Seth Klarman and Baupost Group: Do the work, find the value, keep your nerve

09 / 30 / 2010
by Charles Skorina | Comments are closed

Hedge funds and the “real economy”,

CFO salaries, we’re not like Greece

CIOs, CFOs, Seth Klarman and a Hostess Twinkie

CFOs see love and money

Seth Klarman speaks

Endowment results: pep talks in the locker room

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Heroes, whatever high ideas we may have of them, are mortal and not divine.  We are all as God made us, and many of us much worse.”

 

I was thinking about “efficient” markets versus the value of active management the other day when I recalled that line from an old movie — the 1963 Tom Jones.  (I’m told that Henry Fielding never put that line verbatim in his original novel, but what do you want?  I was finance major.)

The point is that neither the most celebrated financial theorists nor the most successful investors have ever been consistently right about how money is made.  But, experience teaches us that good managers can often add real value.  Consider the case of Seth Klarman and his Baupost Group, recounted below.

Many observers of the global economy, especially as regards the fiscal crisis now faced by most of the advanced industrial states, think that the tide of beta that lifted so many boats in the decades before 2008 has washed out for the foreseeable future.  If that’s so, then investment skill will matter more than ever as institutions build processes to mitigate risk and, somehow, also find alpha around the edges by understanding the regions, sectors, and themes where value is still hidden.

 

Our goal in The Skorina Letter is to focus on the comings and goings, the hits and misses, of the very mortal, non-divine people who manage institutional money, and the outside managers who help them.  These times may be especially challenging; and, as always, there may seem to be more money around than the skill to manage it.  But that just makes it more important than ever to watch and learn.

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Comings and Goings:

Scott Richland: Caltech Lands a State-of-the-Art CIO:

 

California Institute of Technology is a school with a towering reputation but a relatively small endowment.  The (London) Times Education World university rankings earlier this month rated Caltech the second-best university on the planet. (Harvard beat it out for first place by just one-tenth of a point.) But the endowment stands at just $1.6 billion.

Scott Richland, a Stanford MBA with strong private-markets experience, took over the endowment two weeks ago, heading up an investment office with four director-level professionals.  Caltech has a new president – Jean-Lou Chameau – who may have sparked the nation-wide search which turned up Mr. Richland.  Caltech lost 26.1% in fiscal 2009, just before President Chameau was installed.  That was less than Harvard, Yale, or Stanford, but still a bitter pill that cost the school $500 million.

Mr. Richland already has some endowment experience, having just finished a six-year hitch on the board of the Stanford Business School Trust, which manages an independent, 20-percent slice of the B-school’s endowment.

Mr. Richland was previously president of Andell Holdings in L.A. for six years.  Andell is a family office minding the interests of Andrew Hauptmann and Ellen Bronfman Hauptmann (Ms. Hauptmann is a granddaughter of the Canadian tycoon and Seagram’s founder Samuel Bronfman).  His duties at Andell included a vice-chairmanship of the Chicago Fire, a professional soccer team which was acquired by Andell on Mr. Richland’s watch.  Then, in 2009-2010, Mr. Richland briefly ran his own private investment company, Lunada Bay Investors.

I’ve had some pleasant conversations with outgoing CIO Sandra Ell, a 25-year vet at Caltech and proud Pasadena native.  I wish her all the best as she goes on to her next assignment.

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Koonal Gandhi: A Rookie CIO for Kaiser Family Foundation

Henry J. Kaiser Family Foundation in Palo Alto, California has hired Koonal Gandhi to oversee its $500 million portfolio.  Mr. Gandhi was previously a director with the Overseas Private Investment Group in Washington, an obscure but influential federally-chartered organization which assists U.S. private investment in emerging markets.

The Foundation has an educational outreach mission focusing on health care reform in the U.S. and around the world (and has no direct connection to the Kaiser hospital system).  Appropriately, its board is studded with media types, including former L.A. Times CEO Dick Schlosberg and network news stars Cokie Roberts and Charles Gibson.

Drew Altman, CEO of the Foundation, in a terse announcement, didn’t explain what specific strengths Mr. Gandhi would bring to the position.  We note that he earned a BA in economics and political science from University of Michigan, then worked for a time at the Foundation in the late 90s, before going on to earn a Masters in Public Policy from Georgetown University in D.C.

The position is well-compensated, or at least has been.  Mr. Gandhi’s salary was not announced, but his predecessor, Bruce Madding, had a base of $505 thousand plus $140 thousand in benefits, deferred compensation and allowances, per 2008 tax filings.

Mr. Madding, after 22 years at the Foundation, will now head up C.M. Capital Advisors, also in Palo Alto, as its president and chief investment officer.  CMC is an investment firm associated with the Hong Kong-based Cha group.  In addition to his investment experience, Mr. Madding, who is well-connected in the foundation world, would presumably be an asset to his new employer as a marketer to that sector.

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Half-time Report: Columbia beats Penn beats Harvard beats Dartmouth beats Yale:

In today’s Ivy League, we hear, real men play lacrosse (or, maybe bridge, or Halo 3), and football is of little consequence.  All eyes, however, are on the endowments, from which most blessings flow.

As of last Friday, only five of the eight Ivy schools have reported endowment results.  The spread is significant, with Columbia University stepping out as the Lion King.

Columbia posted a 17% gain in the year ending June 30.  And, it was the only Ivy so far to beat the S&P 500, which earned about 14% over the same period.

Dr. Swensen’s Yale brings up the rear with a modest 8.9%.  Penn, Harvard and Dartmouth stand betwixt them, with returns of 12.6, 11, and 10 percent, respectively.

 

All the schools recouped a good chunk of their appalling losses from FY 2009, but most are still in negative territory since mid-2008.  Harvard’s 11% return, for instance, follows its 27.3% loss in the previous fiscal, but that’s still a net negative 17% for the last two years.  Per NACUBO, the average performance for all endowments in FY 2009 was negative 19%. 

Columbia, on the other hand, which lost “only” 16.1% in FY 2009, is now in positive territory for two years; up almost 1%, net, since mid-2008.  The school’s five-year annualized performance is now 7.9%, far exceeding the S&P Total Return Index of negative 0.8% during the same period. 

Here are the numbers: 

The half-time scorecard:

Columbia University (Columbia Investment Management Co), CIO: Nirmal P. “Narve” Narvekar – up 17%

University of Pennsylvania, CIO: Kristin Gilbertson – up 12.6%

Harvard University (Harvard Management Co), CIO: Jane Mendillo – up 11%

Dartmouth University, no CIO, (Former CIO David Russ left in June; Steve Mandel heads Investment Committee) – up 10%

Yale University, CIO: David Swensen – up 8.9%

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Exactly how Columbia made its money is hard to say.  It does not reveal its allocations in any detail.  Nor does Mr. Narvekar, a Wharton MBA who’s been at his post since 2002, have much to say for himself.  Unlike some endowment chiefs, he does not write books, nor regale seminars.  He seems to stick to his aerie up on the 67th floor of the Chrysler building, where he runs the money.  And he’s doing it pretty well.

Is it too early to talk about the “Columbia Model?”  Yeah, probably.

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An out-sourcer beats (most of) the Ivys:

 

As a footnote to the above, we see that the endowment of Columbia’s smaller sister-school, Barnard College, also did quite well.  And so did Middlebury College (MIIS), one of my own alma maters.

Endowments for several prestigious but smaller private schools, including Barnard, Smith, Middlebury, and Trinity (the one in Connecticut) are run by Alice Handy’s out-sourcing firm, Investure, in Charlottesvile, Virginia.  Ms. Handy, after many years managing the University of Virginia endowment, founded Investure in 2003, which controls about $6.5 billion for six schools and four foundations.

Although the individual endowments weren’t named, Investure told the New York Times that their returns ranged from 15.2% to 17.7%.

(Most of the assets are pooled, but each of its clients has some separate, legacy assets, causing returns to diverge.)

So, the Investure endowments, in aggregate, would rank number two in performance among the Ivys reporting so far.  Not bad.

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Position opening: Casey Family Programs – Director of Investments

 

I have been retained to find a Director of Investments for Casey Family Programs, the nation’s largest operating foundation focused entirely on foster care. ($2 billion AUM)

The Director of Investments will work with the Chief Investment Officer on selection and management of the foundation’s entire private markets portfolio.

The preferred candidate will have a strong analytical background, substantial exposure to other asset classes (in addition to private markets), a roll-up-your-sleeves attitude, and the ability to think and work without close supervision.

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CFOs need love, too.  Also, money:

In the last issue, I made some remarks about the current market-value of chief investment officers and hedge fund portfolio managers.

I’ve been talking to a very methodical friend who is launching a hedge fund and surveying the supply-and-demand situation for hedge fund chief financial officers and controllers.  This is a key professional group we haven’t much attended to in this letter.

There is an obvious reason for the new-found respect they’re getting.  Institutional investors are demanding to see industrial-strength financial control systems and processes run by people who know what they’re doing.  The memory of Bernie Madoff (and all the less-infamous fraudsters of his era) are now burned into the consciousness of this generation.  They expect outside managers competing for their business to able to point to highly-qualified, pro-active CFOs on their team.

My friend has found that there is a definite upturn in demand for these people, and a firming of salary levels.  Hedge fund controllers and CFOs in the New York and Connecticut area are commanding anywhere from $150,000 (plus bonus up to 100%), to $250,000 (plus 1% to 3% of ownership) depending upon experience.

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What I did on my summer recruiting trip:  Chilling with the CIOs:

I spent a torrid late August in New York recruiting for Casey Family Programs, and also had a chance to sit down (and share the AC) with some hardworking chief investment officers.  Thanks to all of them for their time, and here’s a quick précis of their current thinking.
Joseph Boateng, the CIO of Casey Family Programs, has deep experience with corporate pensions at Xerox and Johnson & Johnson, and now at a major private foundation.  He emphasizes that you can never have too much information.  So he built a system to drill down into the foundation’s private markets portfolio and give himself a clearer, real-time picture of what’s going on.  “I need to protect the assets, pay the bills, and earn some money,” he said.  He knows that a lot of foster kids and their families depend on the foundation, so he questions every assumption and scours the world for opportunities.

Scott Pittman, CIO of the $1 billion Mount Sinai Medical Center endowment, believes in conservative ends, but innovative means.  He has 80% of his portfolio in hedge funds, including money with some of the best managers in the business.  He also has a supportive board which includes some other hedge honchos who understand his strategy.  Scott argues that his asset allocation is actually quite traditional and conservative, but the investment vehicles are tuned for performance and speed.

Linda Strumpf, CIO of the Helmsley Trust (and former CIO of the Ford Foundation) faces the challenge of building and mentoring an investment office for a brand new $3 billion fund.  She is convinced that equities are definitely not dead.  She sees high-quality, high-value stocks as the best long-term hedge against whatever’s coming.  In her view, these companies are earnings machines, adaptable and diversified, with little debt and lots of cash.  They will survive and prosper.
On the other hand, as a former bond analyst, she does worry about what she views as the herd rushing once again into fixed income.  She sees risk climbing, yields dropping, and institutional money making the same mistakes they’ve made before as they fight for a few extra basis-points.

Lisa Danzig, the CIO of the Rockefeller University endowment feels the pressure every day.  The University depends on the endowment for about 35% of their operating budget, so, like the Big Ivys, she has to walk a fine line between capital preservation and growth on one hand, versus payout on the other.  But her situation is even tougher because the University, an excellent but small graduate and research institution, doesn’t have a huge network of alumni to ante up contributions.  So, the investment office has to do just that much more of the heavy lifting.

But the pressure doesn’t translate into risk.  Her allocations are broad and conservative.  And they do a ton of in-house research to back up every move.

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Observations:

 

Seth Klarman and Baupost Group: Do the work, find the value, keep your nerve:

We missed this interview with Seth Klarman (founder and president of Boston’s Baupost Group), but our friend – the blogger known only as Jay – at his blog site, MarketFolly, just linked to it. (He confessed that he had overlooked it, too, so we didn’t feel so bad.)

See: http://www.marketfolly.com/2010/09/interview-with-seth-klarman.html

We try to listen when Mr. Klarman talks.  First, because he has an unassailable record as an investor (he’s made 19% per year for his clients for 27 years).  Second, because he says interesting things in an interesting way

Some of the biggest non-profit institutions in the country are happy to be on his select client list, notably including the Harvard endowment.

Some out-takes:

Why he thinks we may be living inside a Hostess Twinkie:

A Hostess Twinkie is a confection that has made many childhoods slightly happier, but it is composed of totally artificial ingredients…I am worried… about what would happen to the markets, to the economy if, in the midst of all these [government] manipulations, we realized that they are, in fact, a Twinkie…Until recently, I thought it was enough to have a good process at our firm…I worry now that a new element has been introduced into the game, which is, in effect, Will the dollars we make be worth anything?

Why he thinks a Depression mentality is actually a good thing:

[W]e didn’t get the value out of this crisis that we should have… It’s awful to have a depression, but it’s a great thing to have a depression mentality because it means that we are not speculating, we are not living beyond our means… From the recent crisis we have developed a “really bad couple of weeks” mentality, and that’s not enough to tide us through, teach us to avoid future bubbles, and ensure a strong recovery.

How he hires people:

We…look for ideational fluency, which essentially means that someone is an idea person. In response to an issue, do they immediately have 10 or 15 different ideas about how they would want to analyze it -threads they would want to pull…- or are they surprised by the question?

Why we should love short-sellers:

We don’t sell short [but]…short sellers are the market’s police officers. The act of selling something short, of voting that it’s overvalued, is a positive for the system.

How he makes money:

[W]e make money when we buy things.  We count the profits later, but we know we have captured them when we buy the bargain…[W]e enter every trade with the idea that we are going to hold to maturity in the case of a bond and for a really long time, potentially forever, in the case of a stock… if you don’t do that, you are speculating and not investing.

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Hedge funds versus the Fortune 500

We tend to think of hedge funds as small boutiques making lots of money for a few investors and partners.  But we don’t think of them as constitutive of the “real” economy in the way a Fortune 500 company is.

But last week the Financial Times reported on the revenue generated by the top hedge funds, suggesting that they have as much heft as the world’s great industrial and service companies.

A study by LCH Investments, part of the Edmond de Rothschild Group, concludes that the big hedges generate as much wealth – based on earnings from employed capital – as major non-financial firms.

James Mackintosh, FT’s investment editor, says that the top ten hedge fund managers have earned more than $153 billion for their investors since they were founded, a third of the income generated by the whole 7,000-strong universe of  hedge funds.

Since their founding, George Soros’s Quantum Fund and John Paulson’s Paulson & Co, for instance, have together made more money than Walt Disney or McDonald’s.  Paulson’s returns – $26.4 billion – are nearly equal to the net income of Boeing over the same period.

And, commenting on their economic efficiency, Mr. Mackintosh says, “David Tepper’s Appaloosa Management, for example, has earned investors $12.4 billion, yet runs only $12.5 billion [invested capital] after regular cash returns.”

So Paulson, Soros, and Tepper, with a relative handful of employees have created more wealth than Disney (144,000 employees), McDonald’s (185,000 employees), or Boeing (157,000 employees).

LCH chairman Rick Sopher, commenting on the study, said that one common denominator among the successful mega-hedges was their strict control of capital inflows.  They didn’t outgrow their own strategies.

See: http://www.ft.com/cms/s/0/4b877178-bd13-11df-954b-00144feab49a.html

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Parting Shot:

 

Why We Aren’t Like Greece…Yet:

 

Interested, as we are, in the troubles of the public pensions, an odd deal in Pennsylvania caught our eye.  It seems the Pittsburgh city pension is so woefully under-funded that the state has threatened to take it over.

To raise cash, the city fathers have put one of their few saleable assets on the block: the future income of their municipal parking system – meters, garages, the whole shebang.  A group of investors led by J.P. Morgan has offered to take that revenue stream off their hands for an upfront cash payment, $200 million of which will be used to re-float the pension.

But one local official objected to the deal, saying that the city could eventually have harvested a $1 billion from the franchise.

A memory stirred.  Didn’t the equally broke city of Chicago recently do something similar?  We looked and, sure enough, there were the investment bankers again, helping the pols monetize their parking business.  Back in 2006, Mayor Daley handed a 99-year lease on the downtown parking system to Morgan Stanley, et al.  Then came a 75-year lease of another chunk of parking spaces to Allianz Capital, Abu Dhabi Investment Authority and, again, Morgan Stanley.  The city realized about $2 billion on the deals.

Downtown parking rates, once only $0.25 an hour under the benevolent Mr. Daley, will be $1.50 by next year.  In the Loop they are already up to $4.25 an hour.

One analyst has concluded that the city will have used all the prospective parking revenue for the rest of the 21st century just to shore up the current budget (including pension contributions) for just four years.  The groups led by Morgan Stanley may collect almost $12 billion over the life of the investment.

see:  http://peureport.blogspot.com/2010/09/pittsburgh-parking-follows-chicago.html

Although the funds were not dedicated specifically to the pensions, it’s all fungible, and it’s well known that the under-funded and over-promised pensions of both Chicago and Illinois are sucking public revenue faster than it can be raised.

No doubt the investment bankers are just doing their duty.  It’s just infrastructure investing, after all; everybody’s doing it.  And, ironically, some of the investors behind Morgan Stanley are almost certainly other public pensions.

Still, there is an air of panic about such maneuvers, and we wonder how many more parking meters Wall Street has their eye on.

And it made us think of Greece.

Now, we are certainly not Greece; not even close.  But, we couldn’t avoid a tiny frisson when, in light of those desperate measures in Pennsylvania and Illinois, we read Michael Lewis’ article in the latest Vanity Fair Magazine reporting on the Greek financial catastrophe.

He writes:

The investment bankers also taught the Greek-government officials how to securitize future receipts from the national lottery, highway tolls, airport landing fees, and even funds granted to the country by the European Union. Any future stream of income that could be identified was sold for cash up front, and spent.

Mr. Lewis (author of Liar’s Poker, The Big Short, etc) is probably our best living writer on the financial markets.  And, he has fastened on certain aspects of the Greek situation which are different in degree, but not entirely different in kind, from ours here in the Land of the Free.

You can read the whole thing here:

http://www.vanityfair.com/business/features/2010/10/greeks-bearing-bonds-201010?printable=true¤tPage=all