A Hedge-Fund Manager's New Groove

Date: Tuesday, November 2, 2010
Author: Jenny Strasburg, The Wall Street Journal

A former hedge-fund manager who made a fortune shorting stocks has switched to the long side, and is raking in money in the process.

William von Mueffling surprised clients and competitors last June by announcing he would close his hedge funds and return $3.5 billion to investors. His firm, Cantillon Capital Management of New York, kept managing $1 billion in long-only assets, typically considered the unsexy piece of the business.

Now, the 42-year-old stock picker controls more money than he did before he closed his hedge funds. Cantillon has raised billions of dollars from pension funds in the U.S. and abroad, and from sovereign-wealth investors, according to clients and other people familiar with the matter.

 

The inflows, helped by a 21% return this year, have boosted Cantillon's assets to more than $5 billion, the people said. The average stock mutual fund focused on world-wide equities is up 8.6% this year, according to Morningstar.

Cantillon is now a firm with an altered investment process and much lower fees.

After years of "long-short" investing, Mr. von Mueffling and his analysts and traders no longer short, or bet against, stocks at all. Instead, like a typical stock mutual fund, they stick to buying company shares they expect will rise. Mr. von Mueffling said the strategy is "the right long-term decision."

"I'm not saying there aren't overvalued stocks out there," he said in an interview. "There are, but trying to short them when the government is printing money is a very, very challenging game," he said, referring to, among other things, Federal Reserve programs to buy government bonds, which the Fed is widely expected to announce this week.

William von Mueffling

The remade Cantillon pulls in much lower fees than a hedge fund with similar returns would. Hedge funds typically get to keep 20% of profits, on top of a flat management fee, usually 1.5% to 2% of assets, that clients pay. In contrast, the majority of Cantillon investors pay just a management fee of 1.25% or less, according to fund documents.

That means that no matter how well the fund performs, Mr. von Mueffling and his team won't take in anywhere close to what they used to in their heyday as hedge-fund managers.

But Cantillon has multiplied its size during a period when many hedge funds and mutual funds continue to shrink and as investors have fled stocks in droves.

Managers might expect institutional long-only money to stick around during down markets, compared with the urge by some hedge-fund investors to pull out amid losses. Mr. von Mueffling, by focusing on institutional long-only money, appears focused on building an asset-management business less prone to clients bolting after a bad year.

Last week, Mr. von Mueffling told clients he would stop taking money from new investors. He has discussed barring inflows altogether next year, even from existing clients, to cap assets in his fund, Cantillon Global Equity, at about $7.5 billion, said people familiar with the matter.

The former hedge-fund manager was born in Munich to a German investment-banker father and an American mother. His father died when he was a toddler, and his mother moved William and his siblings to New York.

Mr. von Mueffling started Cantillon in 2003 after gaining fame as an investor in his early 30s at Lazard Asset Management. He made a killing shorting technology stocks, posting average annual returns of more than 30% from 1998 to 2003. When he left Lazard, money followed him, and so did ex-Lazard peers Rob Cope and Tom Ellis, now both at Cantillon.

At its peak, strong returns and client inflows helped Cantillon expand to manage $10 billion in assets. In 2008, the five-year-old firm lost less money than most hedge funds did, but clients withdrew funds nonetheless amid a broader exodus from hedge funds.

Then last year through May, its hedge funds were down about 7%, trailing most peers. In Mr. von Mueffling's eyes, the markets had changed, and his business needed to transform, too.

"Our strategy has run its course," he told clients last June, according to people familiar with the private conversations. He discussed how in 2008 and early 2009, Cantillon had a hard time finding stocks to short profitably, despite hiring more analysts to do more research. More broadly, hedge funds face a harsh reality when losses persist: They can't earn big fees again until they make up for those losses.

Short selling has, for many hedge funds, been treacherous recently, said fund managers and investors. Hedge funds that specialize in short selling have had the worst performance during the past rolling 12 months, with an average return of negative 14%, of any strategy tracked by Hedge Fund Research Inc.

Part of the pain has come from macroeconomic issues, such as low interest rates, that have overwhelmed company-specific factors that can drive stocks. At the same time, markets driven increasingly by computer programs have undermined some investors' abilities to predict how stocks will move on a short-term basis. Shorting also has come under fire around the world, with some governments proposing bans on short selling altogether.

Cantillon's strategy is to dig around for companies that, regardless what business they are in, produce higher-than-average returns on shareholder equity, while they are priced cheaply relative to their earnings streams.

"You want to be in businesses that can pass through inflation, and also that have exposure to currencies in parts of the world that are growing," which in this environment helps protect against the declining value of the U.S. dollar, Mr. von Mueffling said.

Cantillon holds 50 to 110 stocks at any given time. Right now, they include Intertek Group PLC, a firm that tests everything from shoes to chemicals; toothpaste-maker Colgate-Palmolive Co.; and brewer Heineken NV.

Other hedge-fund managers have started long-only funds. They include ex-Tiger Management LLC stock pickers Steve Mandel and Andreas Halvorsen and quantitative investor Cliff Asness. But unlike Mr. von Mueffling, they didn't shut down their hedge funds.

"Diversifying products means diversifying business risks," said Stuart Hendel, head of UBS AG's prime brokerage business, a unit of the bank that caters to hedge funds.

Most of Cantillon's standard hedge-fund-only investors are gone, including the funds of hedge funds. EnTrust Capital Inc., a New York fund of funds, is an exception.

"I think his analysis of securities is very disciplined," said Gregg Hymowitz, EnTrust managing partner. "We're not getting the short exposure, but we're also not paying the hedge-fund fees."

Cantillon held onto at least one trait typical of hedge funds: Investors didn't get in cheaply. The minimum to invest was $10 million.

Write to Jenny Strasburg at jenny.strasburg@wsj.com