Big Hedge Funds’ Succession Problems
Who will follow in the footsteps of high-profile hedge fund managers? Not many of them know.
ISRAEL (IZZY) ENGLANDER CAN CERTAINLY AFFORD to kick back and relax. The veteran hedge fund investor has established an enviable record since founding Millennium Management in 1989, delivering outsize average annual returns of 16 percent and amassing personal wealth estimated at more than $1 billion. But at the age of 63, the white-haired Englander says he has no plans to retire.
“I have no place to go,” he says. “My wife didn’t marry me to have lunch.”
Leon Cooperman is equally determined to stay in the saddle. At 69 the billionaire investor is even more involved in the daily trading activities of his firm, Omega Advisors, than Englander is at Millennium, and he has no desire to give up the action. “I still get a charge finding something someone doesn’t see, making a bet and having Mr. Market prove me right,” Cooperman says in his spacious Lower Manhattan office overlooking the South Street Seaport.
Englander and Cooperman are hardly alone. The financial world offers plenty of examples of investors, such as George Soros and Carl Icahn, who have remained active well into their 70s or even 80s. But these workhorses obscure a larger trend. For every hedge fund investor who stays in the game into his golden years, many more will look to step back, whether to retire and enjoy their earnings or to pursue philanthropic or other activities. And never before has such a large class of well-heeled investors reached that stage in life.
Over the next ten years, dozens of high-profile, successful hedge fund managers will reach their 60s and 70s. Some will return money to investors and effectively convert their firms into family offices, as Centaurus Energy Master Fund’s John Arnold and Duquesne Capital Management’s Stanley Druckenmiller have done in the past 18 months. But many more vow to keep their firms going without a glitch. To do so, they will have to engineer a transition to new leadership, a delicate task that in some ways could be as tough to pull off as their firms’ initial rise to prominence.
Institutional Investor estimates that more than $600 billion is currently managed by hedge funds whose founders will reach at least their 60s within the next decade. Many of these managers are stars whose names are intimately linked with their firms — in many cases etched on the front door. Their personal investing prowess is the very lifeblood of their enterprises. These managers include such luminaries as Louis Bacon of Moore Capital Management, Steven Cohen of SAC Capital Advisors, Paul Tudor Jones II of Tudor Investment Corp., Seth Klarman of Baupost Group, Stephen Mandel Jr. of Lone Pine Capital, Paul Singer of Elliott Associates, David Tepper of Appaloosa Management and, of course, Englander and Cooperman, to name just a few.
Many of these managers are mindful that the biggest names of the previous generation — Leon Levy and Jack Nash of the former Odyssey Partners, Michael Steinhardt of Steinhardt Partners and Julian Robertson Jr. of Tiger Management Corp. — shuttered their firms when they retired. In fact, these days when hedge fund managers talk about succession, they invariably point to Robertson, who closed his firm in 2000 after suffering losses the previous two years, as if to say, “I don’t want that to happen to me.”
“To pass on a firm where the principal is the dominating person making the money is very difficult because finding a replacement for someone like that is very difficult,” says Englander.
Yet many firms don’t even seem to be trying. Dozens of interviews with hedge fund managers, investors, consultants, lawyers and other industry experts make it clear that many managers are not taking the succession process seriously enough or are not willing to face up to what it entails. Some managers eschew succession planning but don’t want to communicate this for fear of spooking investors and employees, who might be tempted to depart if they think the manager will be leaving soon. Billions of dollars worth of assets, and the lucrative fees they generate, are at stake. Some industry experts, including a few longtime managers, believe some managers talk about succession solely to retain employees and clients, even though they have no plan to keep their firms running after they retire.
“This is an issue the industry must face over the next several years,” says Daniel Stern, head of the hedge fund research team at consulting firm Cliffwater.
A recent survey by accounting firm Ernst & Young suggests that many hedge fund managers are in denial on the issue: Nearly two thirds of hedge fund investors said having a well-articulated succession plan in place was important to their investment decisions. By contrast, fewer than 40 percent of hedge fund firms that responded to the survey said they considered a succession plan important to retaining investors.
Jonathan Hook, chief investment officer for Ohio State University, said his team spends a lot of time discussing succession with hedge fund managers when doing due diligence. “We want to know, when the main guys step down, who is running the fund and pulling the trigger?” he says.
Some investors are demanding a “key man clause” giving them the right to withdraw funds from a hedge fund firm if the founder and in some cases the top portfolio managers depart. Many firms refuse to provide such clauses; this is fine with some investors as long as the fund involved is highly liquid and has a liberal redemption policy.
“If the strategy is illiquid or moderately illiquid, succession planning is more important,” insists Charles Stucke, senior managing director of Guggenheim Partners and CIO of Guggenheim Investment Advisors, a global multifamily office and investment advisory practice. “Also, the more important trading, systems and personnel infrastructure is to the fund, the more important succession is in supporting that strategy. An orderly succession allows the LPs to hang on to valuable, developed trading-related infrastructure, such as the technology and operating platforms of well-baked quant and relative-value managers.”
Over the years a number of hedge fund managers have successfully handed the reins over to a new generation. Among the most recent examples, several quantitatively oriented firms — like D.E. Shaw Group and Renaissance Technologies Corp., which were not dependent on their founders for day-to-day trading decisions — have successfully completed transitions to new leadership.
Succession is a much greater challenge for the high-profile firms that rely on or are closely identified with a single star investor. These investors earned their iconic status by consistently generating outsize returns, often for decades. They must convince investors that a qualified successor or successors exist and that performance will not suffer when the founder is out of the picture.
Baupost’s Klarman is well aware of this challenge. His response? For years he has been telling investors and the industry that he is not really the dominant figure that many perceive him to be. “People give me way too much credit and then assume that I’m integrally important,” he told II in an e-mail response to questions. “I would say I’m important, but I’m not integrally important and will be less important over time. I’ve got 40-plus people on my investment team. The vast majority of our ideas are not my ideas, they’re their ideas.”
Some observers are skeptical of such claims. Hedge fund stars are a rare breed; relatively few people have been able to build large firms by beating the market year in and year out over a long period. Investors can’t assume that these stars can simply pass on the mantle. “When the individual or individuals who have the market skills to make money are gone, the market skill is gone,” says Hans Hufschmid, a former principal at Greenwich, Connecticut–based hedge fund firm Long-Term Capital Management who is now CEO of GlobeOp Financial Services, an administrator of middle- and back-office services for hedge funds.
In recent years several managers, such as Bacon and Jones, have taken the opposite tack from Klarman and assumed more responsibility for running their firms, with no apparent successors in sight.
Unlike Klarman, Englander and Cooperman, most prominent hedge fund managers refused to comment for this article. Spokespersons for several fund managers played down the issue of succession or insisted that their firms have it under control. At Taconic Capital Advisors, co-founder Kenneth Brody says simply that the firm has a unique succession plan, but he declines to elaborate. Most managers avoid addressing succession questions publicly. But they can’t duck the issue indefinitely.
“We have a large group of funds where the managers have been there for a long time and the time line for deciding what to do with the future is getting closer,” says Cliffwater’s Stern. “A vast majority do not have a succession plan, and if they do, it is not well articulated to investors.”
THERE ARE SEVERAL KEY ELEMENTS OF A good succession plan. The most important, which any smart investor should know, is proper timing and preparation. Experts advise that firms name the designated successor or successors several years before the founder steps down and elevate them gradually by having them participate in conference calls and investor days, and sign the investor letter. Clients and prospective investors need to know these heirs apparent, so firms should give them as high a profile as possible rather than keeping them under wraps, as most hedge fund firms do, so competitors don’t poach them.
Also vital: the principal keeping most or all of his wealth within the firm. “That’s a tremendous marketing and trust issue,” says Joel Press, founder of New York–based Press Management, which advises hedge fund firms on succession planning and is one of the foremost authorities on the issue. It gives investors tremendous comfort to know the founder has the confidence to trust his own money with the new team, Press says.
Founders should liberally share equity in the firm with their successors so they have big financial stakes in staying on, experts say.
One early, successful transition took place at Sandler Capital Management, founded by former Goldman, Sachs & Co. media analyst Harvey Sandler in 1988. Sandler retired in the early 1990s for health reasons and handed over his responsibilities to three partners, who have since retired. Today the firm is headed by Sandler’s oldest son, Andrew Sandler. It manages more than $1.3 billion in its hedge fund portfolios and has 32 employees.
One of the most successful hedge fund transitions took place in 2002 when legendary futures trader Monroe Trout Jr. retired at 40 and sold his Bermuda-based Trout Trading to CEO Matthew Tewksbury, who had been with the firm for a decade. Trout also left his own money in the then-$3 billion firm, which was renamed Tewksbury Capital Management. The firm now manages between $3 billion and $4 billion, and Tewksbury has maintained Trout’s legacy of never suffering a down year. His returns have been consistent, rising between 4.6 and 10 percent in all but one year, 2006, when he was up nearly 28 percent.
In recent years David Shaw of $26 billion D.E. Shaw and James Simons of $20 billion Renaissance Technologies have managed to seamlessly hand over the operational control of their firms to new, handpicked management teams. To some extent, their success reflects the fact that both firms are quantitatively oriented, relying mainly on the algorithms and programming talents of their legions of Ph.D.s rather than on the analytical skills and gut instincts of a veteran trader who picks stocks based on painstaking fundamental analysis. Both Shaw and Simons have kept major chunks of their wealth invested in the funds.
Shaw, who taught computer science at Columbia University after receiving his Ph.D. from Stanford University, founded his firm in 1988 “as essentially a research lab that happened to invest and not as a financial firm that happened to have a few people playing with equations,” he told II in a 2009 profile. In 2002 he handed over day-to-day management to a group of six managing directors: Anne Dinning, Julius Gaudio, Louis Salkind, Stuart Steckler, Max Stone and Eric Wepsic. Today, D.E. Shaw has some 1,100 employees managing $26 billion in assets, making it one of the largest hedge fund firms in the world. Shaw, who serves as chairman and chief scientist at D.E. Shaw Research, an affiliate that conducts basic scientific research in the field of computational biochemistry, has an estimated $2 billion of his wealth invested in the firm’s funds and is said to still get involved in major strategic decisions.
Like Shaw, Simons turned his academic brilliance into hedge fund billions. A mathematician with a BS from the Massachusetts Institute of Technology and a Ph.D. from the University of California, Berkeley, Simons launched his famous Medallion Fund in 1988, the same year that Shaw began trading. Over the years, the fund, which is now closed to outside investors and is believed to contain some $9.5 billion, has racked up average annual returns of 36 percent, net of the firm’s 5 percent management fee and 44 percent performance fee. Simons relinquished control in 2010, stepping up to the position of nonexecutive chairman and appointing as co-CEOs Peter Brown and Robert Mercer, who were among the early Ph.D.s whom Simons recruited to the East Setauket, New York–based firm. Last year the Renaissance Institutional Equities Funds (RIEF), whose net-long investment strategy trades U.S. and non-U.S. equity securities listed on U.S. exchanges, surged about 34 percent. This came on the heels of its 16.45 percent gain in 2010 following two straight losing years and management threats to shut the funds down. Medallion gained about 35 percent in 2011, while the Renaissance Institutional Futures Fund was up 1.82 percent. Simons is believed to have at least $10 billion of his wealth invested in the funds.
Highbridge Capital Management has pulled off both a partial leadership transition and a change of ownership. The multistrategy firm was founded in 1992 by childhood pals Glenn Dubin and Henry Swieca. In late 2004, JPMorgan Chase & Co. paid about $1.3 billion for a majority stake. In June 2009 the bank raised its stake to nearly 100 percent from 77.5 percent and Swieca, who had gradually decreased his role, severed all ties to the firm.
Dubin still runs Highbridge as chairman and CEO, which is one reason the firm has continued to grow seemingly without a glitch. Dubin proudly points out that Highbridge, which has more than quadrupled its assets, to $30 billion-plus from $7 billion, since JPMorgan made its initial investment, still resides in a building several blocks away from the bank’s Midtown Manhattan headquarters.
Another reason the transition has been so smooth is that Dubin and Swieca never personally completed a trade, relying instead on expert managers to run the various strategies. The pair designed Highbridge that way, hoping to build a firm that would outlast their tenures. That also explains why the firm doesn’t bear either of their names. “We never put on trades ourselves,” says Dubin. “That distinguished us from many of our peers. We also have a deep senior management team and are fortunate to have found the right partner [JPMorgan], who has protected our culture.”
By contrast, Caxton Associates had always been closely identified with its co-founder Bruce Kovner. He had directed the trading strategy at the New York–based macro hedge fund firm since its inception in 1984, delivering average annual returns of 21 percent. It would take careful preparation for Kovner to leave without undermining the firm, which had $9.3 billion in assets at the start of the year.
Kovner and Caxton’s co-founder and president, Peter D’Angelo, began the succession process more than a decade ago. “Bruce had seen firms closed down when the founder ceased to be actively involved. He did not want that to happen at Caxton,” John Forbes, the firm’s COO and CFO, told II’s sister publication AR magazine earlier this year. First, the two executives began informing clients that Kovner, then in his 50s, was not planning to run Caxton forever. Around that time, Kovner and D’Angelo created a risk committee and drafted a disaster recovery plan. “We assured investors a plan was in place should something happen at any time,” Forbes recalled.
By 2007, Kovner had stopped taking the lead on the trading side, turning that responsibility over to Andrew Law, a Briton and onetime Goldman Sachs prop trader who had joined Caxton in 2003. He formally promoted Law to become the firm’s CIO the following year. Law quickly put his imprint on the firm, converting Caxton into a Delaware-based partnership, naming eight individuals as partners and instituting a daily telephone conference call. He also jettisoned several strategies and returned Caxton to its macro roots, with the goal of concentrating on the most-liquid markets. By the time Kovner and D’Angelo retired and Law officially took control as chairman and CEO, at the start of this year, investors were more than prepared for the transition. In fact, thanks to substantial inflows, Caxton ended 2011 with the highest level of full-fee-paying assets since the end of 2008.
Caxton is more the exception than the rule, however.
Over the years, hedge fund superstars like Bacon, Cohen, Druckenmiller, Jones, Soros and Tepper have been directly associated with their firms’ outsize gains and risk management. They have skill sets that are hard to replicate. Over decades they have developed the instincts that enable them to do the research and make the judgments that produce eye-popping returns, as Tepper did in early 2009 when his research, experience and sense of history led him to buy beaten-down bank stocks before anyone else, allowing Appaloosa to post triple-digit gains in its main funds that year.
For these reasons, experts are more skeptical about some firms’ ability to flourish after their founders’ departures. “Most luminaries are luminaries because they are so good and impactful,” says Michael Hennessy, co-founder and managing director of investments at Morgan Creek Capital Management, a fund-of-funds firm based in Chapel Hill, North Carolina. “When they leave, I’ll bet most of their funds will do well but not as well.”
GlobeOp’s Hufschmid echoes the point. “You can’t teach and institutionalize instincts,” he says. “You can’t pass it on to the next generation.”
The issue of how to pass on intangibles was raised by no less than Jones four years ago in an interview with Alpha magazine. Jones, of course, first made a name for himself in 1987, when he called the October stock market crash and rode a heavy short position in stock index futures to a 201 percent gain for the year. The Memphis, Tennessee–born macro specialist, who began his career as a cotton trader, is equally proud of the fact that he has never had a down year since he formed Tudor Investment in 1980. (In 2008 the flagship Tudor BVI Global Fund, which Jones runs, lost about 3 percent, but a small private fund he personally steers remained in the black.) Although the firm’s assets have fallen to $11.5 billion from a peak of $20.9 billion, the BVI Global Fund has enjoyed 20.2 percent net annualized returns since its 1986 inception.
In the 2008 interview Jones lamented the dearth of the kind of tape reading that he credits for his success. “I see the younger generation hampered by the need to understand and rationalize why something should go up or why something should go down,” he said. “Usually by the time that becomes self-evident, the move is already over. When I got in the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you?”
It is not surprising, then, that although Jones is 57 and has more than 30 partners and 40 portfolio managers on his team, he has taken on an increasing role at his firm. In the aftermath of the 2008 market meltdown, Jones told investors in a 2009 letter that he would be responsible for about half of the performance of his main, $10 billion fund for the foreseeable future.
Today, Jones has no apparent successor. James Pallotta, one of his few prime candidates, left the firm in 2008. The founder insists he is happy playing a leading role. “Right now I really love trading, and the opportunity set I see for the next four or five years seems very compelling, so retirement seems not for me,” he tells II.
A similar scenario is playing out at Moore Capital Management. Louis Bacon founded the firm in 1989, when he was just 33, using $25,000 he inherited from his mother after her death from cancer. Today, Moore manages $15 billion, down from a high of $20 billion in 2008, and has some 400 employees.
According to sources close to the firm, Bacon, 55, still controls roughly 70 percent of the $8.2 billion in assets currently invested in the firm’s flagship offshore fund, Moore Global Investments, and its U.S. domestic counterpart, Remington Investment Strategies. He also sets the risk exposure for the funds, working closely with Richard Axilrod, his chief strategist, who has been with the firm since 1996. The formula has been wildly successful to date: MGI has compounded at a rate of 18.56 percent a year since inception in 1990, while Remington has delivered average annual returns of 17.7 percent since its launch in 1995. The question is, can Moore keep up the performance? In the past few years, several experienced individuals have left the firm, including Jean-Philippe Blochet, a co-founder of Brevan Howard, who came out of retirement to join Moore in early 2010, only to leave in May 2011.
Sources close to Bacon say he has no plans to retire in the near future and remains as engaged as ever in managing the firm’s assets. But these same sources acknowledge that it would be unrealistic to expect someone else to replicate his performance and risk profile at MGI and Remington. Whenever Bacon decides to step aside, they say, those two funds will most likely become a family office for Bacon’s personal wealth, while Moore Capital’s $4.3 billion Macro Managers funds could continue to trade independently.
Similar question marks hover over SAC Capital. Cohen, 55, the firm’s founder, chairman and CEO, is one of those larger-than-life personalities who have come to personify the hedge fund industry. His firm is one of the most active stock traders around, and a track record of 25 percent annualized gains since inception in 1992 enables SAC to charge an astounding 50 percent performance fee. But it’s unclear who would run the firm if and when Cohen decides to call it quits.
Lately, Cohen has tried to downplay his influence and make his firm sound like a mundane institutional operation, describing it in marketing documents as “a diversified hedge fund that uses both fundamental and quantitative analysis based approaches.” Not long ago, a spokesman for the firm sought to minimize Cohen’s role, asserting that he trades less than 10 percent of the firm’s capital and insisting that SAC has a senior management team with the experience and ability to run the company.
But industry experts say Cohen still has a huge influence at the firm. His desk sits smack in the middle of SAC’s 20,000-square-foot trading floor in Stamford, Connecticut. He is said to be obsessed with silence, so the trading floor is eerily quiet, with phones blinking rather than ringing. Cohen himself is a major art collector and recently lost out on a bid to buy the Los Angeles Dodgers.
If Cohen tries to keep the firm open after his retirement, leaves a lot of his capital in and persuades a significant number of investors to remain in the firm’s funds, several industry experts believe he could see the firm survive his departure. This is because SAC could lose three quarters of investors’ assets and still have a sizable firm thanks to Cohen’s enormous personal wealth.
Others, however, doubt a transition would be smooth at SAC. For one thing, despite Cohen’s managing less than 10 percent of the assets, his imprimatur and aura are well enmeshed in the SAC psyche.
As for that supposedly deep investment bench, few outside the firm know who these people are. A number of industry pros think a war over control would break out no matter what succession plan Cohen designs. “When you take the dominant lion out of the pack, the others will fight until someone wins,” says one well-regarded hedge fund investor. “Everyone who thinks they are an alpha male will go for it. They want to be rich like Stevie and own the place.”
To try to head off such a scenario, Guggenheim’s Stucke says, years before a transition is expected to take place, hedge fund superstars should have open discussions with their senior teams about the value of working together and each member’s prospects in the business going forward. “It is a hard conversation to have and takes several years,” says Stucke. “The founding principal must move the team to agree about sharing value together or identify which member does not fit and plan his or her succession as well.”
A NUMBER OF HEDGE FUND managers do, in fact, have viable plans to pass the baton to a new generation, and some have taken the first steps of a transition process.
Consider the case of Bridgewater Associates. Raymond Dalio launched the firm from his two-bedroom New York City apartment 37 years ago and has relentlessly built it into a juggernaut. Today, Westport, Connecticut–based Bridgewater is the world’s largest hedge fund firm, with $76 billion in assets and an additional $45 billion or so in long-only strategies.
Sources say Dalio set a succession process in motion in 2008 when he drew up a ten-year transition plan. Under the plan Bridgewater required roughly 15 to 20 key executives to invest most of their net worth in the firm by buying equity at a very deep discount. This group included co-CIOs Greg Jensen and Robert Prince.
In addition, Bridgewater earlier this year sold a nonvoting stake to the Teacher Retirement System of Texas for $250 million and another stake to an undisclosed institutional investor. The sales aimed to strengthen the firm’s capital base by bringing on board deep-pocketed long-term investors. Dalio has reportedly told investors that he aims to reduce his ownership stake to something in the range of 10 to 20 percent by the end of the ten-year period.
Industry observers say Bridgewater has a good chance of outliving its founder. For one thing, Dalio doesn’t appear to be going anywhere any time soon. He is apparently leaving much of his personal wealth, which Forbes estimates at a cool $10 billion, in the firm. And Bridgewater’s design lends itself to institutionalization. The firm describes itself as a fundamentally based systematic investor, relying on sophisticated computer programs and a staff of 1,200 to direct its trading rather than the instincts of a star trader.
Yet even Bridgewater, despite its massive scale and careful succession planning, faces big questions about the future. Perhaps the biggest one: What happens to the company’s controversial corporate culture when the boss is no longer around? Dalio is perhaps best known for requiring that everyone in the firm read his 110-page “Principles,” which are reflected in an atmosphere of radical transparency that encourages every employee to speak openly — and critically, if necessary — about one another. Will these principles survive their author?
As Lee Cooperman sees it, there are two hedge fund succession models. One is the Michael Steinhardt model: The renowned hedge fund manager shut his firm down when he retired in the 1990s after having produced compound returns of 24 percent, net of fees, over 28 years. Then there’s the George Soros model. The octogenarian handed the day-to-day management of his offshore Quantum Fund to Druckenmiller in the 1990s but still remained involved. After Druckenmiller left in 2000, Soros tapped other outsiders to run his firm, only to periodically return to the helm, like Billy Martin coming back to the New York Yankees, when his successor underperformed. He finally decided to return all outside money late last year, converting Soros Fund Management into a family office.
Cooperman’s plan: Follow the Soros path. The former Goldman Sachs partner insists that at 69 he still enjoys sleuthing for value. Working also gives structure to his life; he says he has few outside hobbies, stressing that he is not into art like some other hedge fund managers. Besides, his wife, Toby, who works with special-needs children and adults at ECLC of New Jersey, is still very active and plans to keep working. Last year the billionaire took Bill Gates’s Giving Pledge, promising to donate roughly half his fortune.
Although he insists it’s premature to talk about succession, Cooperman has already begun to make sure Omega Advisors is ready for that day. First, he has his trusted deputy, vice chairman Steven Einhorn, who joined Omega in 1999 after having served with Cooperman on Goldman’s investment policy committee in the 1980s. At age 63, however, Einhorn doesn’t appear to be a lasting solution.
In recent years Cooperman has brought on board two investors he hopes may one day be able to take over the firm. Jon Aborn, 39, and Sam Martini, 37, serve as co-directors of research and general partners. Both joined the firm in January 2011 after consulting for the company more than a year and a half. Previously, Aborn managed Starpoint Capital, which he founded in 2007, while Martini was a generalist at Cobalt Capital Management, a hedge fund firm co-founded by one of Cooperman’s two sons, Wayne.
Cooperman is in a unique position. He says having Aborn and Martini around extends his shelf life and frees him up to spend more time visiting companies. And the fact that two talented young investors have decided that their futures lie at Omega should help the firm attract and retain talent.
Cooperman says that if he and Einhorn remain confident in the abilities of Aborn and Martini, the younger men could take over leadership of the firm one day. Otherwise he would likely give his wealth to his son Wayne to manage or turn Omega into a family office. “There is no one-size-fits-all,” Cooperman says. “My money will go where it is treated best.”
Baupost’s Klarman began focusing on succession, or “progression planning,” as it’s called at the outfit, well over a decade ago. That’s when he started spreading ownership stakes in the firm among key people. He knew, given his firm’s success and his reputation, that the transition would be a long, slow process. After all, the value manager is one of the greatest hedge fund investors of all time, if one adjusts for risk. Boston-based Baupost has generated an annualized return of more than 18 percent in its oldest fund since its founding in 1983, despite Klarman’s penchant for holding cash — on average, 33 percent of the fund since 2001. Such investing success has turned Baupost into the world’s ninth-largest hedge fund firm. Its 190 employees were managing about $25 billion in assets at the start of this year, up more than fourfold from the end of 2006. That amount is nearly 1,000 times the $27 million he received in 1983 from a small group of wealthy individuals, including two Harvard University professors, to help launch Baupost.
Klarman started thinking about Baupost’s future more seriously five years ago, when he turned 50, even though he says he is in fine shape and has no plans to retire.
In June 2010 he started to share overall portfolio management duties with Herbert Wagner III, who at the time was managing Baupost’s public investment group, which oversees all corporate and mortgage debt, structured products and equity investments. Klarman also promoted more key people. Today there are 11 partners, and he expects this roster to grow in the coming years. Klarman has been obsessed with raising the profiles of many of the firm’s top talent. Partners and analysts participate in regular webcasts, speak with clients over the phone when they have specific questions and contribute to the quarterly investor letters. What’s more, several of them write their own commentaries. For example, Baupost’s recent, 31-page year-end letter for 2011 features, in addition to Klarman’s detailed review and analysis, somewhat lengthy commentaries written by four others: Wagner, COO Paul Gannon and the co-heads of the firm’s private investments group, Tom Blumenthal and Sam Plimpton.
“It is crucial that investors get comfortable with the next level of management and even the one after that one,” says Myron Kaplan, a founding member of New York law firm Kleinberg, Kaplan, Wolff & Cohen, who represents a number of hedge funds. “They want to know their money is safe and there will be continuity.”
As Klarman sees it, Baupost has a fiduciary responsibility to its employees and clients to ensure that the firm lives on after he is gone. “We’ve got a good thing going here,” he tells II via e-mail. “It would be regrettable for everyone involved — clients and employees — if Baupost doesn’t get passed down from generation to generation.”
But don’t suggest to Klarman that he is solely responsible for the firm’s success. He insists that most of Baupost’s investments are not his ideas. “I’m not sourcing the idea; I’m not doing the analysis on it,” he stresses. “I’m playing a role in deciding when to buy or sell and how much, working along with the co-PM and the other partners.”
That is the key message most hedge fund managers want to put forward. But it is a delicate dance for Klarman and most of the other rock stars. After all, Klarman makes the key investment decisions, along with Wagner, and he has defined the firm’s mission, strategy and focus.
Of course, the first test will be whether investors demand to redeem their money if and when Klarman leaves. Like most hedge fund firms these days, Baupost does not have a key man clause in its partnership agreements and does not engage in side letters with limited partners. The next significant test will come if and when the new team faces adversity, such as sagging performance.
The new team has to produce. It will be judged like a new investment in a new fund. Industry experts say investors are unlikely to show much patience. Just ask Jones and Bacon, who saw a huge wave of withdrawals after 2008 even though they did a great job of protecting their investors’ money during the financial crisis.
Klarman is well aware of the “vicissitudes of fortune,” as he puts it. “If the first thing that happens after I go — whether I retire or pass away — is that the market falls in half and Baupost loses a lot, that will shake confidence just like it would if I’m here,” he told II in an interview two years ago.
Englander has a similarly pragmatic view. He has spent the past few years making Millennium “more institutional” and building up a strong talent bench. In fact, he is the first to acknowledge that the hiring two years ago of John Novogratz to boost marketing was largely responsible for the firm growing back to $15 billion in assets.
At the end of the day, however, Millennium will only be as strong as its performance, with or without Englander. “Investors are very fickle,” he says. • •