High-Flying Hedge Fund Falls Back to Earth
By Louise Story
14 October 2008
Only 10 months ago, Remy Trafelet was so flush that he treated about 100 employees at his hedge fund to a getaway in Venice. He and his crew spent a long, luxurious weekend at the five-star Hotel Bauer, which has Murano glass chandeliers, private gondoliers and a splendid view of a 17th-century basilica.
But now, a bit like Venice, Trafelet’s hedge fund seems to be sinking. His flagship fund has fallen about 26 percent this year, and Trafelet is struggling to hold on to anxious employees, as well as some investors.
Perhaps the most remarkable thing about Trafelet is that he is not so remarkable at all. Thousands of hedge fund managers like him — mostly young, mostly male and virtually all unknown outside financial circles — confront a sober reality: for now, the days of easy money are over.
The economics of the hedge fund industry, so lucrative on the way up, are trying even the most seasoned managers on the way down. Hotshots who amassed millions or even billions of dollars from deep-pocketed investors are struggling to persuade those backers to stick with them. For the $2 trillion hedge fund industry, a long-feared shakeout is at hand. Some analysts say one out of every 10 funds could fold.
Trafelet, who is 38 and first made his name managing money at the mutual fund giant Fidelity, insists his Trafelet & Company will be one of the survivors. He has been through rough patches before and says he is not about to give up now.
“There is an easy way out, but I’m not the one who is going to take it,” Trafelet said in an investor call on Thursday. “I feel an absolute personal and moral obligation to work as hard as possible especially through a difficult period.”
Still, managers like Trafelet confront formidable challenges. His fund has dwindled to about $3 billion, from $6 billion at its peak in 2006. It has been three years since he produced the kind of double-digit returns that many funds generated in the industry’s heyday, before thousands of new managers crowded in and made spotting profitable trades far more difficult.
It might be easy to dismiss Trafelet’s story as a simple tale of a highflier falling back to earth. But the fortunes of the hedge fund industry matter to nearly every investor big or small. In recent years, public and corporate pension funds, endowments and foundations poured money into these private investment vehicles in the hope of reaping market-beating returns.
So far this year, the average hedge fund is down 17 percent, about half as much as the Standard & Poor’s 500-stock index.
As losses mount, hedge fund managers are consulting lawyers to determine whether their fiduciary duty dictates that they should shut their doors, liquidate their holdings and use the proceeds to pay back investors — before the losses get worse — or stay in business and try to trade their way out of the hole.
It was easy to look like a star during the bull market. Trafelet returned 42 percent in 2005, 17 percent in 2004 and 39 percent in 2003. He made money after the technology bubble burst and others struggled.
Trafelet says he believes he can survive. He said in an interview on Friday morning that he had shifted half of his Delta Institutional fund’s money into cash and that he thought his bets would turn around.
“We wouldn’t be working this hard and investing in the firm if we didn’t see the massive opportunity,” Trafelet said.
But Trafelet, founded in New York in 2000, is in a weaker position than other hedge funds because the fund returned only 6 percent last year and 2 percent in 2006, according to an investor. Investors who are evaluating whether to leave Trafelet’s fund versus other funds may choose to remain with funds that made them more money recently.
Much of Trafelet’s money is Trafelet’s own, so to an extent, he can choose to keep going regardless of investor flight. In the hedge fund world, traders have remade their fortunes dozens of times over, and Trafelet may impress again in the coming years.
It has been quite a ride for Trafelet, who developed his taste for stock-picking while attending the elite boarding school Phillips Exeter Academy. After graduating from Dartmouth College, he took a job at Fidelity. By age 25, he was managing a $500 million mutual fund.
Today, Trafelet enjoys the trappings of success and is still rich by most standards. He has a home on Park Avenue and takes vacations in places like Fishers Island, the private island in Long Island Sound whose beaches have long attracted old money. In a single good year like 2005, his fund generated hundreds of millions of dollars, which would have been divided between Trafelet and a few partners after paying expenses.
Unlike some hedge fund traders who use complicated computer models and formulas to spot investments, Trafelet picks stocks the old-fashioned way: by combing through corporate fundamentals like profits and sales. He makes long-term bets on companies large and small, based on research and meetings with executives at those companies. It has become an urban legend among the stock-picking community that Trafelet paid college students to count the cars in shopping strips as part of his research.
He is still spending most of his time studying companies, despite the market turbulence, he said, and he says he thinks there is money to be made when the storm passes.
“I don’t know if the market’s going straight up from here or straight down from here,” he said in the investor call. “But I can tell you that there’s massive mispricings all over the place.”
While Trafelet bets both for and against stocks, he was more long going into September. He lost big on his largest position, the Ultra Petroleum Corporation of Houston, which plunged from $84 three months ago to $40 on Monday, before the broad market rally lifted the stock.
In the middle of September, when regulators temporarily banned short-selling, Trafelet, like many hedge fund traders, was squeezed. He had to exit some short positions. By the time the month was over, he had lost a stomach-churning 18.5 percent, according to an investor.
Others in the industry started asking questions when Trafelet laid off a sizable portion of his back-office staff in the middle of the month. He says those cuts were because of a technology upgrade. Last week two more senior employees left. Trafelet said the departures were not because of the fund’s performance.
Trafelet’s fund is up 4.5 percent in October, according to an investor, while hedge funds on average are down. But Trafelet knows the clock is ticking. He has to retain his staff to have any hope of pulling back into the black. At the end of August, he personally guaranteed bonuses for his top traders for this year and told them that, if needed, he would pump more of his own money into his fund in 2009 to safeguard their pay.
