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 Farallon Capital's Andrew Spokes

ON AN EARLY MORNING IN OCTOBER, just as San Francisco was starting to emerge from the fog, Thomas Steyer, founder of Farallon Capital Management, strode across the ballroom stage at the historic Fairmont hotel. Wearing one of his signature plaid ties — a fiery red sartorial flourish — Steyer radiated casual power and confidence. His investors have come to expect no less. Since launching hedge fund firm Farallon more than a quarter century ago, Steyer has gained a reputation for aggressively pursuing investment opportunities across a wide sweep of markets around the world and tenaciously holding on to some positions for years. His ability to deliver steady returns has attracted a roster of blue-chip investors, and on that day about 200 of them were eagerly awaiting the chance to hear him speak.

But that morning was different from previous investor meetings, because Steyer, 55, had just announced his plans to retire.

A few days earlier he had written to his clients to tell them he intended to step away from the business at the end of 2012, and he named his co–managing partner, Andrew Spokes, as his successor. Although the timing was a surprise, the decision was not. For the past five years, Spokes, 47, has been working alongside Steyer at the firm’s San Francisco headquarters, gradually assuming greater control of Farallon’s $18.6 billion portfolio. In recent years most clients have called Spokes when they needed to know what was happening with a particular investment. But few people outside the firm are familiar with the genteel, boyish-looking Brit. Over the past few years, as Steyer has increasingly stepped into the media spotlight as the public face of Farallon, Spokes has remained the inside man.

Now the former Goldman, Sachs & Co. investment banker has taken on a more visible role as the leader of one of the world’s largest hedge fund firms — and the pressure is rising. In Steyer’s absence Spokes will have to deliver profits in line with Farallon’s historical performance, satisfy clients’ expectations and keep the investment team focused. Everyone will be watching the numbers. Although the firm suffered a disastrous year in 2008, when its flagship fund, Farallon Capital Partners, lost 36 percent net of fees during the financial crisis — humbling Steyer and his team — its returns over time have been solid if somewhat unspectacular. Since its 1986 inception Farallon Capital Partners has delivered a net annualized return of 13.41 percent, besting the S&P 500 index, which has returned an annualized 9.55 percent during the same period.

Steyer emphasizes capital preservation, and that is no accident. Early in his career he observed that there are primarily two reasons financial businesses blow up: using too much leverage and being dishonest. The native New Yorker vowed to avoid both sins. As his fund grew he spent tremendous energy seeking to insulate his portfolio from downside risk — a characteristic that set his business apart from its high-flying, more volatile peers. For 22 consecutive years, until the financial crisis, Farallon made money. That remarkable consistency helped attract investments from prestigious institutions including Yale University, where Steyer earned his BA in economics and political science in 1979, and Stanford University, where he got his MBA in 1983. Steyer has also won mandates from major pension funds and foundations, including the Canada Pension Plan Investment Board and the William and Flora Hewlett Foundation.

Given the change in leadership at the top of the firm, however, Spokes can no longer take those high-profile allocations for granted. If he wants to keep them, he’ll have to engage more closely with clients even as he assumes ultimate responsibility for Farallon’s investment portfolio. Steyer will be watching to see how he does. Although the hedge fund impresario doesn’t intend to have any further involvement in the firm, he does plan to remain its largest investor. “From here on out,” Steyer told the assembled crowd at the Fairmont, “I’ll be sitting with you in those seats, looking back up at the podium.”

The key to Farallon’s future lies in the firm’s understanding of ever-more-important cross-market interplays, whether they occur in the U.S., Asia or Europe. Onstage at the Fairmont, Steyer seized the opportunity to highlight Spokes’ international experience, underscoring his co–managing partner’s knowledge of various geographies and strategies. Since joining Farallon in 1997, Spokes has worked as an investor or team manager across most of the firm’s five portfolio strategies: credit, arbitrage, value investing, real estate and special situations. In late 1998 he was responsible for opening Farallon’s London office, which he ran for nearly a decade before moving back to San Francisco. He has also lived and worked in Hong Kong and New  York. From Steyer’s perspective, Spokes’ ability to move fluidly across business cultures gives him a competitive edge. “You need someone at the head of the organization who understands — and is comfortable in — different geographies,” he says. “Globalization has occurred.”

Although the financial crisis has clearly had a sobering effect on Farallon, prompting a massive rethink of the firm’s approach to liquidity risk, the core tenets upon which Steyer built the firm still hold. Integrity counts. Absolute returns have to be earned, not leveraged. Risks must be understood.

Spokes, who has adopted his mentor’s style of investing as his own, strongly believes in the value of providing risk capital in a liquidity-constrained market. Like Steyer, he seeks to gain an edge by performing rigorous analysis of companies’ cash flows, probable returns and potential downside hazards. But merely emulating Steyer’s approach may not be enough to secure the future of the business; Spokes will need to carve out his own strategic approach and raise his profile.

The urgency of that challenge has prompted Spokes to open up, and, in the months leading up to Farallon’s leadership transfer, he and Steyer spoke extensively — and exclusively — to Institutional Investor about their 15-year partnership and the firm’s transformation in the wake of the financial crisis. In a series of conversations that took place in Farallon’s offices in San Francisco and London, the two reflected on the changing nature of the hedge fund industry and their desire to build a lasting enterprise.

  Exiting founder Thomas Steyer

The very nature of the hedge fund business complicates such transfers of power, because these firms, given their entrepreneurial origins, are often hard to maintain without their founders’ direct involvement. In the past hedge fund managers tended to shutter their firms upon retirement or turn them into family offices; more recently, however, as the industry has become institutional, managers have been increasingly motivated to resolve the succession question and keep their funds open to new investors.

Steyer and Spokes spent considerable time — literally years — preparing Farallon’s clients for the transition. Ana Wiechers-Marshall, co-CIO at the Menlo Park, California–based Hewlett Foundation, which manages $7.5 billion in assets and has invested with Farallon since 2001, considers those preparations time well spent. “For any investor who has really had an ongoing dialogue with the firm, the news came as no surprise,” she says.

Jeffery Mora, a partner at Makena Capital Management in Menlo Park, agrees. “I think it’s been a pretty seamless transition,” says Mora, who oversees absolute-return and tactical hedged equity investments for Makena and has known Steyer for more than a decade. “Even though Tom is riding off into the sunset, he is still in touch with what’s going on at Farallon because he has a significant personal investment with the firm.”

For Spokes there may be no sharper goad than knowing that his former boss is betting on him to preserve his wealth. Spokes may not be as outspoken and flamboyant as Steyer — who once bought dozens of red plaid ties after his own fraying favorite was swiped by his mischievous staff — but he has a marksman’s eye for detail. His thoughtful, incisive approach to investing has already won admirers.

“Andrew has got a rigorously analytical mind,” says Reuben Jeffery III, chief executive of New York–based investment management firm Rockefeller & Co., who worked with Spokes at Goldman Sachs in London in the early 1990s. “He is smart, precise and incredibly disciplined in his thought processes. He is also, in his own quiet way, fiercely competitive.”

As experienced as Spokes is, current market conditions are bound to test his mettle. The affable Brit will have to navigate a difficult macroeconomic environment and recruit bright new talent as Farallon expands into distant international markets. The firm’s ambitions are wide-ranging, but the team has a knack for finding unusual, uncorrelated investments. Over the past two years, for example, Farallon’s credit portfolio has profited handsomely from the firm’s growing involvement in the recovery of client assets from Bernard Madoff’s Ponzi scheme — an investment that took legal savvy and a lot of research. Looking ahead, Spokes is keen to further diversify his firm’s portfolio and expand its geographic reach. In 2011, Farallon helped found a dedicated subadvisory firm in Brazil that is now securing private investment natural-resource deals. In 2012, Farallon received permission to launch a commercial lending operation in mainland China, and the project is under development. “It’s really quite exciting,” Spokes says. “We’ve been approved to do onshore lending, so it’s not a banking license — we can’t take deposits — but it will allow us to be providers of capital for small- to medium-size businesses.”

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