Sofaer, so good

The doyen of Asian hedge fund managers -- Michael Sofaer -- is obsessive about control and dislikes marketing. But after some sour years, he’s determined to delegate responsibility and turn to building up his firm.

The doyen of Asian hedge fund managers -- Michael Sofaer -- is obsessive about control and dislikes marketing. But after some sour years, he’s determined to delegate responsibility and turn to building up his firm.

By Kevin Hamlin
August 2002
Institutional Investor Magazine

Barton Biggs and Michael Sofaer were halfway up 17,058-foot Mount Kenya in Africa when Sofaer’s bad back gave out. The Morgan Stanley & Co. global strategist advised the anguished hedge fund manager that he had a choice: stay overnight in a flea-infested hut until proper help arrived or be carried down the mountain by locals. Sofaer, then 40, thought about it a moment and chose a third course.

“I decided it would be less painful to hobble down on my own,” he says. It took him all day.

Sofaer is hardly the first money manager to ignore Barton Biggs’s advice, but these days the head of London-based Sofaer Capital is earnestly trying to be a little less headstrong. Indeed, his legacy as the maven of Asian hedge fund managers may depend on his willingness to let others make portfolio calls for him so that he can concentrate his energies on something he has long neglected: building up his firm -- into nothing less, he says, than a $3 billion to $5 billion hedge fund colossus.

Sofaer has a reputation for being obsessive- compulsive as a money manager -- and as a boss. “He had a tendency to do everything himself and not to delegate sufficient authority and responsibility to his individual managers,” says Marc Faber of Hong Kongbased Marc Faber Ltd., who has known Sofaer since the early ‘80s and sits on Sofaer Capital’s board. “If they were good, they set up on their own or moved to somewhere where they got more autonomy. A key weakness in the past has been defections of key employees.”

Another weakness was Sofaer’s reluctance to treat Sofaer Capital as a commercial enterprise rather than as a calling. Blame George Soros, in part. Way back in 1983, when Sofaer was an upstart 26-year-old analyst and mutual fund manager who had the chutzpah to want to start his own hedge fund, he wangled an introduction to the legendary hedge fund manager through Drexel Burnham Lambert. Over breakfast at Soros’ Manhattan town house, Sofaer said that the purpose of his visit was “marketing,” to which Soros responded: “That’s a mistake.” The Quantum Fund founder warned Sofaer that he couldn’t manage money and market a hedge fund at the same time.

“I thought Soros was right in the sense that you can’t market and focus on investing,” recalls Sofaer. “So I took the easy way out and did what I enjoyed most.” Besides, Soros had entrusted Sofaer with $1 million to invest in his new hedge fund.

The impressionable Sofaer deemphasized marketing and most other aspects of building a business and focused on his first obsession -- managing money. Now he laments: “The record speaks for itself. I’m not a natural marketer. It’s been a big mistake of mine that I’ve never bothered with marketing.”

Clients might disagree with Sofaer that his decision to emphasize managing money was a blunder. Except for a few wobbly years at the start and a couple of off ones of late, Sofaer Capital has done pretty well by its investors. The flagship SCI Asian Hedge Fund has recorded a creditable 11.1 percent compound annual average return over the past ten years through June; this compares favorably with 3 percent for the MSCI all countries Far East ex-Japan index. And since its inception in 1989, SCI Asia has risen a cumulative 451 percent, compared with 327 percent for the Van Asian portfolio hedge fund index. “Sofaer has navigated his firm well in what has been a difficult environment in Asia,” points out his friend and fellow hedge fund manager Leon Cooperman of Omega Advisors.

Sofaer’s other long-standing fund, SCI Global Hedge Fund, started in 1987, has a 13 percent average annual return for the past ten years, compared with the MSCI world index’s 6.1 percent. SCI Global lags somewhat behind the Van global hedge fund index, however. Sofaer’s funds have never lost more than 14 percent in a given year.

Returns, though, could sometimes be spectacular. Sofaer Capital took off in 1993 when the Asia fund leaped 83 percent and the global fund almost 40 percent. From just $25 million at the end of 1992, Sofaer Capital’s funds under management surged in a year to roughly $300 million. Marketing seemed beside the point.

Performance slipped in 1994, but Sofaer quickly recovered, and by 1997 the firm’s funds under management topped $500 million. Still insisting that he was no marketer, Sofaer opened two more funds over the next few years to exploit the firm’s momentum: SCI Europe Hedge Fund in June 1998 and SCI Japan Hedge Fund in October 1999.

The Asia crisis beginning in 1997 would only add luster to Sofaer’s reputation -- and money to the firm’s coffers. Sofaer saw the crash coming and shorted the Thai baht as well as the Indonesian rupiah, the South Korean won and the Malaysian ringgit. SCI Asia outperformed the MSCI all countries Far East ex-Japan index by a cumulative 63.3 percentage points from January 1997 through December 1999.

Describing Sofaer’s investment style takes some doing. It’s a melange of methods -- what investment professionals politely call a multistrategy approach. “It’s very difficult to put him in a box,” says Ophelia Tong, one of the high-profile portfolio managers who decamped from Sofaer Capital. “There are times when he is a value investor, times when he is a momentum investor and times when he is a macro investor.”

Tong, who had been CEO and CIO of National Mutual Funds (Asia) in Hong Kong, joined Sofaer in 1999. She quit some 15 months later to start hedge fund firm HT Capital Management.

Sofaer’s funds go long and short, of course, but rarely use leverage. A value investor at heart, he looks for companies with a competitive advantage and high-quality management that generate free cash flow and return 20 percent or more on equity. Sofaer continues to be responsible for macro analysis of global liquidity, which he considers probably the single most important influence on market sentiment.

In 1999 all four Sofaer hedge funds racked up strong absolute returns: SCI Asia gained 58 percent; SCI Global, 44 percent; SCI Japan, 42 percent; and SCI Europe, 26 percent. By the end of that year, Sofaer Capital’s funds had reached $1.2 billion, and the firm seemed poised for further growth.

Then the bottom fell out of the world’s stock markets, of course, and Sofaer Capital landed with a thump. SCI Asia slipped more than 10 percent in 2000, though the MSCI Far East and Van Asian hedge fund indexes fared worse, dropping 37.8 percent and 17.3 percent, respectively. The next year was rougher: SCI Asia fell 12 percent, while the MSCI Asia index declined just 4.9 percent and the hedge fund index actually gained 14.9 percent. SCI Global, meanwhile, was off 5 percent in 2000 and a further 12.6 percent in 2001.

Sofaer blames much of last year’s poor performance on having to write down private equity investments, which had risen to 18 percent of Sofaer Capital’s total assets. Those holdings have now been shifted into a separate fund.

Clients yanked out some $200 million, leaving Sofaer Capital today with $900 million in funds under management, once portfolio reverses are taken into account. For a while, things got so glum that Sofaer contemplated shuttering his firm. The hastened retirements of hedge fund greats Michael Steinhardt, Julian Robertson and, temporarily, Stanley Druckenmiller and George Soros -- after steep performance dips -- rattled Sofaer. What stunned him was that investors could dump “great managers” merely because of short-term declines.

“History shows that you can’t blip for more than 12 months,” Sofaer says grimly. “You are only as good as your last 12 months. If investors have that time frame -- no matter how much money was returned to them previously -- there’s a question mark over the quality of the business.”

But after some soul-searching, Sofaer concluded that he could not abandon an activity so vital to his being. “I thought, Investing is the only thing I know, it’s the most stimulating thing I’ve ever done,” he says. “I don’t like walking away from anything.” For Sofaer, the solution was to try to remake his business and -- more challenging by far -- remake himself.

His aim, he explains, was to create a firm with the depth of talent to survive him and a diversity of products to insulate it against short-term-fixated investors. Sofaer Capital had always been a prep school for portfolio managers: The best ones learned from professor Sofaer (who took firsts in economics and politics at Montreal’s McGill University) and then graduated to other things. To recruit -- and retain -- topflight asset managers required two things, Sofaer concluded: providing a high degree of autonomy and financial incentives.

The arrangement he came up with is unusual. Sofaer Capital subcontracts fund management to advisory companies whose sole equity holders happen to be Sofaer’s partners. They are paid no more than a “living salary,” he says, but they get “100 percent of an incentive fee when performance exceeds certain hurdle rates.” If their funds do nicely, the partners do too. Sofaer is quick to add that partners must “eat their own cooking” by putting half of their incentive income back into the fund for their first three years at the firm.

Short of clapping himself into restraints, Sofaer could do only so much to temper his tendency to meddle in portfolio managers’ business. Nevertheless, he has forced himself to give his partners autonomy within an agreed-upon risk framework. “I interfere only when the risk as shown by the profit and loss is outside of the agreed framework,” Sofaer insists. “I don’t tell people what to do outside that P&L framework. I want people to paint on their own canvas.”

A long-term investor like Sofaer would say it’s too soon to pronounce his strategy a success, but in the 18 months since he introduced the new model, there are hints it’s beginning to work. He was able to lure two veteran portfolio managers, Michael Browne and Steve Frost, from Chase Asset Management to jointly run SCI Europe. The pair have already made a splash: SCI Europe rose 7.68 percent last year, versus the MSCI Europe 15 index’s 19.64 percent drop, and the fund was up 6.9 percent through June in dollar terms, compared with the MSCI index’s 4.3 percent decline.

Last year Sofaer persuaded Hong Kongbased Giampaolo Guarnieri, 38, to merge his Asia hedge fund firm, Phoenix Research, with Sofaer Capital, so Guarnieri could look after the SCI Asia and SCI Japan funds. But first came a trial marriage: Sofaer and Guarnieri, who had once been in charge of Salomon Brothers Asset Management’s Asia-Pacific stock portfolios, spent four months comparing notes on investments before agreeing to combine. Phoenix and SCI Asia merged this February. Sofaer Capital, says Guarnieri, is capitalizing “on the long-term experience and reputation of Sofaer” by building enough management depth “to pitch our story to larger institutional investors.”

Sofaer is weighing adding more funds and more partners to run them. The firm’s biggest challenge, believes new partner Browne, will be “managing growth.”

Institutionalizing success at a hedge fund is always a tricky business, of course. You risk tampering with a delicate corporate culture built around a unique, and sometimes quirky, individual. Some ex-Sofaer employees are skeptical that he can grant his new partners enough autonomy to keep them happy. “I don’t see it,” says one former fund manager. “If you love this business like he does, why would you let go?”

“I’m determined that is what I want to do,” declares Sofaer. “I’ve set my mind to it, and that’s what I will do.”

Asia, so long a drag on global portfolios, may prove to be Sofaer Capital’s leg up. “The economies of Asia are in much better shape than they have been for many, many years, and the investment opportunity in the stock markets is better than it has been for 15 years or more,” Sofaer says. Always thinking of the long term, the portfolio manager intends to be patient.

“I like making a great deal of money,” Sofaer says. “I just don’t need to make it all today.”