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Race-Horse Hedge Funds Begin to Gallop

Date: Tuesday, June 10, 2008
Author: Dealbook, New York Times

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Big Brown may have failed to complete his Triple Crown sweep on Saturday — indeed, he came in dead last. But hasn’t slowed down what appears to be a burgeoning new sector: the race-horse hedge funds.

Big Brown’s owner, International Equine Acquisitions Holdings, isn’t the only player trying to raise a new horse-focused hedge fund, in which the owners adopt the much-ballyhooed two-and-twenty fee structure. The Wall Street Journal reported that Nick Zito, the trainer whose horse bested Big Brown, is also seeking to get into the game with his own fund.

Long ago, hedge funds diversified from stocks, bonds and financial instruments into more esoteric investments, like fine art. Now investors seem comfortable with the decades-old art of picking the next Secretariat or Affirmed — or even, yes, Big Brown.

I.E.A.H. is seeking to raise $100 million, with entrée costing a reported $500,000. It already has a big backer in TAG Virgin Islands, an investment-management firm based in St. Thomas. And it doesn’t hurt to have Big Brown, which won both the Kentucky Derby and the Preakness with shocking ease, as a recruiting tool.

“This was a business unrecognized on Wall Street, but very much like Wall Street,” James Tagliaferri, TAG’s founder, told The New York Times last week. “It’s impacted by some of the same characteristics that drives commodities like gold. It’s risky, but biotechs can be riskier than horses, and believe me I’ve seen biotechs of mine go down.”

Meanwhile, Mr. Zito and two other legendary trainers, D. Wayne Lukas and Robert Baffert, are busy raising the Thoroughbred Racing Legends Fund, which will draw on their long and successful careers to find equine diamonds in the rough. According to the Journal, potential investors must commit at least $3 million over three years; the fund will charge a 2 percent management fee and 20 percent of racing and sales profits.

The very idea of an equine hedge fund unsurprisingly upsets many, including aficionados of horse-racing. Trading horses like gold futures strikes these critics as an affront to decency. Here’s what Peter Thomas Fornatale, an author of several books on horse racing, wrote in an op-ed in Saturday’s Times:

Instead, his main owner is International Equine Acquisitions Holdings, whose stated purpose is to be an equine hedge fund that delivers profits to its investors by consistently racing winners. When you run your stable like a hedge fund, the horse becomes just another commodity to be bought and sold like a share of stock, with little concern for its fate.

To others, there’s also the worry that the fast-money crowd will sweep in, bringing along a host of unsavory characters. Indeed, some critics have targeted Michael Iavarone, I.E.A.H.’s co-president, as an object of scorn. As The Times and others have pointed out, he wasn’t a “high-profile investment banker” who once worked at Goldman Sachs, as he once claimed; instead, he worked at four small brokerages, one of which was shut down for fraud. (Mr. Iavarone himself was fined $7,500 and suspended by the National Association of Securities Dealers for unauthorized trading in client accounts.)

To be fair, the days of small families raising a Triple Crown winner have mostly faded away; tales of friends banding together to buy a surprise winner, as happened with Funny Cide, are more the exception than the rule. As The Journal points out, the average price of a one-year-old at the Keeneland sale was $101,347, a 41 percent jump from six years ago.

And the problems haunting horse racing today were in plain sight long before the arrival of big-money investors. Ask any longtime observer about the longstanding dangers that steroids and selective inbreeding pose for American race horses today. I.E.A.H. is obviously aware of some of its image problems: It is building a $17 million equine medical facility near the Belmont race track.

Perhaps it is the hedge funds themselves that should be most concerned. As Breakingviews’ Richard Beales points out, such funds make concentrated bets, which can pay off big — if fortune swings the investors’ way. While Big Brown isn’t a part of I.E.A.H.’s hedge fund, the temptation to focus on just one or two seeming winners could prove disastrous if, well, dark horses like Da’ Tara blindside these investors.