WSJ 7/15/04
DAN BENTON is learning the downside of running a big hedge fund.
Mr. Benton, one of the top technology-focused stock investors, is having a somewhat disappointing year. The four big tech hedge funds he manages are down between 3.6% and 7% for the year through July 9, according to investors. That's worse than the 2.3% drop in the Dow Jones Industrial Average, though not far off from the 4.4% decline in the technology-heavy Nasdaq Composite Index and the even-bigger decreases in various tech-stock indexes.
Other hedge funds run by Mr. Benton's $5.7 billion hedge-fund company, Andor Capital Management LLC, are having a more impressive year, with one up 5% and a health-care fund up a heady 14%.
Amid all this, the challenges for Andor are mounting. Yesterday, in a letter to investors, Mr. Benton said that Chris James, the firm's co-founder, is bolting. Mr. James, Andor's chief investment officer and portfolio manager, who according to a person at the firm had been unhappy at Andor in recent months, will leave at the end of August to start his own firm, forcing Andor to liquidate his $600 million hedge fund. The move likely will inspire some investors to consider pulling their money out of Andor, potentially forcing Andor to dump various positions, a step that could have an impact on certain stocks.
Behind all the turmoil is a single, awful call last year by Andor that the stock market's rebound would be short-lived, tech earnings wouldn't bounce back sharply and stocks would tumble. When shares soared in 2003 and Andor was too slow to jump on the market's bandwagon, returns at Mr. Benton's firm suffered.
Mr. Benton's biggest hedge fund, Andor Technology fund, dropped almost 16% last year, while Andor Diversified Growth fund lost a steep 22%, even as the Nasdaq soared 50%.
The losses became the talk of the hedge-fund world, largely because Mr. Benton, who investors say has produced annualized gains of about 30% in the past decade, was considered to have a golden touch. Andor remains one of the larger hedge funds, though it is down sharply from the more than $9 billion it managed at the start of 2003.
Mr. Benton's bad bet in 2003 continues to haunt his firm. It underscores how today it only takes one bad year to put most hedge funds in peril, a point that many money managers rushing to start their own hedge funds often fail to focus on.
Hedge funds, unlike mutual funds and other money-management organizations, make a deal with their investors. They charge super-high fees -- usually a management fee of 1% or 2% of all assets and at least 20% of the firm's gains in a year as an "incentive" fee. But if the fund loses your money, it won't make anything until it makes up the losses first. An investor who places $1 million in the fund, and then sees it drop 10%, doesn't have to pay the incentive fee until the investment gets back to the high-water mark, in this case the $1 million figure. Until then, employees only get a base salary, which can be $150,000 a year, while the hedge-fund manager himself can go without any paycheck.
The promise to make investors whole before the hedge fund again starts to earn the juicy incentive fee can exert pressure, as Mr. Benton found. That is because there are so many new funds looking for talent, making it tempting for employees at a struggling firm to jump ship. Mr. James took over the Diversified Growth fund from another manager in December of last year, and it was his job to deal with the aftermath of the 23% loss in 2003. Although Mr. James's fund managed to gain 5% this year, the fund still has to rise about 20% just to reach the high-water mark that brings investors back to where they started at the beginning of 2003.
It proved such a deep loss that analysts who work with Mr. James began grumbling, according to people close to the matter, putting pressure on Messrs. James and Benton to come up with a way to keep employees around. Mr. James also was aware that investors would line up to go with him if he were to start his own firm.
Rather than try to dig out of the deep hole, while at the same time not getting paid as much as they could earn elsewhere, Mr. James and his team began to contemplate starting out on their own.
"With no incentive fee to spread around it makes it hard to retain talent; if you're down significantly you first have to make it back," said Tom Trowbidge, who works with institutions who invest in hedge funds. "There's always the incentive for smart guys to head off on their own in the hedge-fund world."
It was a tough decision for Mr. James, according to people familiar with the matter, because he and Mr. Benton are close friends. They co-founded Andor in 2001 after Mr. Benton left another large hedge-fund firm, Pequot Capital, and worked together for eight years. Mr. James even served as Mr. Benton's best man at his wedding last year.
"After serious consideration, Chris James and I have decided to end our successful eight-year partnership," Mr. Benton said in the letter to Andor investors. "This has been a very difficult decision for us, but we both believe that it is in the best interests of our investors." Yesterday, a spokesman said Mr. Benton wasn't available to elaborate.
Although Mr. James has promised to keep the 20% high-water mark for those investors choosing to keep their assets with him, he now will be able to raise new money allowing him to charge both a management fee and an incentive fee right off the bat, a proposition that proved tempting enough for Mr. James.
Andor also is closing its health-care hedge funds, and Mr. James likely will try to recruit that team to his new fund. Andor said that with Mr. James's slated departure, the firm will focus on managing various technology hedge funds.
Now all eyes are on what impact, if any, the situation at Andor will have on stocks. Andor's liquidation of Mr. James's funds, and the firm's health-care funds, may not have much impact because together they only manage $700 million, but they did own big holdings of a few smaller stocks. The firm, for example, as of March 31 was the sixth-largest holder of Vion Pharmaceuticals Inc., a drug company with a market value of about $220 million.
Andor also will allow the rest of its investors, representing almost $5 billion, to pull their money out at the end of August. Signs point to at least some taking the firm up on its offer. At the end of June about $700 million was redeemed by investors, even before the news of Mr. James's departure. That could force Andor to sell some stocks, potentially moving smaller companies in its portfolio, such as Varian Semiconductor Equipment Associates Inc., a $1.2 billion company that tumbled 5.2% yesterday on the Nasdaq Stock Market. Andor held about 1.5% of Varian's shares as of March 31, according to public filings.
But Andor doesn't use much leverage, or borrowed money, to amplify its returns, suggesting that even if investors pull money out it might not cause much of an impact. At the same time, the firm has a sizable cash position, reducing pressure to dump stocks. And its largest holdings include stocks such as Dell Inc. with so many shares outstanding that Andor's potential selling may not move the stocks.
CASH IS ONCE again king.
Across Wall Street, a surprising number of top-ranked money managers are accumulating piles of cash in their portfolios. For investors, this could mean lackluster returns for their mutual funds in the short term, but ultimately could help prevent the kinds of wrenching losses many funds racked up a few years ago. It also raises the question of whether individual investors should follow suit and, if they do, where they can get the best returns on cash while waiting for better investment opportunities.
Inside the highly rated Clipper fund, the level of cash now sits at 30% of total assets. The Aegis Value fund has amassed a cash load of more than 51% of assets. The well-regarded Longleaf Partners fund group has spent the past four quarters selling more stocks than it buys and now holds between 24% and 30% of its assets in cash in its three funds. Tomorrow, it plans to close the Longleaf Partners fund to new investors because managers can find no place currently to invest the money. Additionally, Warren Buffett's company, Berkshire Hathaway Inc., has doubled its cash holdings during the past year to nearly $35 billion.
Overall, more than 50 stock funds have at least 20% of their portfolios in cash right now, according to research firm Morningstar Inc. Seventy-five bond funds have at least 30% of their assets in cash. Some portfolio managers say they also are building cash in their personal accounts. Robert Rodriguez, manager of the FPA Capital fund, has moved between 35% and 40% of his personal net worth into cash. Last week, he also closed his fund, where the 37% cash load marks a 20-year high.
"The investment landscape with stocks and bonds is now a vast wasteland," Mr. Rodriguez says.
The move to cash comes after investors have ridden Wall Street higher during the rally of the last two years. Interest rates are on the rise; inflation is a concern; earnings growth is expected to slow next year; and the valuation of everything from stocks and bonds to real estate and commodities has plateaued, for the moment at least, at generally rich levels. Cash remains the safest place to endure what many see as a dearth of investment opportunities and the possibility that stocks will go nowhere for a long while.
Still, cash has little allure for many individual investors because of tepid yields. Certificates of deposit, money-market accounts and short-term Treasurys all currently yield roughly 2% or less. Finding the most lucrative cash haven can be tricky. Some options (such as money-market deposit accounts) are decidedly better than others (money-market mutual funds).
The pros' rush to cash is a consequence of higher asset prices and a paucity of investment ideas. James Gipson, chairman and president of the Clipper fund, says that in weeding the portfolio in recent years, cash has accumulated simply because "the market is giving us precious few opportunities right now."
This trend isn't yet visible on a broad scale. Currently, of the $5.5 trillion in non-money-market mutual funds, 4.7% is in cash, a level that hasn't wavered much in recent years, according to the industry group Investment Company Institute.
Of course, many mutual funds are mandated -- often by their management company -- to remain fully invested no matter what, skewing the trend. Yet it's clear managers running the gamut of stock and bond funds are increasingly moving to cash. Even the Kinetics Internet fund, focused on what has been the best-performing sector of Wall Street this year, now has more than 36% of its assets in cash in anticipation of buying stocks much cheaper in the future.
A similar logic explains the 40% cash position at the Weitz Fixed-Income fund, a short-term bond fund. That number is close to an all-time high for the fund, says fund manager Tom Carney.
Clipper's Mr. Gipson doesn't think stock prices are necessarily excessive, but says they are "generously valued." He says that he has found just two investment ideas this year, though he won't name them.
As for where to find the best returns on cash, many pros rely on short-term Treasury bills that mature in 90 days or less. Currently, three-month T-bills yield about 1.33%. You can buy Treasurys online through many brokerage houses, but pay attention to minimum investment sizes. Fidelity Investments requires a minimum of $1,000, the smallest-denomination T-bill, and allows investors to buy new issues commission-free. Charles Schwab & Co., meanwhile, requires a $10,000 minimum and imposes a $15 commission.
TreasuryDirect.gov provides online access to Treasurys directly from the government, though investors must open an account. Treasury bills are auctioned weekly, usually on Mondays.
Avoid ultrashort-term bond funds if you have an investment horizon of less than a year. They aren't immune to rising interest rates, which means your principal is at risk if the Federal Reserve continues pushing rates higher, as expected. Moreover, these funds' management fees are high. So far this year, ultrashort funds have returned just 0.44%.
CDs are another option. The national average yield on a three-month CD is 1.18%, though certain banks offer much better rates. World Savings, the Oakland, Calif., unit of Golden West Financial Corp., for instance, pays 2.34% on three-month CDs of $5,000 or more in states such as New York, New Jersey and Illinois. Bankrate.com provides data on the best rates nationally and on a state-by-state basis.
Finally, there are money-market deposit accounts and money-market mutual funds. Consider the former; skip the latter. Money-market deposit accounts are essentially bank accounts that offer FDIC protection. These accounts pay yields of as much as 2.15% for a $100 minimum deposit at VirtualBank, in Palm Beach Gardens, Fla.; to as much as 2.5% for a $50,000 deposit at Cleveland's Charter One Bank.
Money-market mutual funds, in comparison, don't offer FDIC protection, meaning your principal isn't insured. Plus, the yields are substantially smaller. The top yields are currently at about 1.19%, according to iMoneynet.com.