Hedge Fund Article of the Year Awards
Call it the holiday spirit, but rather than lament the generally sorry state of news reporting about hedge funds, today I want to recognize the best in hedge fund journalism for 2012. We all know that the media is skeptical of the industry and they have reason to be. But, that doesn’t excuse reporters for fundamentally missing the boat on hedge funds as they rehash the same stories about which manager earns what, which trade made the biggest return, and which PM badmouthed which stock. All of that misses the point. The question reporters dance around is why do hedge funds exist and how can managers survive, even thrive, in an ultracompetitive industry where nothing is more elastic than investor appetite for a particular fund or manager.
Periodically, though, the media do get it right. One of the early profiles of Bridgewater Associates (but, ironically, none in the series of profiles that followed) is among these landmarks in hedge fund reporting and so are this year’s winner of the Hedge Fund Article of the Year Award and the runner-up, recognized by this blog.
In second place: “Acting Up,” by Irwin Speizer writing in Absolute Return, June 1, 2012. This article provides an in depth look at ValueAct Capital, the best $8 billion activist hedge fund about which you have probably heard very little. That’s by design, according to Jeffrey Ubben, co-founder, CEO and CIO of the firm. Since its inception in 2000, ValueAct has made 64 core investments and taken 32 board seats at 27 companies — all with only one proxy fight (and that was settled in the firm’s favor before the vote). From its portfolio of companies, ValueAct has influenced 25 CEO changes, 12 major divestitures, and 20 sales of the corporation. According to the article, “In most cases these days, ValueAct is invited to join a board after building a major stake in a company’s stock rather than having to push its way into the room…If there is such a thing as friendly activism, Ubben practices it.”
This article merits recognition because it not only introduces a major firm that has escaped the limelight, but does a great job in documenting the investment strategy of the fund, its investment process, and how responsibilities are shared by its founders. It truly distinguishes ValueAct as a different kind of activist and the facts about the fund’s methodology, track record, successes and failures and expectations placed on investors (the firm has lockups of up to five years) speak much more loudly than the flair typically associated with an activist investor. Several of the better-known activists pursue high-risk, high-reward strategies, and, as a result, media coverage about them is uneven and rarely has a thematic focus on the benefits of the activist strategy. “Acting Up,” in contrast, is a testament to how effective the activist strategy can be and I think it is important to document how a select few managers, Value Act, Starboard Value and others, have quietly had dramatic effect in winning change in the boardroom and generating returns with an activist strategy.
If I had to find any fault, I would like to see more than one client go on the record to discuss their experience with ValueAct and more insight on the firm’s view on or prescriptions for the range of corporate governance issues that plague so many public companies.
Winner: “Caxton’s Law,” by Stephen Taub, writing in Institutional Investor, February 2012. Caxton isn’t the largest hedge fund (although at $9+ billion, it’s plenty big) and it hasn’t kicked off eye-popping returns in recent years (up only 0.7% last year). What makes it among the leaders in the industry is its high degree of operational institutionalization, a culture that embeds solid risk management practices and steady leadership despite the fact that Caxton’s founders retired last year. “Caxton’s Law” wins the Hedge Fund Article of the Year award because it is a best in breed article for both the journalist, who has chronicled critical aspects about a hedge fund that are rarely covered, and the fund itself, which comes across as a disciplined investor and as a firm that goes further than just about anyone to safeguard against losses. The story details three fundamental aspects about Caxton that trip up or even shut down other funds. Each should speak volumes to existing and prospective clients of the firm.
First, is succession. Caxton’s founders retired last year, yet the fund continues to attract assets (AUM is at its highest since 2008). Handing over the reins in an orderly way is no small feat, especially in the hedge fund industry. Indeed, several well-known managers don’t appear to have succession plans. The article documents how new CEO/CIO Andrew Law and new chief risk officer Matthew Wade joined the firm and the degree to which cultural fit and a shared vision of the identity of the fund were part of the hiring process and how Law assumed leadership at the firm.
Next, the article shows how Caxton has managed through market cycles and explains what the firm did in 2007 and 2008 to survive and even thrive during the recent credit crisis. “‘We concluded the order of events of the last five years (2002 – 2007) was over,’ Law recalls. ‘We were entering a new era of economic and policymaking uncertainty, and one that was likely to reward macro trading.'” The firm exited its private equity investments, shuttered non-core trading operations, shorted equities and made the right calls on interest rates. In the process several principals left the firm. What is noteworthy is the fund’s ability to sense a sea change and act with conviction, shrinking itself in the process. It is rare that a reporter gets this kind of back story. From the LP’s point of view, getting this kind of insight about how a manager navigated the most significant shock to the markets in 10 years is rare and valuable. In a world where many hedge funds are one hit wonders and where a significant number of funds close down when the market turns sour, Caxton’s steady performance stands out.
Finally, Taub builds the entire article on the theme of risk management. Whether this construction is by the writer’s design or if Caxton consciously engaged with Taub with this theme in mind is unknown, but the result is one of the most detailed looks into risk management practices at a major hedge fund ever documented by a journalist. The firm is described as having an “obsession with risk management” and Taub writes “managing and controlling risk has always been a cornerstone of Caxton’s success.” “We are disciplined when we don’t understand what the markets are doing,” Law says in the article.
Evidence is given through descriptions of the firm’ risk committee, which includes a rotating member drawn from one of the firm’s senior trading partners, and process by which the firm allocates capital to each portfolio manager. Along with a process to ensure that portfolios have low correlation to each other, the amount of capital allocated to each of firm’s 29 PMs is determined by at least half a dozen factors outlined in the article. Also explained, is how the firm’s “drawdown rule,” which puts traders who are down five percent on ice for three to five days. A trader down 10 percent has to produce a written analysis, discuss it with the risk committee, and sit on the sidelines for a “few weeks.” This policy, which is atypical in the industry, is not viewed as a penalty within the firm. Caxton says it expects PMs to hit the 5 percent drawdown every 18 months. “If a portfolio managers do not reach that mark for several years, they are either very good, lucky or not taking enough risk.”
Congratulations to Stephen Taub and to Caxton Associates. The article should serve as a reminder that the cream of the hedge fund industry includes institutions that are not only savvier than most about the markets, but also have processes in place to make sure that systems and protocols engage to ensure proper risk management. With funds like these, LPs can sleep well at night.