 made him money.

Humility and Intellectual Honesty. Top managers constantly reevaluate their positions, says Yusko. They look for data that contradict their thesis, rather than focusing on information that bolsters their view. When a position moves against them, their first question is: Am I early or am I wrong? Is this conviction or pigheadedness?

The best managers aren’t afraid to say they made a mistake, says Yusko. “When they’re wrong, they change their minds. Arrogance doesn’t work in this business because the market will smack you down. You can be confident, but you can’t be arrogant.”

Roy Neuberger, founder of money management firm Neuberger Berman, whom Yusko lists among the greatest investors of all time, is widely believed to have said there are three rules to managing money: Rule 1: Do not lose money. Rule 2: Do not lose money. Rule 3: Never forget rules 1 and 2. And if adhering to those rules means you may have to eat crow, the only decision remaining is which fork to use. “The difference between a mistake and an error,” says Yusko, “is that an error is a mistake you don’t correct. Managers who press a bad position, insisting the market is wrong, usually don’t survive it. The good managers don’t cling to the mast as the ship goes down. They jump in a lifeboat and go look for another ship.”

And they jump quickly. On the Friday before the October 1987 stock market crash, Druckenmiller famously decided to switch his portfolio. He shifted from wagering that U.S. stocks would fall to betting that shares would rise. He even borrowed money to goose returns. After the close that day, he had a conversation with Soros (who was not yet his boss), and over the weekend a talk with Jack Dreyfus, founder of the Dreyfus Fund, that convinced him he was dead wrong. On Black Monday, the market opened 200 points lower, and Druckenmiller acted with lightning speed, selling his entire position early in the day and going net short. He ended the month with a profit.

Connections. The best managers know the value of networking. Yusko sometimes finds great managers by talking to other investment professionals he respects. About once a year he has dinner with Hugh Sloane, cofounder of Sloane Robinson, a hedge fund company in London, and makes a point of asking him if he’s given anyone money to manage. Yusko knows that any manager Sloane mentions is worthy of serious consideration. He takes it as a given that the person is smart. “That’s because I know how smart Hugh is,” says Yusko, “and how savvy and how discriminating, so it helps narrow my search.”

Clearly, the value of a network depends on who’s in it. Yusko is convinced that we become like the people we spend our time with: “Find out who the three or four most important people are in someone’s life, and you’ll know what kind of person he is.” The goal, ideally, is to network with people whom you and others respect. Most people don’t. In fact, Yusko believes that most people would be sadly disappointed if they examined their close associates, because they’d see that these people are not a help to them. “The great managers have great mentors and great friends and great sources,” says Yusko.

The greater the manager, the greater the associates are likely to be. “Knowing who these guys spend time with, who they respect and admire, and who their mentors are is key to getting a sense of who they are,” says Yusko. He tells the story of being in Robertson’s office one day when he received a phone call. Robertson listened for a bit, then said, “You go next door and tell Putin that if he lets Yukos go down the tubes, there’s going to be hell to pay.” The fellow on the other end of the line was sitting next door to Russian President Vladimir Putin at the Kremlin, discussing the Russian oil company Yukos, then run by billionaire Mikhail Khodorkovsky. In the end, Putin didn’t heed the warning—Khodorkovsky was convicted in 2005 of fraud and tax evasion, and the company was declared bankrupt in 2006—but the fact that Robertson was in a position to issue one speaks volumes.

Ambition. Hedge fund managers may be among the most intense players in financial markets. “Every manager I think highly of is very, very competitive,” says Yusko, and they all have some hobby or interest that suits their competitive nature. Marc Lasry, who runs Avenue Capital Group in New York, is renowned for hosting high-stakes poker games in which the take can be as high as $20,000. Many of them look for the same kind of relentless drive in the people they bring into the firm. Robertson, for one, likes to hire college athletes because of their competitive nature as well as their sense of discipline and teamwork. The theory goes: if they take no prisoners on the golf course, on the soccer field, or at the poker table, they will be the same way in the markets.

Smarts. Even an abundance of guts and the most exclusive network can’t help the cerebral lightweight. “Raw intellectual horsepower has to be there,” says Yusko. That horsepower can have a range of fuels. Some are mathematically gifted; others have photographic memories. “Some of them just have a knack for being able to extrapolate and interpolate trends,” he says. “They have a feel for the changes in the markets. They are sensors or seers.” He cites David Bonderman’s ability to see trends before they happen, a skill related to pattern recognition. But Yusko insists that masters like Bonderman simply have “different wiring.” Some of the best managers are woefully inarticulate about why they see things that other investors miss. As the New Yorker’s Malcolm Gladwell points out in his best-selling book Blink, they can’t explain it because the decisions, based on years of experience, are being made at the unconscious level. They just know.

Respect for Employees. The top managers treat their employees well. They pay them handsomely, and they listen to their ideas. “If you’re approachable and admired by the people who work for you, you get their best ideas and their best thinking,” says Yusko. If employees feel cheated or mistreated, they will walk. There is always another hedge fund that will hire them. Treating them fairly doesn’t mean that a manager won’t lose his temper now and then, especially when an employee messes up. “They are brutally harsh when mistakes are made,” says Yusko, “but an employee learns from that not to make mistakes.”

Integrity. “Integrity might be the defining characteristic of most great managers,” says Yusko. “They don’t cut corners. They do it the right way.” In his view, if a manager cheats on little things—an advantageous call on the tennis court, a small lie on his résumé—he might well cheat on bigger things. He might be tempted to value the contents of his portfolio incorrectly or lie to investors about his returns. Some of the biggest hedge fund frauds in the industry to date—from Michael Berger’s Manhattan Capital Management to Sam Israel’s and Daniel Marino’s Bayou Group—started with little lies that turned into hundreds of millions of dollars of undisclosed losses.

In addition to identifying top managers, Yusko’s job involves monitoring them once they have his clients’ money in hand. This review requires a different set of questions: Are they disciplined in their investment style, or are they creeping into areas where they don’t have expertise? Are they less hungry than they were in their younger days? Has something changed in their life that has taken their focus away from the job? The following are some of the red flags he looks for.

The Red Ferrari Syndrome. The hedge fund business is lucrative, and people can change when they start making serious coin. As the cash starts to roll in, some managers get lazy or focus more attention on acquiring new toys than on investing in the markets. There are some telltale signs: Does he have a fleet of new sports cars? Is she building a fourth vacation home? Is his golf handicap dramatically lower? Yusko tells the story of a tongue-in-cheek wager that Steven Feinberg, head of New York hedge fund Cerberus Capital Management, made with him as proof he’d never succumb to the Red Ferrari Syndrome. Feinberg declared that if he ever moved out of his house in Greenwich or bought a new car, he’d double the return Yusko made on his investment in Cerberus. Yusko says technically he could have called in that bet a couple of years ago because Feinberg bought a new Chevy pickup when his old one clocked 260,000 miles. Yusko chose to overlook it.

Calling in Rich. In 2000, after George Soros’s Quantum Fund lost 20 percent in the first two weeks of April when technology stocks tumbled, Soros told investors he was going to change the way the $8.5 billion fund was managed. Much of the money in Quantum was his, and he said he was more interested in preserving capital than in making more of it. “When people have too much of their personal money in the fund, they tend to become too careful,” says Yusko. “I don’t hire these guys to be conservative.”

Personal Tragedy. “People experience tragedy and loss, and that usually impairs them—many times beyond repair,” says Yusko. An ugly divorce, for example, can take a manager’s eye off the ball, and some investors may even pull their money out of a fund until the legal battle is over. Nevertheless, Yusko says there are many examples of managers who come back stronger after a grave illness or a huge loss. In 1998, John Meriwether’s Long-Term Capital Management lost 92 percent of its money and prompted a bail-out orchestrated by the Federal Reserve. A year later, he founded JWM Partners in Greenwich, Connecticut, and has produced steady returns ever since.

WHAT MAKES A MANAGER GREAT? What separates the run-of-the-mill stock pickers from the market superstars? Brains, courage, and humility, for starters. You’re not likely to find one who lacks these strengths. Yet, what makes the managers profiled in this book most interesting is not so much what they have in common but how each is so different from the rest. Money management is far from a science, and none of these managers, even those trained by the same mentors, do what they do in exactly the same way. Some are skilled at betting on securities whose prices are tumbling, others are excellent traders, some have inexhaustible patience, others thrive on risk. The approaches they take and the choices they make are influenced and informed by their backgrounds and early successes and by their failures. Taken together, these professionals can offer considerable insight into the art of the trade.

AFTER THE CRISIS

Getting Real

“When the tide goes out, you see who’s swimming naked,” says Yusko, quoting an aphorism made famous by investor Warren Buffett. In 2008, the tide receded farther and faster than it had at any time in fifty years.

The previous five years had produced some relatively easy times for making money. After the Internet bubble burst in the early years of the decade, stock markets across the globe took off, jumping by about 2.5 times off their lows. Economies around the world, both developed nations and the likes of China, Russia, India, and Brazil, were on a tear. Borrowing was easy. Inflation was low.

With investment dollars plentiful, hedge funds mushroomed. Their assets reached $1.8 trillion by the end of 2007, double what they were five years earlier.

The lush times caused a bit of market amnesia among hedge fund managers. They forgot that market booms beget market busts. They forgot that there can be periods when prices jump around irrationally, and in those times, it’s often better to get out of the way. They lost sight of the dangers of crowded trades and of buying hard-to-sell assets. They forgot that clients might want their money back. They didn’t consider the perils of using borrowed money in volatile times. They forgot that markets go down. “A lot of people were ill-prepared to deal with what happened because they weren’t good at the short side,” or betting on the decline of stocks, bonds, currencies, and commodities, says Yusko.

Clients, including Yusko himself, were guilty of going too easy on the people who were handling their money, he says. “We didn’t judge managers as stringently as we should have.” Investors should have focused more on how well their managers could shift their portfolio between cash and wagers on falling and rising securities as markets changed, and on how adept they were at limiting losses when a trade didn’t go their way. In 2008, it became abundantly clear that these attributes mattered at least as much as being a strong analyst.

Many of the managers Yusko invested with in 2008, including some of the largest, lost money and limited withdrawals. Still, he sees the aftermath of the disastrous year as positive for the industry as managers return to sound practices of doing business. The message for 2009: Back to basics.

That doesn’t mean managers aren’t concerned about growing their businesses. Almost every manager wants to raise money after losing as much as 50 percent of assets from losses and redemptions. Even the top-performing traders whose funds had been closed to new investors for years decided to open the doors at the end of 2008. Some of the biggest names in the industry have been making more of an effort to meet with clients and speak at investor gatherings.

Even so, Yusko says 2009 has been about making money. That’s particularly important after a losing year, because the managers who are down won’t get to charge their 20 percent performance fee until the previous year’s losses are recouped. “The industry will move from gathering assets to managing assets,” he says. Managers will depend less on borrowed funds to make money and focus their efforts on generating returns no matter the market direction.

Yusko also sees a return to the “sole practitioner” model of investing, in which one person calls the shots. “Hedge funds gave into the temptation to hire lots of people. What they forgot is that groups don’t make good decisions,” he says. “An investment committee should have an odd number of members and three is too many.”

He also sees a change on the horizon in fee structures and other terms for clients. Some funds have told their investors that they will trade only liquid securities and will allow clients to leave the fund every quarter, or even monthly, rather than making them wait a year or more to exit. Other managers who want to lock up their investors for longer periods of time are paying for that privilege by lowering their fees.

Overall, Yusko says, if 2008 taught us anything, it’s that everything is cyclical.

The question that remains is why so many managers, even the smart ones, forgot that.