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  Whither the young lions?

BENJ GALLANDER and BEN STADELMANN

Monday, September 17, 2007

The proliferation of hedge funds over the past two decades has created a coterie of managers who have been able to transform their talents into immense wealth.

Some have been spinning their investment acumen into gold for a long time, like the wily George Soros and the irrepressible T. Boone Pickens, who at 78, is still tacking on extra billions to his stash. But there is also a new generation on the honour roll of "extreme capitalism," one whose members have gained amazing success without accruing so much as a grey hair.

Billionaire Ken Griffin started his Citadel hedge fund in 1990 at age 22. He now oversees a firm with more than 1,000 employees and $13 billion (U.S.) in assets, and is responsible for one to three percent of all trading on the New York Stock Exchange each day.

New on the billionaire block is superstar oil trader John Arnold. He started Centaurus Energy after the collapse of Enron, and with the disintegration of rival Amaranth Advisors last year, he finds himself crowned king of the global oil castle at just 33.

But among the younger crew of hedge fund superheroes, perhaps no luminary glows more brightly than 45-year-old Eddie Lampert. After graduating from Yale, he did a tour of duty with Goldman Sachs, where he was mentored by Robert Rubin, who later served as Treasury secretary in Bill Clinton's administration.

In 1998, Lampert started ESL Investments, which has since cranked out annualized returns of nearly 30 percent. A measure of his reputation is that other billionaires trust him with their money — Michael Dell and David Geffen were early fans.

Further burnishing Lampert's legend was an incident in 2003, when he was kidnapped by four thugs and held for ransom. He talked his way into being let go two days later without paying a dime.

Unlike many hyperactive hedge funds that make money through exotic trading strategies, Lampert's approach is more old-fashioned, emulating the value methodology of Warren Buffett. Like the Omaha Oracle, Lampert isn't afraid to make huge bets on a select few companies that he really likes. But there are important differences, too.

Part of Buffett's success can be attributed to his uncanny ability to assess the capabilities of management. When he buys a company, he tends to leave these people alone to build the long-term success in the enterprises they run. Lampert, on the other hand, has been quick to fire and insert himself into the decision-making process.

Another contrast in approach is that Buffett takes a modest $100,000 fee for his efforts at Berkshire Hathaway. That's quite a bargain compared with the $940 million in compensation that Lampert charged ESL in 2006 (he made a few hundred million more with his own stake in the fund).

However, given how 2007 is shaping up so far, he may be in for a pay cut. ESL's largest holding by far is Sears Holdings, the retail juggernaut that Lampert cobbled together from the bankruptcy of Kmart and the subsequent takeover of Sears Roebuck. It's down 17 percent this year.

Next is AutoZone, the largest retailer of car parts in the United States, which has slipped 11 percent. ESL's third major holding is car dealer AutoNation, off by seven percent.

The defining feature of the economic landscape of the past decade has been a sea of easy money unleashed by the U.S. Federal Reserve as it has striven to mitigate the effects of the tech crash and 9/11 and its aftermath, escalating consumer and government debt as well as fiscal and trade imbalances.

This liquidity not only created ample fuel for a trillion-dollar hedge fund industry, it inflated a real estate bubble while simultaneously keeping American consumers shopping at the mall. These conditions were perfect to promote Lampert's rise.

But with the U.S. real estate market hobbled and a consumer slowdown afoot, it appears Lampert will have to learn some new tricks to do as well in a very different environment. It is the nature of investing that no methodology will work all the time. Investors either have to adapt or wait for a new cycle to bring more favourable conditions.


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