Preface
I was 17 years old when I got my very first real job—in Citigroup’s Global Corporate & Investment Banking department at their headquarters at 388 Greenwich Street in the uber hip Tribeca area of downtown New York. It was the fall of 2002 and I had started as an intern in the Credit Risk division of the prestigious Financial Institutions Group, or FIG as it was called, where the bank represented such high-profile and lucrative clients as AIG, Washington Mutual, and many of the major banks, broker dealers, and insurance companies.
I had always been a strong math student; however, it was fair to say I was out of place. It felt more like a scene from the movie Wall Street than reality—so different than the world where I had grown up in suburban Westchester, where there wasn’t even a McDonald’s in town and there were practically more deer than people. As I was ushered up to the forty-second floor and led into a conference room with sweeping views of all of midtown Manhattan in the far distance, I knew I’d landed somewhere where people were having a real impact on the world in a big way and felt fortunate to be there.
I was fascinated hearing about how the team identified credit risk and mitigated losses for thousands of clients and outside parties. Hearing about how the bank would work closely with companies advising on potential mergers and takeover targets seemed exciting—this must be what Carl Icahn does, I thought. Citigroup had “the big balance sheet” that dwarfed many of the more prestigious investment banking teams on the Street, and so we were always allowed into the consortium for deals—even as the deal arranger. I left the building with an offer for a semester internship in hand, convinced I had found my calling with the good guys—good guys with nice shoes.
I ended up taking my Series 7 exam and staying with the bank for three and a half years while attending school. Eventually, I moved to the Wall Street Journal after a brief stint at Merrill Lynch in its Global Research & Economics division. During my time at the Journal, the first cracks in the financial system were beginning to show, but it was still unclear how far the plague would spread. After about a year, by late 2007, working at the Journal and following financial stories so closely—minute to minute—made me nostalgic. Figuring everything was mostly okay but looking for an experience beyond plain vanilla banking, I decided to try to go back to the Street and had been interviewing with a bunch of small organizations called “hedge funds,” one of which was founded by a very famous investor: George Soros.
I got called for an interview at the Quantum Fund for a position opening for an analyst covering either retail or health care companies. At the interviews, two young research analysts in their mid- to late 20s wanted to know if I had the technical skills to rip apart an annual report and process all the numbers in a way that could help the team discover if there was any investing potential on the long or short side across industries. After a few simple questions, my interviewer quickly discovered I knew very little about what short-selling—or borrowing stock to sell in the market at its current price with the expectation of further declines—was even about. Little did I know I was about to find myself in the center of it all.
Around the same time as the interview at Quantum Fund, I got an unsolicited e-mail from CNBC, asking if I’d come in for an interview. Growing up watching the network with my father as he talked about the stocks he was buying and selling, I was naturally curious and excited to see what the business news network would be like. The moment I stepped onto the news desk, it was like a different world. Suddenly, all of the news was in real time, up to the second. The buzz, the energy, the bright lights all captivated me. Spending the past few years poring over financial statements, loan documents, credit agreements, and deal “pitch books,” the things the anchors were saying right in front of my eyes on the set made sense to me. I had no formal journalism training or TV experience but my time on the Street landed me the job as a producer on Squawk Box.
A Hedge-ucation
Very quickly after I landed at CNBC in February 2008, it became clear to the entire world that something was seriously wrong—the nation’s entire financial system became crippled by toxic credit products. Words like subprime mortgages began appearing at an almost rapid pace in the news, along with structured investment vehicles (SIVs) and credit derivatives.
Around April, buzz started to spread around a hedge fund manager, David Einhorn of Greenlight Capital, and his new book, Fooling Some of the People All of the Time, detailing his six-year battle with a company he was short, Allied Capital. David agreed to come on Squawk Box to talk about his book the following month. In preparation for the segment, I got an advance copy of the book and started marking it up with colorful Post-it notes with items to remember and reference on the show. The depth of his research and conviction was inspiring to me. The finance geek that I thought I was could not hold a candle to him.
When David came on the show in early May, I made him sign my book. He wrote, “You are my hero for tearing this thing apart!!” I couldn’t help myself. The story had struck a chord with me.
Together, Einhorn and I planned a show centered on short-selling; the guests included a professor from Yale and Einhorn’s fellow hedge fund manager and friend, Bill Ackman from Pershing Square. We even set up a poker game at the end of the show that pitted Neill Chriss, a former SAC Capital portfolio manager who had skills strong enough to challenge Einhorn and who had ranked eighteenth in the World Series of Poker tournament in 2006. That show caused waves across Wall Street; viewer e-mails and calls arrived for days afterwards, telling us how important it was for the network to continue to bring such smart investors to the table.
After that, I started researching names of other smart investors at other hedge funds, their strategies, and their big calls. It wasn’t easy. Most hedge fund managers shied away from the press for fear that the Securities and Exchange Commission would come after them for potentially marketing outside their authorized accredited investor base.
It was an industry that remained under the radar, with the rare manager who would agree to speak to the press. The world knew about the legends that had since retired: Julian Robertson and his fierce “Tiger cubs”; George Soros and his famed short sale of $10 billion in pounds in 1992, earning him the title “The man who broke the Bank of England”; and Michael Steinhardt, known as much for his temper as his trading prowess.
But what of the investors who were following in the footsteps of the legends and who were leaving their own footprint on the markets? How were the strategies they used today different from the ones used before them? As technology and trading was advancing, how was portfolio management? These were compelling questions. To answer them, I began the arduous process that any new journalist must go through when first starting to cover a beat—I started reaching out to every expert in the industry, academic, researcher, trade publication, and magazine I could get my hands on. The more I absorbed about these hedge funds—their freedom to make liberal and exciting and complex trades and deals and investments—the more fascinated I became.
For the next three years, I slowly made progress getting face-to-face meetings with the chief players in today’s hedge fund landscape. Most meetings would take up to a year to coordinate (in some cases, two) and always took place on background, or not for attribution. Once the managers realized I was truly interested in things like portfolio construction and alpha generation—a return in excess of a benchmark adjusted for risk and country analysis—I started to get more access and even some complimentary comments on Squawk Box from Julian Robertson, Michael Steinhardt, and Carl Icahn. Beyond that, I continued to speak to investors and get a pulse for what they were seeing, hearing, and concerned about within hedge funds.
As I continued to study the leaders of this new age of hedge funds, I realized that the investors who had consistently outperformed the broader market for a significant period of time, these alpha masters, were bound together under the hedge fund umbrella, yet were wildly unique. They employed different strategies and had very different views of the world. But the one thing they had in common was that they could see things other investors couldn’t see. Short-sellers like Jim Chanos of $7 billion Kynikos Associates, the world’s largest short-selling fund, were the first to warn investors about massive frauds like Enron, WorldCom, and Tyco in 2001. Others like John Paulson of then $6 billion Paulson & Co. generated earnings of $15 billion on speculative trades betting against the subprime housing market from 2006 to 2008.
The Framework
My goal became to tell their stories with the active and aspiring investors in mind. This book is aimed at those who want to understand the anatomy of a great trade, the analysis for a sound framework, and the sense of self to strike out on their own and stand by their convictions. For two years I was fortunate enough to have hundreds of hours of unprecedented access inside these managers’ offices while they told me their stories.
All of the subjects of my book were generous enough to speak with me candidly, on the record, and many times on topics well beyond the scope of investment. I was privileged enough to see them during periods of stress, moments of reflection, and flashes of sheer genius.
I traveled with some, heard vivid recounts of memorable travels from others, and perhaps unexpected but most valuable of all, I got to see them as human beings—and could share in their successes and failures equally. I was privileged to be able to experience that intriguing journey, and I hope I have been able to accurately transmit these feelings to the reader.
The “Hedge Fund” Misnomer
My research led to another important question, which was: what is, in fact, a hedge fund? I posed the question to Ray Dalio, the 62-year-old founder of the world’s largest hedge fund, Bridgewater Associates, which has $120 billion in assets under management.
“I don’t even know what a hedge fund is!” he exclaimed, half-jokingly as we sat in his glass office surrounded by forest and a lake in Westport, Connecticut.
“What we’re called and how we’re categorized, by our basic structure, doesn’t capture the essence of what we are,” he quipped. “I trade long and short,” he continued. “Does that make me a hedge fund?” he asks rhetorically.
“No. I consider myself a financial engineer. I started trading commodities. Then commodities became various futures, which evolved into various swaps and derivatives. I could separate things in a way that was unique. I evolved.”
These elements are not exactly encompassed by the definition of a hedge fund, which, at its core, groups many of the world’s most sophisticated investors by nothing more than a compensation structure. As Dalio said to me, “I likely have nothing in common with the other managers in the book except for the fact that we are a unique group of good investors doing unique things.”
2011’s Mixed Signals
When I met with the subjects of this book, they were in the middle of steering their ships through stormy markets. We had just emerged from the worst recession since the Great Depression, and the U.S. markets, still smarting from their own severe crisis, were then paralyzed with fear about the voraciously eroding crisis in Europe. The year 2011 represented a time where many managers were defensive for the first half of the year and slowly began to wade back into the markets toward the third and fourth quarters.
It was one of the most tumultuous years the U.S markets had seen following the financial crisis. Markets suffered a high degree of pressure from a high degree of global economic uncertainty, the subsequent downgrade of the U.S. credit rating below “AAA” for the first time in history, and Europe’s increasing debt woes. Yet, for all its volatility, the market ended the year pretty much exactly where it started, with the S&P 500 Index closing within a tenth of a point of its starting place and the Dow up 5.5 percent.
Hedge funds saw more mixed performance, closing the year down 5.13 percent, according to industry data provider Hedge Fund Research. It was only the third calendar-year decline since 1990.
Spending time with the managers during such a tumultuous period was difficult but also very reflective. The managers had no choice but to sit back and really think about the answers they gave. Many had to admit miscalculations by comparison to prior years and point to wrong assumptions and mistakes.
Even though last year’s performance was lackluster, assets continued to climb throughout the year and regained precrisis levels of $2 trillion by the end of the year. Deutsche Bank’s December 2011 Alternative Investment Survey estimated a net inflow of $140 billion in 2012, bringing industry assets to an all-time high of $2.26 trillion by the end of 2012. While a prime driver for hedge fund assets in earlier years was ascribed to wealthy individual investors, it is now governed by the institutional participation, currently making up two-thirds of assets, according to the Deutsche Bank survey.
Still, the weak figures sparked attention. Aren’t hedge funds supposed to deliver “alpha”—returns in excess of expected risk—after all?
Well, according to research by LCH Investments NV, the world’s oldest fund of hedge funds, hedge fund managers made net profits from inception to June 30, 2011, of $557 billion for their investors. Furthermore, LCH found that $324 billion, or 52.8 percent of the profits stemmed from the equity markets.
One thing that mystified me was how, through various applied strategies, managers were able to profit by using publicly available information, and by seeing things in that data that the majority of investors could not see.
Part of it has to do with conviction of character. You will see each of these managers at one time or another with their backs up against a wall and the wolves circling in. Yet they stand their ground time and time again. They are not always media favorites for it, but they hang on to their own conviction with a steadfast faith in what they know to be true and wield it to their advantage.
This isn’t a guideline for how to be like the men profiled in the pages that follow. This is simply the retelling of their stories, the memories that make them who they are, and how they got all of that to work for them. Some came into the game knowing how to play and some invented the rules as they went along, but each instilled their core personalities into their work. The lesson to be learned is that you don’t have to be them for it to work. You just have to make a proven strategy yours. You will take hits. You will take losses. But so long as you do your own research and make the trade your own, you can always land on your feet.
The nature of humanity is that people reveal themselves (not to everyone, not always, but eventually). These are the stories of the moneymakers. They are the big players; the behind-the-curtain rock stars whose strategies and successes surpass those of the vast majority of investors around the globe.
These are the alpha masters. I hope you find their revelations as fascinating as I do.
Maneet Ahuja
April 2012