Loeb is proud of his letters, which are thorough, well argued, and filled with clever turns of phrase. (He had a batch prepared for his high-school English teacher.) In a letter to the CEO of Warnaco, he referred to the CEO’s “imminent involuntary extraction.” To the CEO of Bindview Corp., a software company, he wrote of “your seemingly perpetual failure.” He’s gone after Intercept, Potlatch, Penn Virginia. There’s one where he calls the CEO “Chief Value Destroyer,” which he abbreviates CVD. “I’m surprised some CEO hasn’t had him shot,” says one manager.
Loeb’s letters are great entertainment. They also show the degree to which hedge funds play by different rules. Anyone who’s consulted an investment adviser has seen the “rules of intelligent investing for the rest of us.” They’re in a booklet apparently printed just for you—usually your name is on the cover. The booklet appears to prove several shocking facts. First, how stupid you are to even try to pick winning stocks. Second, how dangerous it is for you to try to time the market, to buy at a bottom or sell at a top.
And so, he tells you what financial advisers tell most every hapless investor. Diversify your portfolio and your asset classes. Which is his way of letting you know he’s not going to actually manage your money. Rather, he’ll divide it into a few asset buckets and diversify it by industry group, and then he’s going to, as Loeb says of Ross, “extract his fee,” which, though he does his work up front, must be paid each year.
For most hedge-fund managers, this is insanity. “You might as well walk through Times Square with money sticking out of your pockets and yell, ‘Rob me!’ ” says one. Hedge funds don’t, as a rule, take the diversified view, an attempt, in their mind, to perform just like everyone else. They’re looking for winners. Their goal is to get in near the bottom and slip out of the way when the top crests.
The pressure is on. Mutual funds live off a percentage of the money invested. “We eat what we kill,” hedge-fund people like to say, a reference to the fact that they take a share of the profits. To a hedge-fund manager’s mind, mutual funds, or plain vanillas, are lazy. Vanillas, so the thinking goes, make their money through their vast marketing machine. Their investment goal is simply not to lose more than the market average. “My eyes glaze over when people start talking about their performance relative to an index,” says Loeb. “I’m an absolute-return guy,” says another manager. After all, no profits, no bonus.
And so, for hedge-fund managers, investing is an aggressor’s game. “If you’re buying into the market,” points out one, “then, by definition, you’re saying the person selling to you is an idiot.”
“Investment bankers?” says a hedge-fund guy. “Their lives are miserable.” He lists the shortcomings: punishing hours, dull, needy clients.
Joseph Carvin is unlike Loeb in many ways. Carvin helps run the $1.2 billion Altima Partners, not from Madison Avenue but from a cluttered two-person room in White Plains about the size of an SUV. (His eight other partners are in London.) Loeb focuses on U.S. stocks; Carvin on everything but. (Ask for a tip, and he suggests Argentine debt denominated in yen.) Still, like Loeb, he knows that the key to outsize returns is to make big bets on good ideas.
“Diversification is deworsification,” says Carvin, then tosses his head back and laughs like Beavis. This July, Altima Partners spun out of Deutsche Bank, where it had been for five years. Some hedge funds own dozens, even hundreds of positions. Loeb probably has over 50. Still, the point holds. Your investment adviser believes that a rising market lifts all investors, and thus, really, it doesn’t matter what stocks you’re in as long as you’re in the market. The hedge guy believes, as Carvin explains, “you have to be right, like, 75 percent of the time.”
And so, what hedge managers need is not a pie chart that divvies up a portfolio into offsetting slices. For the hedge manager, the trick is coming up with the right ideas. As one mournful manager asks, “How many good ideas do you get a year?” Carvin expects his fund to find four or maybe five a year (which, incidentally, means his “biggest challenge is to sit and do nothing”). The trick is to gain, as citizens of Hedgeworld like to say, “conviction,” an almost mystical thing. “If you have to run the numbers, it’s too late,” says Carvin, only half-joking. Really, the hedgie believes you ought to be able to, as one put it, “smell a good deal.”
You’re after an informational edge—“something that someone else doesn’t know,” says one hedge-fund guy—the more inside, the better. “I have to know things about a company before the company does,” says Zach. (Sometimes he’d tweak a company by calling an exec to let him know what’s going on with his company.) Some hire private investigators. Loeb’s letters bristle with insider details, the result, he says, of “The Investigation,” which he likes to capitalize. He learned that one company leased a private jet from a firm controlled by the CEO, and that the CEO’s son-in-law was on the payroll and, as Loeb’s Investigation further determined, on the golf course during the workday.
Information in hand, hedge-fund managers tend to be high on their own analytic powers. One manager started an online chat room where he liked to hold forth in the guise of stock-market lord. “In His divine wisdom,” he began one entry, then laid out his analysis for buying an inexpensive telecom stock.
Loeb’s background is in bankruptcies—“investment’s black art,” according to a fellow practitioner. When Drexel Burnham went bust in 1990, 10,000 people lost jobs, which was terrible. It was also, Loeb recalls, “one of the most successful bankruptcy investments ever.” As a hedge-fund manager, Loeb has a preferred strategy: to buy into troubled companies—this, not the letter-writing, is the key to his success. It’s a terrific way to catch a company at the bottom. Most emerge from bankruptcy having shed millions of dollars of debt. (For companies, bankruptcy is like fat camp.) He bought Warnaco in bankruptcy, paying, as he couldn’t resist writing to the CEO, the equivalent of $6.50 a share—a 59 percent discount, he calculated, over the then–trading price. Eventually he’d sell his stake for about $16.50 a share.
Once the hedge fund spots an opportunity, the trick is to throw $50 million or $100 million or more at it, sometimes borrowing if he has to. Loeb calls it “concentrating my positions.” He’ll put as much as 10 percent of his assets—$170 million—into a single idea. Judging by Loeb’s letters, there have been nine ideas good enough to prompt a 5 percent stake in a company so far this year. Pirate’s $20 million stake in Cornell was 10 percent of its assets.
Smaller bets don’t make any sense. “If you have $10 million in a position and it doubles, which is spectacular, okay, so you make $10 million,” explains Carvin. “But $10 million over $1 billion! Who cares?” In fact, in that case, the only possible conclusion is that you’re a moron. “You should’ve had $50 million in it,” says Carvin. “Then it has an impact.”