Top Hedge Fund Managers: They Aren’t Wizards, but They Are Masters

ahujaManeet Ahuja is going head-to-head with Jack D. Schwager, and his “wizards” books, in this new volume from Wiley. Though some of the resulting book will seem familiar, on the whole it is worth a look.

Ahuja, a producer for CNBC’s Squawk Box, offers nine case studies, one chapter each, on the “alpha masters” who find their own “wildly unique” ways to outperform the broader market. These studies are packaged with her own brief introductory reflections, a foreword by Mohamed A. El-Erian, and an Afterword by Nobel Prize winner Myron S. Scholes.

And there’s no reason Schwager should forever have a monopoly on this sort of collection.

Ford’s Bank Debt

The standout essay for me covers Marc Lasry and Sonia Gardner, of the Avenue Capital Group. This is the brother-sister pair that founded Avenue in 1995 and that has taken a leading role in the distressed debt space in the 20 years since. Their story gives us a perspective on the re-building of the U.S. auto industry after the global financial crisis.

Avenue Capital started aggressively buying Ford’s senior secured bank debt in the transition period between the Bush and Obama presidencies. It was typical of Avenue that it stuck to the top of the capital structure of the company.

Ahuja quotes Lasry saying that they may not have bought this debt at the absolute bottom, but this doesn’t bother him. He doesn’t believe in timing the market. “We invest when we have conviction in the credit and we believe it’s cheap. If it gets cheaper, then we buy more.”

Avenue sold its Ford positions about a year later, with a profit that made 2009 one of the best annual performances in the history of Avenue’s U.S. funds.

Ahuja’s account is clear and informative both on the Ford deal and on another (more recent) Avenue coup, involving the amusement-park company Six Flags.

What is the division of labor between brother and sister? As Ahuja describes it: brother runs the front office, sister runs the back. Quoting Gardner, “I think some funds don’t place enough importance on establishing institutional-quality infrastructure – in terms of accounting, compliance, legal, investor relations, and information technology capabilities.”

The Pennsylvania Public School Employees Retirement System, which (under director Charles Spiller) started investing in Avenue in late 2000, is a contented institutional investor. Spiller praises Avenue’s “conservative utilization of debt – they really don’t lever their portfolio,” he said, so their investors never get the impression that they’re panicking.

When Sears was Ready to Lose Its Independence

The book also includes a fine study of William A. Ackman and his vehicle, Pershing Square Capital Management. One of the tales she tells about Pershing Square involves its early days, in 2004, when it acquired a stake in sears Roebuck & Co. Though the name of that company is itself an enduring piece of Americana, Ahuja quotes Ackman expounding his view that the enterprise itself “had reached the end of its strategic life” by 2004. Its parts (the real estate, brand names Craftsman and Kenmore, the inventory, and so forth) were worth more than the whole as measured by its stock value.

Pershing Square itself was just a small new fund “without a lot of firepower” at this point, so it sought an ally with the same view, and found one in Vornado Realty. Together, Pershing Square and Vornado took a 4.9% equity stake in sears: a position that paid off handsomely when Kmart bought Sears in November of that year.

Like Avenue, Pershing Square attracts money from pension managers. Ahuja says that in 2010 the New Mexico Public Employees Retirement Association allocated $20 million Ackman’s way. She also quotes J. Tomlinson Hill on Ackman’s secret sauce. His genius as Hill sees it is that he is “able to analyze companies better than the companies can themselves [though] he is restricted to whatever information is in the public domain. He creates value in a way no other manager can.”

Scholes’ afterword translates some of Ahuja’s points into terms within the comfort zone of quants. Avenue Capital prospers, Scholes says, because it focuses on value while other investors/traders focus on liquidity. To Scholes this means that the others demand liquidity “and are willing to give up returns to risk-transfer specialists who are willing to provide it.”

Ackman, too, on Scholes’ reading, is a risk transfer specialist. If a company is in difficulty, Ackman analyzes whether its assets can “carry the risks forward while others who have little understanding or the skills to analyze the situation give up returns.”

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