Lampert, Wood Reveal Failings of `Concentrated\' Hedge-Fund Bets

Date: Friday, May 9, 2008
Author: Katherine Burton, Bloomberg

When Jon Wood opened his Monaco-based hedge fund, the former UBS AG trader told investors he'd beat the market by buying stakes in no more than 40 companies -- the same way he made $2.4 billion in six years for his old employer.

Instead, holdings such as failed U.K. bank Northern Rock Plc and Calabasas, California-based Countrywide Financial Corp., the largest U.S. mortgage lender, imploded. From its start in late 2006 with $3 billion, Wood's SRM Global Fund lost about 70 percent through March 31, said two investors, who asked not to be identified because the firm doesn't publicly disclose returns.

``These concentrated funds scare the hell out of me,'' said Brad Alford, head of Alpha Capital Management LLC, an investment consultant based in Atlanta. ``Either the manager knocks it out of the park or he strikes out.''

Other managers who follow the approach of betting big on out- of-favor stocks are also struggling as market volatility hits historic highs. Edward Lampert's ESL Investments Inc. dropped 27 percent last year and an additional 1.3 percent in the first three months of 2008, investors said. The 45-year-old Lampert, who oversees $17.5 billion, has been hurt primarily by a $6.1 billion stake in retailer Sears Holdings Corp. of Hoffman Estates, Illinois, that has fallen 48 percent in the past year.

Investors expect that Wood and Lampert, who both declined to comment, will survive their losses because clients can't pull their money for three to five years. The lock-ups leave investors no choice but to wait for a turnaround. Other funds that concentrate their wagers haven't been so lucky.

Endeavour Liquidation

Paul Matthews, head of Endeavour Capital LLP in London, told investors last month he would liquidate what had been a $2.9 billion hedge fund after losing money on Japanese government debt. The fund lost about a third of its value in March when the spread on yields between 7-year and 20-year Japanese government bonds ballooned to their widest in nine years.

``We thought we were dispersed enough and we weren't,'' said Matthews, 47, who plans a new fund with better risk controls. ``It's a very expensive lesson to learn.''

Thomas Hudson, founder of Pirate Capital LLC, learned a similar lesson. Assets at his Norwalk, Connecticut-based firm reached a peak of almost $2 billion in August 2006, when he owned stakes in about 20 companies. Half his money was in our stocks, including Brink's Co., the Richmond, Virginia-based armored-truck provider, and mining company James River Coal Co., also of Richmond.

Investors Exit

Investors began fleeing after five of Pirate's 10 employees quit in 2006. Hudson's firm held board seats in eight companies at the time, so his ability to sell those shares was limited by securities law. Instead, he liquidated other positions to raise cash, making his biggest holdings an even larger percentage of his portfolio.

Now his only holdings are Brink's; Philadelphia-based Pep Boys - Manny, Moe & Jack, which runs automotive-parts and repair shops; and military contractor Allied Defense Group Inc. of Vienna, Virginia, which had a combined market value of $154 million as of March 31, according to a May 5 filing with the U.S. Securities and Exchange Commission. In the past several months, clients who exited his funds received stock, rather than cash, because Hudson, 42, is still a director at Brink's and Pep Boys.

Even with such well-publicized losses, investors seem willing to continue to back concentrated funds.

Whitney Tilson who runs concentrated mutual funds and hedge funds at New York-based T2 Partners LLC, said that although his T2 Accredited Fund has lost money this year, there have been only ``minor'' net redemptions because of frequent communication with his investors.

Barakett's Atticus

Lampert's ESL raised $4 billion last summer even as the Greenwich, Connecticut-based manager was losing money. Lampert has produced an average annual return of almost 30 percent since 1988.

``He's had a spectacular long-term track record by focusing his analysis and mental capability and knowing a few situations extremely well,'' said Tilson, 41.

Timothy Barakett's Atticus Capital LP, which oversees $19 billion, lost 14.8 percent in its global fund and 11.5 percent in its European fund this year through April, according to investors. The New York-based firm's returns have been dragged down by a 12 percent stake in Deutsche Boerse AG, currently valued at 2.4 billion euros ($3.7 billion). The stock of Europe's biggest exchange by market value has tumbled 25 percent this year.

Side-Pocket

While investors say clients are not asking for their money back, Barakett, 42, took the precautionary step of placing shares of Frankfurt-based Deutsche Boerse into a special account known as a side-pocket. That means that even if investors do redeem, their stake in Deutsche Boerse remains at Atticus.

Barakett's European fund has climbed an average of 30 percent a year since opening in 2001 and has never had a losing year. The global fund has returned 20 percent a year, investors said. Andy Merrill, a spokesman for the fund, declined to comment.

Atticus's lock-ups generally range from one to five years, depending on the share class, although the longest-standing clients can redeem their money quarterly. The side-pocket sends a message to Deutsche Boerse board members that the hedge fund will remain a long-term investor.

For Wood's investors, the news isn't getting any better.

In the first quarter, the fund sold off holdings in at least seven companies, according to regulatory filings.

Immediately after Wood culled those positions, the shares jumped. At the end of the year, SRM owned 4.9 million shares of Bermuda-based Nabors Industries Ltd., the world's largest onshore oil and natural-gas driller, then worth about $135 million. Since the end of March, those shares have jumped 17 percent.

To contact the reporter on this story: Katherine Burton in New York at kburton@bloomberg.net.