In this issue
Rosalind M. Hewsenian, Leona Helmsley, The Helmsley Trust
Hedge funds and new money — a speed bump ahead?
Money managers — picking the right horse
Comings and Goings:
Rosalind M. Hewsenian has just been hired as deputy chief investment officer of the $3 billion Helmsley Trust in New York City, with the expectation that she will be bumped up to CIO in the near future. Current CIO Linda Strumpf is expected to move aside for her, while remaining chair of Helmsley’s investment committee.
In her lifetime, the late Leona Helmsley was pilloried in the tabloids for alleged mistreatment of employees and a cavalier attitude toward her tax obligations. And sport was made of her bequest of $12 million for the maintenance of her beloved Maltese dog, “Trouble,” while overlooking two of her grandchildren .
Then a final post-mortem melodrama: The ASPCA and other dog-lovers sued the Trust, arguing that its mission statement required it to spend most of its resources on canine-related causes.
Well, de mortuis nil nisi bonum. Whatever were her quirks in this life, Mrs. Helmsley’s money now goes marching on, and will be used primarily to benefit our own species. Last February, a surrogate-court judge ruled against the ASPCA, et al, and the trust has now been able to embark on a conventional course of human-centric grant-making. The judge also reduced Trouble’s inheritance to $2 million, and awarded $6 million to each of the passed-over grandchildren. With the unencumbered addition of almost $3 billion, the trust instantly became one of the twenty largest private foundations in the country, roughly the same size as the Rockefeller Foundation.
Linda Strumpf, previously CIO of the $9 billion Ford Foundation, joined the Helmsley Trust as its first CIO a few months ago very quietly, with no press release or formal announcement. It now appears that she was hired to set up the Trust’s investment office and recruit a permanent CIO. Ms. Strumpf had announced back in May, 2008 that she would retire from Ford in 2009 after 28 years of service, including 16 years as CIO. Her total compensation at Ford was $1.3 million in 2008.
Eric Doppstadt succeeded Ms. Strumpf as Ford’s CIO last June. Mr. Doppstadt, previously director of private equity, earned $710,000 before his promotion. Ford, the second largest private grant-maker in the country (after the Gates Foundation), lost 19% of its portfolio value in FY 2008. Two quarters later, in April, 2009, their new CEO announced a 30% drop “over the last year.” To trim expenses, the foundation closed offices in Russia and Vietnam, laying off 30 employees; and offered buy-outs to some New York employees.
Ms. Hewsenian, previously CEO of Clay Finlay, was out of a job last year when their parent, Old Mutual Asset Management, closed the boutique equity firm. Before that, she had a key role at Wilshire Associates as their lead consultant to CalPERS in Sacramento.
Trouble, by the way, is prospering. According to her caretaker (who receives $60,000 per annum for dog-sitting), she benefits from $100,000 for 24/7 security, $8,000 for grooming, $1,200 for food, up to $18,000 for medical care, and $3,000 for miscellaneous items.
Baylor University, which has lost two chief investment officers in two years, hopes that they now have a keeper in R. Brian Webb, PhD, whose appointment was announced a week ago. If the old school tie is worth anything, then Dr. Webb should have a job for life. He is a Baylor grad; his wife is a Baylor grad; his oldest son and daughter-in-law are both Baylor grads; and his daughter is a double-Baylor grad. His younger son is currently a sophomore at Baylor’s Waco, Texas campus.
Baylor’s previous CIO, Kent Muckel, served just seven months in the job, departing in December, 2009 to join his old boss, Christopher Bittman, at Perella Weinberg Partners
From 2001 to 2008, Baylor had a star in Jonathan Hook, a Baylor MBA and the school’s first CIO. Starting with no organization and just $600 million (moved over from the Baptist Foundation of Texas, where it had reposed for 70 years), Hook crafted a state-of-the-art portfolio which returned a remarkable 25.3% in 2005, when it outperformed every endowment in the country, including Harvard and Yale, and earned Hook national recognition.
At the end of FY 2008, the endowment stood at $1.05 billion, although it lost about 13% and dropped back under a billion in FY 2009, as the downturn bit. Still an outstanding performance in a bad year, when the average endowment lost 19% and the Ivies lost 25-30%.
Even the London-based Financial Times took notice of his innovative portfolio, which used just four broad asset classes: a market exposure folder (domestic and international equities and long-short hedge funds), an inflation hedge folder (including real estate, timber, infrastructure, natural resources and other real assets), a risk-reducer portfolio (fixed income and low-volatility hedge funds), and a return-enhancing folder (emerging market and private equity investments).
Unfortunately for Baylor, Mr. Hook’s success led to an offer he couldn’t refuse from Ohio State University, who hired him away as their first CIO in 2008. His pay went from $391,000 at Baylor to a reported $600,000 base salary at OSU to run their $2 billion endowment.
Dr. Webb was hired from UBS Global Asset Management, where he was a managing director in Dallas. He earned a BBA and MBA at Baylor, then a PhD in finance at University of North Carolina. He was a faculty member at Indiana University for several years before shifting to a career in real estate and financial management.
Even optimists are sometimes right:
Michelle Celarier, the editor of Absolute Return-Alpha magazine makes a good point in her April “Top Hedge Funds Earners of 2009” edition.
We all remember that John Paulson made a stunning $3.7 billion in 2007 by shorting the subprime bubble. But David Tepper of Appaloosa Management, the magazine’s cover-boy for April, reaped an even more colossal $4 billion by betting that banks would recover handsomely on the other side of the blow-out.
There’s always a whiff of popular disapproval attached to the successful short-sellers. But you don’t have to be a cranky pessimist to win the big bets. Being an optimist can work, too. As long as you’re the only one in the room.
Penn’s Kristin Gilbertson tells all:
Last month, Kristin Gilbertson, CIO of the University of Pennsylvania endowment, was named Institutional Investor magazine’s Large Endowment Manager of the Year for “innovative strategies and fiduciary savvy,” and she will be honored at their big hoe-down in New York this month.
Ms. Gilbertson skillfully slalomed through a very tough year while sustaining a relatively modest hit to her $6 billion endowment. Penn was down just 15.7% in the last fiscal — much better than its Ivy peers.
Her recent Q & A in the Penn News is way better than the usual puff-piece. It includes some meaty details about how she did it and should be a good read for her fellow CIOs.
Hedge funds and new money: more may not be merrier:
The flow of new money into hedge funds is pushing their total holdings back to nearly their pre-2008 levels: close to $2 trillion world-wide, by some estimates. Which is fine for the hedgies, but raises an interesting question: is there any natural limit to their growth? That is, as they run more and more money, at what point do their supposedly above-average returns become just…average?
We found a paper on the Money and Science website suggesting that the inflection point isn’t far off. The authors say the limit is around $2.5 trillion, or approximately 5% of their estimated $50 trillion in global financial assets.
Of course, the extrapolations are crude and in aggregate. And the authors — NYU math professor Marco Avellaneda and Paul Besson, head of quantitative research at French hedge fund ADI – add a hopeful caveat to the effect that creative fund mangers will come up with new strategies that will allow at least some funds to keep generating premium returns, even as others trend toward mediocrity.
It’s an interesting exercise and adds even more complications to the problem of distinguishing between the excellent and the mediocre managers in time to do investors any good.
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What traits make an exceptional money manager?
I posed this question to our readers, many of whom responded with sharp insights. Thank you to all.
For an institutional investor, apart from strategizing the portfolio itself, decisions about hiring, firing – or just sticking with – their outside managers are the most critical they face. It’s the skill (or luck) of these firms that will make the portfolio strategy succeed or fail.
But despite the tight specifications, consultant recommendations, and the due diligence processes, there is always a large residue of judgment, intuition, and feel based on the experience of the institutional leaders. That’s what they’re paid for. And that’s really what my innocent question was about.
I had just read Michael Lewis’ entertaining book, The Big Short, and, as I was looking through my reader responses, I kept thinking about some of Lewis’ outrageous, Dickensian characters, all of whom happened to be real people who were willing to bet against the subprime bubble when the whole world was on the other side of the bet.
Here’s a portrait of Steve Eisman of FrontPoint Partners, for instance: “Even on Wall Street people think he’s rude and obnoxious and aggressive…He has no interest in manners…He’s not tactically rude, he’s sincerely rude.” And that was according to his own wife!
Mr. Eisman was just one among Lewis’ cast of misfits and outcasts who made a ton of money for their clients. But what I kept thinking was: How would I present this guy? Who would hire him? And even if these battered victors of the sub-prime wars had the requisite presentation skills and clean resumes, how could we be sure it wasn’t just personal demons or outrageous luck that made them winners?
We have a lot of science available to us. Modern portfolio theory gives us an analytical framework and a common language for working through our problems. But investing money is, as everyone eventually learns, as much art as science, and it’s getting that mix right which is the hardest thing of all.
Cambridge Associates, the mega-consultant to institutional investors, has been involved in as many of those hiring/firing decisions as anybody, and they pointed me to a study they did back in 2003. They looked at five years of data for nearly a hundred clients, crunched the numbers, and came up with results that many will find counter-intuitive, or just humbling.
When institutions impatiently tried to trade up by firing “underperforming” managers and hiring fresh, shiny new ones who were currently beating all their benchmarks, they were usually disappointed. The cast-off managers often, embarrassingly, reverted to the mean and started hitting their numbers again, making money for someone else. The new hires, just as embarrassingly, often slumped once they were on the payroll, as their recently-stellar returns descended to mediocrity. If you figure in the time and transaction costs of doing the hiring and firing, things look even worse.
In fact, what these sophisticated investors were doing in too many cases was just a more rarefied version of what dumb-money retail investors are always accused of doing: following behind the trend; selling at the bottom and buying at the top.
Bottom-line: “Most institutions gained nothing by switching managers.” And, if you require another 100 basis points of performance to justify the change, only 31% of the switches could be called a success after three years. Or, to put it less politely, more than two-thirds of the decisions left the institutions worse off than they started. And this study deliberately excluded the quirkier categories of private equity and hedge funds.
Cambridge advises their clients not to do this, but the advice is often ignored. We’re up against some almost irresistible human psychology, here. Not to mention that returns to specific strategies and asset classes just don’t change in a linear way. They change cyclically, at best, or chaotically at worst; and they carry their style-boxes and managers along for the ride.
They conclude that, above all, investors should develop a clear understanding of the role each manager plays in the portfolio and the expected variability of returns of their chosen strategies. Sub-median performance in the short term should only be a firing offense when it can be tied back to some serious organizational problems within the manager.
What we can do, I would humbly suggest, is try to understand how the human beings to whom we’re giving the money will actually run it. This judgment has to do with character and psychology as much as performance numbers.
Here are a few reader responses that touch on these almost-ineffable matters:
Look for someone who has an investment process that fits their genetic makeup. There is no one way to make money, but a common theme in successful managers is that they have found their way to something that makes sense for them (e.g. you wouldn’t want Warren Buffet and Jim Simons to switch chairs)
— A Hedge fund manager with prior fund of fund experience
My suspicion is that a good manager has an ability to weave together many elements into a cohesive whole that runs counter to the main biases of Wall Street, including those held by those on the boards that evaluate managers.
— A Manager of long and long/short strategies
Discipline is what enables you to cut a losing position. Discipline is what tells you to add to a winning trade. Discipline is what makes you leave your ego out the front door before you sit on the trading desk. Discipline is what gives you the ability to be confident.
— A Manager experienced with various trading strategies
No one is right all the time, but if you are diligent in cutting the losers and running the winners, you have taken an enormous step in the right direction. It’s often a manager’s ego that hurts his P&L most. Admitting your wrong is very difficult, but there is nothing better than a good slice of humble pie to teach that lesson.
— A Long/short hedge fund manager
All good advice, distilled from years of hard experience. But, still, we would all like to find an edge. We’d all like to think we could get it right more than once out of every three tries.
Are there any new tools out there which could really improve the quality of the hiring-firing decision? Well, maybe one.
There’s a UK-based firm, Inalytics, (http://www.inalytics.com/) which uses, in their words, “quantitative evidence-based analyses” to identify and isolate the components of investment manager skill. In plain English, they’re using the kind of raw computing power wielded by hedge quants, but crunching a different set of data: measuring on a fine, granular level, just how your outside manager is running your money in real time.
They will analyze every single trade a manager has made over a period of years — using data direct from the manager’s custodian — to quantify three core skills: Do they get more decisions right than wrong? Do they let their winners run and cut their losers? And, do they correctly time entry and exit decisions?
Dix Hills Partners, (http://www.dixhillspartners.com/ ) an interest-rate specialist hedge fund in New York, worked with Inalytics to study their record of forecasting the short-term direction of U.S. interest rates by taking either a long or short position in 10-year US treasuries.
The conclusion proved what Dix Hill had believed, but wasn’t able to prove empirically. They were, indeed, skillful; not just lucky. In all three aspects their day-to-day work was consistently adding value for the investor. They got more trades right than wrong (the “hit rate”), and the good ones more than offset the poor ones (the win-loss ratio).
Bill Gordon, one of the Dix Hills founders, told me they came across an Inalytics white paper and called them to see about doing a study together. Dix Hills believed they were good, but they wanted to drill down to find out exactly how they did it. Bill said, “We have a completely liquid strategy with no credit risk. We make money whatever the direction of the market. But we wanted a better way to explain to our clients and prospects just what our edge really was.”
Inalytics looked at every single trade Dix Hill made over a six year period to register the outcome, compare the trade against the market movement, and verify whether or not the trade added or subtracted value. Obviously the results were favorable to Dix Hills, or the study never would have seen the light of day. Nevertheless, this is the first time I’ve seen analysis taken to this level and also summarized in such an intuitive, easy-to-understand way.
I called Inalytics president Rick Di Mascio at his office in Croyden, England, and asked him how he got interested in this kind of skill assessment. He said that years ago, when he was head of the UK coal board pension fund (the biggest in the UK at the time), he started looking for a better way to quantify investment skills.
By scoring every trade for its contribution to revenue, the Inalytics process helps an outsider to judge whether the manager’s results are luck or skill, and analyzes the specific components of the skill-set. When my colleague and I read the Inalytics papers, the simplicity of their concept struck us. Although the proprietary algorithms may be complex, the output is elegantly simple.
Hedge funds are supposed to be skillful short-sellers, but, as Rick points out, shorting is a hard skill to master and requires a completely different mindset than conventional stock-picking.
There aren’t that many good short-sellers, a point which should concern CIOs and consultants as they push money into funds using sophisticated hedging strategies. Is there really enough skill out there to run it all?
Rick emphasizes that “we have noticed that good sellers are a rare breed and tend not to fit in with the identikit fund manager. They tend to be cynical, pessimistic and always looking for the hidden problem lurking behind the next corner. As a result, they don’t tend to fit and not surprisingly there isn’t an abundance of individuals with these skills.”
Comments from readers:
Last issue we wrote about updating the “Endowment Model”. Lou Morrell, the former CIO of the Wake Forest University endowment and currently managing a sizable tactical fund, sent us this:
Charles, the big problem we all face is that we are in a series of bubbles which is quite a change. The time between recessions is growing shorter – largely due to the Fed.
Downturns used to come every ten years and now the period is down to five years. We could see a decline every 2-3 years. So while there are potential “black swans” the real challenge comes from the bubbles.
Institutional investors need a new investment strategy suited for the present and the future.
Obviously, conventional MPT is not it. That is built on the past and is very risky. So, one needs a modified version of MPT. This can be accomplished through a combination of wide asset bands, ability to make fast tactical shifts, and a method of managing bubbles.
The first step in the process is to understand the new environment and what can be expected.
Many endowments and certainly pension funds… see a surging stock market but have no idea how to ride it – like someone standing on the beach watching the surf pounding in – but afraid to jump in and yet feeling bad about missing all the fun.
Steve Marsh, a long/short manager with 30 years in the business, both in the States and UK, called me yesterday with these remarks about the strange semi-crash in last Thursday’s (May 6, 2010) market:
“There is so much high frequency trading going on amongst a small group of players that it is masking a systemic lack of liquidity in the market. High frequency trading seems to me to be an electronic form of front running whose costs are borne by the normal retail and institutional market participants.
The true lack of market liquidity means investors will likely see another massive price squeeze the next time a group of any size tries to pull money out of the market. I strongly encourage all your institutional readers to keep a substantial cash cushion on hand. They will likely find the cushion extremely valuable in meeting liquidity needs, sooner rather than later.”
(Steve and his partner, Robert Tymoczko, run AlphaStream Capital Management, a market-neutral long-short fund) in Alameda, California, (510) 749-4999
NPR (National Public Radio) reported on their blog today that:
“Four of the nation’s six biggest banks made a profit from trading on every single business day during the first quarter.  Daily profit often clocked in at over $100 million per bank.”
As Jackie Mason used to say in his comedy monologues, “These are profits even the Mafia can’t get.”