The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds (2 page)

Ahuja, Maneet, 1984-

The alpha masters : unlocking the genius of the world’s top hedge funds / Maneet Ahuja.

p. cm.

Includes index.

ISBN 978-1-118-06552-5 (cloth); ISBN 978-1-118-16759-5 (ebk); ISBN 978-1-118-16758-8 (ebk); ISBN 978-1-118-16757-1 (ebk)

1. Hedge funds. 2. Investment advisors. I. Title.

HG4530.A389 2012

332.64’524—dc23

2012010363

To God — The Ultimate Alpha Master

Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.’ If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion:
For investors as a whole, returns decrease as motion increases.

—Warren Buffett

Foreword

The Less Mysterious World of Hedge Funds

Mohamed A. El-Erian

CEO and Co-CIO of PIMCO

The mystique of hedge funds is undeniable.

In the investment management world, hedge funds are often referred to as “smart money.” They command premium fees and are thought to attract the best and brightest talent. Beyond this world, they are known for having minted several billionaires and hundreds, if not thousands, of millionaires. And they are an increasingly attractive topic for writers of both fiction and nonfiction.

As much as they are admired, hedge fund managers are also feared and, in some quarters, even loathed. Some see them as investment cowboys who, in ruthless pursuit of profits, pose significant risks to the stability of the global financial systems. No wonder hedge funds have attracted the attention of regulators and, in cases of countries in severe crises (be it Asia in the late 1990s or Europe today) that of politicians pointing an accusatory finger claiming that they are sources of disruptive evil and illicit earnings at the expense of entire nations.

Whether you like them or hate them, there is little denying that the hedge fund industry is here today because of their early well-earned reputation of savvy, agility, and investment coups. In recent years, however, the standing of hedge funds has come under pressure as their numbers have mushroomed, average investment returns have generally disappointed, and the investment landscape has become more complex and harder to navigate. It also has not helped that some investors unexpectedly found themselves “locked” in their hedge fund investments, unable to cash out at a time of severe liquidity pressures.

Nowadays, the popular narrative on hedge funds often oscillates between two extremes, and do so repeatedly: characterizing them as highly adaptable and responsive pools of money that help markets become more efficient and, in the process, generate supernormal returns for their clients in a manner that is consistent with the common good; to viewing them as grossly overpaid investment vehicles that consistently promise more than they can deliver while trying to harvest private gains at the cost of the general public through some practices that can sometimes be considered morally, ethically, and legally questionable.

The associated debates can often get very heated and, in the process, lose sight of two simple yet crucial realities. As complex as it may seem to many, the hedge fund industry essentially boils down to two deterministic factors: the type of investment vehicles and the investment managers that have self-selected to run them.

Investment Vehicles

The first of these two elements is getting quite well understood. While they may vary in their sector focus and styles, hedge funds share four common and interrelated characteristics:

• First, they target positive absolute returns rather than simply outperforming a certain market benchmark or a specific style—thus the common claim that hedge funds like to make that they can deliver strong returns regardless of how global stock markets, commodities, currencies, or bonds do.
  
• Second, they have access to a very wide range of investment tools and instruments. Most important, they can go long or short a market, sector, or company. This leads to the common hedge fund claim that they can change their overall positioning quickly and cost effectively, thus “hedging” their investors’ capital from the vagaries of markets.
  
• Third, they can lever their investment footing to a meaningful multiple of their assets under management. This elasticity underpins hedge fund claims of being incredibly flexible when it comes to “scaling” the investment bet commensurate with the depth of their conviction.
  
• Finally, they almost always follow a fee structure involving a base component and a performance component, traditionally known as “2 and 20” (a 2 percent fee that investors pay irrespective of performance and 20 percent of the profits above a specified threshold—though these days many hedge funds find themselves under tremendous pressure to lower their fees).
  

Investment Managers

The second element is less well known. And this is where Maneet Ahuja’s book comes in forcefully and effectively.

This interesting book takes you on a journey through the fascinating and still-mysterious world of successful hedge fund managers. You will make many interesting, and in some cases surprising stops along the way, getting to know managers, their philosophies, styles, quirks, and working practices.

Maneet will tell you about the world of activist investors whose objective is to unlock hidden value in companies, either through operational improvements or through the more controversial company restructurings and asset stripping. She will also expose you to the inherently cynical and always-suspicious short sellers who obsessively plunge into the details to sort out underlying fundamentals from often intricate and possibly obfuscating packaging.

Your stops will include the macro funds, an approach that George Soros made famous in the 1990s when he boldly took on the United Kingdom’s currency policy and won. These managers treat the world as their oyster, finding it full of both absolute and relative value trades.

Then there are the value investors whose love and passion for the micro is matched only by their disdain for the macro. For them, the world is full of very specific individual opportunities to exploit deep value that is yet to be recognized by investors looking for a quick buck.

Your journey will also make a few “special opportunity” stops. You will thus be exposed to distressed debt investors who find value in the often unexpected yet dramatic fall of companies and countries. Where others see junk and despair, they find attractive opportunities to recover value.

Have no doubts, this book will take you on a captivating and eye-opening journey. It will also expose you to some intriguing human stories.

Through her insightful reporting, Maneet will remind you that most successful hedge fund managers faced enormous difficulties and challenges along the way.

Some found it hard to convince their first set of investors. Others chugged along for years before hitting their stride.

Some hit it big only to see thing crumble in front of their eyes and, worse, under the full spotlight of the media. Some faced the constant challenge of maintaining internal harmony in the midst of unforeseen success. And virtually all can claim a particular moment(s) of good luck that enabled them to decisively pull away from the herd, struggling but failing to differentiate themselves in an incredibly cutthroat competitive environment.

Maneet is uniquely placed to take us on this fascinating journey. And she brings it all together in this book in an effective and skillful manner.

In her role as CNBC’s hedge fund specialist and as a producer for
Squawk Box
, the network’s highly regarded and widely watched morning show, Maneet has had an unparalleled window into the life of the often secretive hedge fund managers. She has followed them, researched them, analyzed them, interviewed them, and interacted with them in ways that few can or will. Her access is combined with a mix of curiosity and judgment that allows her to balance admiration with realism, and industry analysis with human dimensions.

Beyond the Personalities

Maneet’s book is about personalities who, due to dramatic success, are eagerly followed. And she does a wonderful job telling us some of what makes each of these talented individuals tick.

That, in itself, is an important achievement for this book. Yet it is only part of what Maneet brings to our attention.

In addition to insights about the personalities of some of the most famous and most successful hedge fund managers, and how they have brought this to bear on their investment decisions (good and bad), Maneet allows us to “compare and contrast” in a manner that was not easy to do before. And in doing so, we can derive lots of interesting hypotheses.

Maneet’s analysis suggests that there is no simple formula for success in the hedge fund world. There is no single way of organizing a hedge fund for success. There is no special set of indicators to follow, books to read, or expert analyses to digest.

Maneet will also show you that the academic backgrounds of successful managers have differed a great deal, as have their socioeconomic origins. Some started straight from university while others spun off from larger enterprises. Some managers extended what they learned in the investment world while others managed to apply different expertise and, in some cases, disciplines (albeit related ones).

Personalities cover the whole spectrum, from introvert to extrovert, from forceful enforcers of personal views to skillful compilers of other peoples’ views, and from media averse to publicity hungry.

Motivations are varied. For many, it is about money, but it’s also quite a mixed cocktail with some heavy on hubris and others eager to make the world a better place.

Notwithstanding all these intriguing differences, Maneet’s wonderful portraits also demonstrate that there are some important commonalities.

Successful hedge fund managers are driven individuals with deep self-confidence about what they bring to the investment management table. They are innovative and intellectually curious. They know that they have to be different but in an intelligent and sustainable manner. They are often able and willing to spend a lot of time not just on the “what” of investing, but also the “why” and “how.”

These are individuals who repeatedly show an admirable readiness to handle the discomfort of leaving the herd and, instead, putting on contrarian trades that often go against them for a while. Most important, they learn rather quickly from their mistakes, and show an amazing ability to midcourse correct.

Bottom Line

After reading this book, you will possess a better understanding of the mysterious world of hedge funds. You will see that successful hedge fund managers can be a special breed that is not easily replicated—a challenge that becomes even harder in a world where the ranks of hedge funds continues to multiply.

With this book you will have a better basis for differentiating between reality and myth—a particularly important factor when promises and high fees are often not followed with superior investment performance. This ability to differentiate will become even more critical in a world that, today, is subject to massive realignments, previous unthinkables becoming realities, and changing market structure.

Finally, this is a book that will put you in a better place to think about some of the questions that are yet to be answered decisively. Can certain hedge fund approaches truly deliver on the claim of being “market neutral” in an investment world where many parameters have become variables? Can the herd of hedge funds continue to justify premium fees on account of the success of just a subset of them? And, as sovereign debt crises persist, will regulators feel a need to impose such a low speed levels on hedge funds to render them ineffective?

These are all consequential questions. Yet they remain unanswered at this point.

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.