Bloomberg News

Goldman Diaspora Falters as Flamand Hedge Fund Declines

March 27, 2012

Pedestrians are reflected as they walk past Goldman Sachs' headquarters in New York. Photographer: Mario Tama/Getty Images

Pedestrians are reflected as they walk past Goldman Sachs' headquarters in New York. Photographer: Mario Tama/Getty Images

Ex-Goldman Sachs (GS:US) Group Inc. traders led by Pierre-Henri Flamand and Morgan Sze raised more than $4.5 billion for their own hedge funds, helped by the experience of having worked at what once was Wall Street’s most profitable securities firm.

So far, none of them has made money for clients.

The two are among at least six traders who have left Goldman Sachs’s biggest proprietary-trading group in the past two years, which the New York-based bank shuttered in response to new U.S. regulations. All, including Daniele Benatoff and Ariel Roskis, trailed this year’s stock market rally after losing money in 2011, investors said. Elif Aktug, who quit the bank in 2011, plans to start managing money for outside clients at her Agora Fund Ltd. in May.

“In spite of their pedigree, many ex-Goldman prop traders have found it much harder than they originally thought to make money,” said Matias Ringel, the New York-based head of research at EFG Asset Management, which invests in hedge funds.

Poor timing led to the slow start for the Goldman Sachs diaspora as the European sovereign-debt crisis and a fragile economic recovery in the U.S. dominated global markets. Yet their failure to generate profits from investments also highlights the differences between trading at a bank, with its extensive research, technology and compliance operations, and running a hedge fund where clients pay top fees and are less tolerant of risk.

Hedge funds as a group have trailed returns of U.S. stocks every year since the end of 2008, making investors more selective where they put their money.

Flamand’s DAX Bet

Flamand, 41, who was the global chief of Goldman Sachs’s principal strategies group before he quit two years ago to start Edoma Capital Partners LLP in London, has lost about 2.4 percent through February since his $1.8 billion hedge fund started in November 2010, according to investors.

Edoma is an event-driven fund, which invests in companies undergoing events such as mergers, spinoffs and bankruptcies. Such funds returned an average 3.9 percent in the same 16-month period, while all hedge funds gained 2.6 percent, according to Chicago-based Hedge Fund Research Inc. The MSCI World Index of developed-country equities returned 10 percent, including dividends.

Flamand, who hired former colleagues including Ali Hedayat, struggled in 2011 like managers across the industry amid concerns that Greece might default on its debt. His fund started November betting that the DAX Index of German companies would rise as a result of the European crisis easing, according to a letter sent to clients that month. The bet failed when European leaders said Nov. 2 that Greece may have to leave the euro, leaving Flamand with losses in the first two weeks of the month.

Sze’s Losses

Flamand had bought credit-default swaps at the end of October that protect against the failure of European companies, as investor fears of defaults increased. The cost of holding the CDS was the biggest drag on his performance in November, when he lost 0.7 percent, according to the letter. Edoma had bought similar contracts earlier in the year.

Martina Slowey, Edoma’s chief operating officer, declined to comment on the firm’s performance.

Sze, 46, who ran Goldman Sachs’s principal strategies team in Asia before briefly replacing Flamand as global head, left the bank in 2010 to start Azentus Capital Management Ltd. in Hong Kong, hiring 13 former Goldman Sachs traders. His event- driven fund lost about 4.8 percent through February since its April 2011 inception, said a person with knowledge of its returns.

Volcker Rule

Event-driven funds declined 2.4 percent in the same period, while hedge funds fell 2.2 percent, data from Hedge Fund Research show. The MSCI World Index lost 0.2 percent, including dividends.

Roger Denby-Jones, Azentus’s chief operating officer, declined to comment.

A track record of two years or less is a relatively short period to judge a fund manager. The Goldman alumni also suffered in part because of a poor market for mergers and acquisitions, and their performance may improve once deals pick up.

Flamand and Sze were among the first proprietary traders to leave Goldman Sachs amid a debate in the U.S. Congress over whether to rein in risk taking by banks in response to the 2008 credit crunch, which caused a $700 billion taxpayer rescue of financial companies.

President Barack Obama signed legislation in July 2010 that included a provision called the Volcker rule in reference to its advocate, former Federal Reserve Chairman Paul Volcker. The measure restricted banks with customer deposits backed by the U.S. government from using their own money to make speculative bets on markets.

Rubin’s Unit

While the Volcker rule isn’t scheduled to go into effect until July of this year, Goldman Sachs decided within weeks of its approval to shut down the principal strategies group. U.S. lawmakers are now urging regulators to revise a draft of the rule before the July 21 deadline imposed by Congress for its implementation.

The principal strategies group, which managed about $11 billion, traces its roots to the risk-arbitrage team once led by Robert Rubin, who later became U.S. Treasury secretary. An earlier wave of traders who left to start their own hedge funds include Frank Brosens, co-founder of Taconic Capital Advisors LP, Eric Mindich of Eton Park Capital Management LP and Dinakar Singh of TPG-Axon Capital Management LP.

Taconic

Brosens’s Taconic, which was started in June 1999, returned 7.6 percent that year, followed by a 16.7 percent return in 2000, according to investors. The fund grew to a peak of $10 billion in 2008 and now manages about $7.8 billion.

Mindich’s Eton Park, which was one of the industry’s biggest startups when it began trading in November 2004 with $3.5 billion, returned 2.3 percent in its first two months and 13 percent the following year, an investor said. Assets grew to a 2007 peak of $14 billion and the firm now manages $12 billion.

TPG Axon’s Singh returned 13.9 percent in 2005, his first year of trading, and 14.9 percent in 2006, investors said. His fund grew to a peak of about $10 billion in 2008 and now manages about $4.4 billion.

Taconic, Eton Park and TPG-Axon generated profits this year after losing money in 2011, according to investors. Officials at the New York-based firms declined to comment.

‘Your Real Friends’

“I’ve spoken to Goldman traders who’ve told me they have a network across the street and the world,” said Larry Chiarello, a partner SkyView Investment Advisors LLC in Shrewsbury, New Jersey, which places money with hedge funds. “When you are at Goldman sitting on a $10 billion prop desk, everyone is your friend. When you are on your own at a hedge fund, you find out who your real friends are.”

Flamand’s and Sze’s experience at Goldman Sachs, combined with expectations for a pickup in corporate deals that event- driven funds thrive on, helped attract investors. Edoma and Azentus were among the biggest hedge-fund startups of the past two years, each raising about $1 billion, said people familiar with the matter, who asked not to be identified because the companies are private.

At the start of 2011, the stage was set for event-driven funds to outperform, said Dariush Aryeh, chief investment officer of Fundana SA, a Geneva-based firm that advises clients on investing in funds. The 1,600 companies in the MSCI World Index were sitting on $4.4 trillion, according to data compiled by Bloomberg, an amount that grew steadily as businesses hoarded cash after the 2008 financial crisis.

‘High Expectations’

Instead of spending the money on acquisitions, corporations stayed on the sidelines in 2011, scared off by the risk of a euro-zone collapse and wide swings in stock prices. MSCI companies now have a cash pile of $5.5 trillion.

While surging stock prices this year have given firms added firepower to pursue acquisitions, the pace of deals has yet to pick up. The value of global mergers and acquisitions was $397.4 billion for 2012 through March 23, down from $499.5 billion in the fourth quarter, according to data compiled by Bloomberg.

“You would think that the economic environment has been favorable for event-driven hedge funds to distinguish themselves, but it’s not been that straightforward,” Aryeh said. “Investors have had high expectations for three years now.”

Facing Redemptions

Hedge-fund clients have become increasingly skeptical of the strategy, according to a February survey by Credit Suisse Group AG. Net demand for event-driven funds plunged to 18 percent at the start of this year, a figure derived by subtracting the number of investors who say they intend to redeem money from those who say they plan to add assets. Such hedge funds had a net demand of 56 percent at the start of 2011, topping all strategies in popularity, according to Zurich-based Credit Suisse.

Event-driven (HFRIEDI) funds were one of two strategies to suffer client withdrawals last year, according to data from TrimTabs Investment Research Inc. and BarclayHedge Ltd. Investors pulled $2.8 billion, leaving the funds with about $170 billion. All hedge funds together oversee about $2 trillion.

Flamand’s Edoma, which last year stopped accepting new money, is now among the funds facing redemptions. Assets at the firm peaked at about $2 billion last year, according to an investor.

Mesirow Pulls

Clients that withdrew money include Mesirow Financial Inc., a Chicago-based hedge-fund investor with more than $14 billion under management, according to two people familiar with the matter, who asked not to be identified because the firm’s investments are private. Greg Fedorinchik, a spokesman for Mesirow, which manages $14 billion, declined to comment on the redemptions.

The transition to running a hedge fund from trading at a bank, where research and legal functions are managed by other groups, can be a challenge for traders, according to Fabien Dersy, director of investment management at NewAlpha Asset Management in Paris.

“A lot of guys have been helped while they were sitting at investment banks,” said Dersy, whose firm invests in startup hedge funds.

Fledging managers are often reluctant to make risky trades out of concern that they may suffer outsized losses and wide swings in monthly performance that may scare off investors, he said.

Joining KKR

Instead of starting his own firm, Bob Howard, who ran the U.S. desk of Goldman Sachs’s principal strategies group, joined KKR & Co. in 2010 to start the New York-based buyout firm’s first hedge fund. The $422 million KKR Equity Strategies LP fund, which started in August, lost 1.4 percent in its first seven months, according to investors.

Howard, 40, outperformed other equity hedge funds, which lost 2.6 percent in the same period while the industry fell 1.5 percent, according to Hedge Fund Research. The MSCI World Index gained 1 percent.

KKR gave Howard, a partner at the firm, $100 million to start the fund, according to marketing documents. He brought 11 people from Goldman Sachs with him to the buyout firm. Kristi Huller, a KKR spokeswoman, declined to comment.

Howard said at a May conference in New York that he liked vehicle-parts manufacturer Wabco Holdings Inc. and cable television shopping-network operator HSN Inc. Wabco, based in Piscataway, New Jersey, slumped 29 percent last year, while HSN based in Saint Petersburg, Florida, gained 18 percent.

Benros Fund

Other Goldman Sachs traders who stepped down from the principal strategies unit include Benatoff, 32, and Roskis, 36. They started trading at their London hedge fund, Benros Capital Partners LLP, last June after receiving $300 million from Brummer & Partners, a Stockholm-based asset-management firm. The Benros Event Driven & Opportunistic Fund has lost about 1.7 percent in the nine months through February, according to investors.

Benatoff and Roskis, who left Goldman Sachs last year, declined to comment on the fund.

Aktug, 37, also quit the bank in 2011 after 12 years to join Pictet & Cie in Geneva, according to a February marketing document. She now manages the 78 million euro ($104.2 million) Agora fund, which has lost 2.3 percent since its start in April 2011, according to a person with knowledge of her returns.

Aktug, after trading Pictet’s money for the past year, is seeking to raise assets from outside clients for her event- driven fund. She aims to produce average annual returns between 8 percent and 12 percent by mainly trading the stocks of the biggest European companies, saying such firms have the competitive advantages of scale, pricing power and healthy balance sheets, according to the marketing document.

She declined to comment on the fund.

“It’s brave to put that out there, but hedge funds are going to have to justify their existence and their fee structure,” said SkyView’s Chiarello. “If you are not going to strive for double-digit returns or at least high single digit in this environment, then you are not going to be gathering assets.”

To contact the reporters on this story: Jesse Westbrook in 東京 at jwestbrook1@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net

To contact the editors responsible for this story: Edward Evans at eevans3@bloomberg.net; Christian Baumgaertel at cbaumgaertel@bloomberg.net


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