THE HEDGEHOG Barton Biggs on hedgehogging, mug’s games, and why invest- ment management is the most overcompensated business in the world.

BY CHRISTINA GROTHEER

“The fox knows many things, but the hedgehog knows one big thing.” If the originator of that ancient saying had known Barton Biggs, author of the new book HedgeHogging, he might have put it a little differently: “The fox knows many things, but the hedgehog is shorting the fox’s position.” Why leave the security of 30 years at for the extreme unpredictability of a start-up ? As far as Barton Biggs was concerned back in 2003, why not? He knew the business from his initial foray in the late 1960s as co-founder of the hedge fund Fairfield Partners. At Morgan Stanley, he had already accomplished everything he could have hoped for, and he wasn’t particularly enamored of a retired, take-it-easy, lots-of-golf lifestyle. So, he decided to make a fresh start. Since Traxis Partners was launched by Biggs and his two partners just under three years ago, the hedge fund’s assets under management have grown to US$1.5 billion (an increase of 55 per- cent from inception). It hasn’t been all roses— see, for instance, the chapter in HedgeHogging called “Short Selling Is Not for Sissies”— but Biggs is back to doing what he most loves: pure, hands-on money management.

CFA MAGAZINE / JULY-AUGUST 2006 41 You’ve probably been asked this period where the big firms According to one article, a London- question a thousand times, but are were thought to be the right place to based fund of funds is creating a we reaching a critical mass of have your . That was the fund of funds of funds, which will hedge funds? rise of Capital Research and Alliance invest in 11 underlying funds of I don’t think so. About a thousand new and places like that. funds, adding a third layer of fees. hedge funds start up every year, and a And now we’re having a migration What do you think about this? thousand old ones disappear every year. of talent away from those big invest- It’s ridiculous. It is so silly that I don’t And they go out of business not because ment management firms for a variety know what else to say about it. they crash and burn in some dramatic of reasons. I talked about this in the way but because they simply don’t have book—the bureaucracy, all the rules, Back in the 1960s, you co-founded enough performance to attract money the conflicts of interest—so, the talent a hedge fund in which you almost and to keep their managers alive. is migrating to hedge funds. got a lesson in Keynes’ belief that Twenty percent of nothing is nothing. The hedge fund is another way “the market can remain irrational for people to run money. It happens to longer than you can remain solvent.” Has the SEC’s relaxing of restrictions be a way in which there are high fees What happened? on leverage and shorting by mutual charged. Eventually, the sheer size of We were short the Nifty Fifty. We went funds led to increased crowding in the money going into hedge funds and short a little early and they kept on certain styles of hedge funds? the number of hedge funds that exist going up. But when the market began Sure, that’s definitely happening. The are going to inevitably result in a to break, they went down and we began short side, currencies, and commodities decline in hedge fund fees. In fact, my to develop big profits in them. are overpopulated with momentum guess is that compensation across the We covered our shorts too soon. traders, some of whom are crazy. I think investment management business is It’s similar to when are going up; they are mug’s games. beginning a secular decline. It’s the you can never imagine how high they most overcompensated business in the are going to go at the peak of euphoria. Are hedge funds becoming less world. Never have so many been paid The same thing applies to even superb of an alternative investment? so much for adding so little. It’s an growth companies when they are going I don’t think the right description of evolutionary process. down: You can never imagine how low hedge funds is that they are alternative they are going to go in the depths of What most concerns you about hedge investments. They are absolute return despair. And God forbid that they funds moving into private equity? investments. That’s the category that momentarily have a business stumble. somebody like [academic researchers at] In the first place, I think private equity Yale or Harvard classifies them under: is the next great bubble. There is no What are the most striking differ- absolute return, not alternative invest- asset class too much money can’t spoil. ences between today’s hedge fund ments. Second, it’s a highly illiquid, long-term world and what you experienced I suppose you could say that investment, which is totally inappropri- the first time around? to the extent hedge funds perform the ate for hedge funds that have liquidity It’s not really that different. It’s obviously way they did in the last bear market, requirements. Third, most hedge fund a much, much bigger space, and the then they could be called an “alterna- managers don’t know anything about it. fund of funds didn’t even really exist in tive,” but I think absolute return is the 1970s, but it’s still the same old What can hedge funds do to minimize more accurate. Hedge funds are— game, what Adam Smith wrote about in tax consequences for their ? his book The Money Game: It’s the same In search of alpha? That’s up to the style of the manager. old game. It’s bigger and faster in terms Right. And alpha comes in varying There are going to be trading hedge of the money flows than it was then, forms at different times. Particular ways funds that are more inclined to take a but I don’t think it’s that much different. to run money come in and out of style. lot of trading profits and losses; they Back in the late 1960s and early 1970s, are going to generate short-term gains. What made you decide to go back so-called go-go investing was very There are also other hedge funds, to hedge fund investing in 2003? much in style, where everybody wanted which we’re more like, that are more I love Morgan Stanley! It made me rich, to have an investment management long-term investors and so are conscious but I’d been at Morgan Stanley for 30 firm that was filled with young, aggres- of creating long-term capital gains. years and I felt it was time to move on. sive “kid” investors who had no memo- It is a case of what the hedge fund’s I’m an , not a corporate manag- ries, no scars, and no fear. The kids investment style is, but I think that er. Also, I really wanted to be able to obsessed on buying small growth stocks, hedge fund managers should be aware focus on running one portfolio with my and then in the early 1970s, they of their investors’ tax considerations and own money in it rather than focus on collected some serious scars. they should be motivated to strive for running 10 portfolios with all kinds of In the later 1970s, market timers long-term rather than short-term gains. restrictions with what I could do with came into style. Then, there was a long my own money.

42 CFA MAGAZINE / JULY-AUGUST 2006 Have you ever come close to starting are prone to bubbles, particularly in a I noticed a number of places where over your portfolio at Traxis Partners global investment world with excess liq- you talked about market sentiment the way Baruch and Livermore uidity, it’s likely the emerging markets being irrational or how investors used to? will end in a big bubble somewhat com- too often buy high and sell low, We definitely do that. When the portfo- parable to the tech bubble. I hope so. which made me wonder if you were lio feels stale, we do go through an a proponent of behavioral finance. You hope so? agonizing reappraisal process. We don’t Behavioral finance? Is that a synonym sell everything, but we try to simulate All big, long bull markets end in a for the madness of crowds? the new money experience. We go away bubble because that’s the nature of for a weekend and each of us separately investor greed and fear. I hope it does It’s the idea, mainly from academia, constructs a fresh portfolio. In effect, in the sadistic sense that we will make though a few investment manage- we consciously construct the portfolio a lot of money on the way up and, ment firms are applying it, that you and bring it to the office. Then the as usual, sell too soon. can make money exploiting ineffi- three of us talk about it and discard the ciencies in the market that are creat- Got it. What other regions are you dead wood from the old portfolio. ed by predictable, but irrational, excited about right now? investor behaviors. I love your quote of John Masters We have a high percentage of our fund Yeah, OK, I view that as an article of that “if you feel entirely comfortable, in emerging markets, one way or anoth- truth; it’s part of being a contrarian. It’s then you’re not far enough ahead er. In Europe, we own Turkey and all part of what’s pretty obvious in mar- to do any good.” How many posi- Russia. In South America, we own Brazil kets: That markets are always reflecting tions do you have that fit into this and nothing else. In Asia, we own a what the conventional wisdom of the category? broad cross-section from Thailand and time is. And the job of the investor Yeah, that warm feeling of everything Malaysia to Taiwan and Korea, and is to identify what the conventional going well is usually the body tempera- I really view Hong Kong as an emerging wisdom is, whether it’s wrong, where ture at the center of the herd. We market. And we, like everyone else, the investment opportunities are. So if describe ourselves as being contrarians, like Japan. that’s behavioral finance, then I believe so when we have positions that seem in behavioral finance [laughs]. You make a number of references to to be in the consensus—that everybody behavioral biases in HedgeHogging. else likes as well—it makes us nervous Christina Grotheer is a contributing What do you think about behavioral and forces us to analyze the ruling editor and an editorial consultant to finance? reasons for those positions even more CFA Magazine. carefully. What do you mean by behavioral biases?

How are you feeling about the market in 2006? Though he was born with a “silver investment spoon” in his mouth, Barton Biggs In the book, I said that a number of didn’t get interested in investing until he found himself at loose ends a few years out very smart people whom I respect of college. His father told him to read ’s Security Analysis once and believe that we have not made the lows then again. He was hooked, finished at the top of his business school class, and went of the 2000 secular bear market. I think to work as an analyst at EF Hutton in 1961. we have. I think we made the lows in 2003. So how do I feel? I’m still very Just four years later, he launched a hedge fund, Fairfield Partners, which he bullish about the market as of this left in 1973 to become a managing director and general partner at Morgan Stanley. date—April 22, 2006. Biggs spent the next 30 years at Morgan Stanley. What are your thoughts about He was the firm’s first research director. He also established Morgan Stanley Asia today? Investment Management in 1975 and served as its chairman for 30 years. Institutional I think we are halfway through a secu- Investor magazine named him to its All-America Research Team 10 times, and from lar bull market in the emerging markets. 1996 to 2003, he was voted the top-ranked global strategist. Emerging markets now sell at a dis- By the mid-1990s, Morgan Stanley Asset Management was annually adding count on valuations to the developed markets. Emerging markets as a group more new institutional accounts than any of its competitors. Biggs also was a member sell at 12–13 times earnings. Developed of the five-man executive committee that ran Morgan Stanley until its merger with markets sell at 17–18 times earnings. Dean Witter in 1996. I think before the bull market in the In June 2003, Biggs left Morgan Stanley. He and two colleagues, Cyril Moulle- emerging markets is over with, emerg- ing markets will sell at a premium to Berteaux and Madhav Dhar, formed Traxis Partners—the largest new hedge fund of the developed markets. Since markets 2003. Traxis now has more than US$1 billion in assets under management.

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