Tuesday, June 18, 2013

How Will Steven Cohen's Saga End?

Should investors take the money and run?
If you were fortunate to invest in Steven Cohen's hedge fund, what would you do? Keep the faith, and keep your funds in SAC Capital Advisors?  Or take the money and run, while government investigators pore through trading records for evidence of insider-trading?

How will the SAC Saga end?

Tucked away along I-95 on the winding hedge-fund corridor in Connecticut is the home of the closely cloaked $14 billion hedge fund run by Cohen.  In the world of quantitative trading and hedge-fund investing, Cohen's SAC Capital is well known, envied by many, desperately copied by others, and revered by most in the investment community. These days, the fund is known outside the hedge-fund world because of  the investigative cloud that lingers above it.

Since its 1992 founding, an obsessed Cohen permitted few to learn about his fund's operations, performance, and trading strategy.  For most of the fund's existence, Cohen avoided public appearances and showed up nowhere if media appeared, except for arts and charity events. (His investments in art are legendary.)

He refused to let others take photos of him. The New York Times or Wall Street Journal published over and over the same one or two photos it could find of him in articles that chronicle the fund's history. The industry factions that follow, watch, report and try to ape his successes hardly knew or understand what went on inside. Forbes magazine estimated his net worth recently to be about $8 billion. The fund eventually reached $14 billion under management.

Nowadays headlines of SAC appear routinely in the financial press. Photos of Cohen accompany many news stories, and his face has become more familiar.  News about the fund has been sour for much of the past year or two, because the news is primarily about insider-trading investigations. 

SAC made its billions from equity trading.  Under Cohen's direction, the fund sponsors many strategies, including high-frequency trading (searching for price anomalies around the globe), fundamental and value trading, and quantitative analysis.

Former analysts, traders and researchers at the fund--after they have departed or were dismissed--have divulged morsels of SAC intelligence.  Cohen is the quarterback and captain of all trading activity, his hands always involved, his voice wielding a final say-so in trading positions and strategies. He grooms strategies, hires stalwart traders, and entrusts them with significant amounts of capital, permitting them to try out their ideas or execute their trading views.

But he was said to be harsh if performance waned or fell shy of his expectations.  He pushed traders hard, not merely to "seek alpha" (as the hedge-fund jargon goes), but to out-perform even the toughest fund benchmarks. Traders are dismissed swiftly if they don't meet targets.

Traders felt the pressure to find an edge, a trading strategy or a performance trend that would please the boss.

Over the past few years, some former traders have been accused and indicted of insider trading at funds they managed after leaving SAC. Some former employees have been accused of illegal trading while at SAC Capital.  The SEC continues its investigation of trading under Cohen's supervision. He has insisted throughout he is innocent and, in recent months, has delivered strong statements assuring investors that from his top perch he has applied tough discipline to make sure the firm stays within legal lines.

Meanwhile, regulators and law-enforcement officials comb through, around and about SAC.  SAC Capital and Cohen may never be charged of anything, but right now, a stench hovers above the fund and seems to have settled there for a long time to come.  Some investors want out--now. The typical redemption rules apply. Investors can get out, but only after applying for withdrawals and then allowing their monies to trickle out over time. 

With investigators in its backyard searching through voluminous trading records, what will eventually happen to the fund? Why would investors want to hang around and leave large amounts of money with Cohen? He has an impressive performance record, but will he admit that he is distracted by the legal cases and investigations around him?

What does an investor do? There are two or three options.

1) Get out now or when redemption rules allow. 

Certain institutional investors (perhaps pension funds and public funds that answer to a broader community) will flee, because they will not want to explain to stakeholders why they are allied with a fund where illegal activity might have occurred and where there exists the possibility, even if remote, that the fund's founder will one day be indicted like some former employees.

2)  Assess the likelihood that Cohen will one day be charged, an event that would likely lead to the subsequent wind-down of the fund.

If that assessment exceeds 50-50, wage the bet that the fund will continue and, with distractions beyond it, performance will resume at stellar levels. Because there are and will be redemptions, Cohen may scale down the fund, reduce the number of strategies, and make itself nimble.

3) Assess the worst-case scenario:

Cohen is charge and indicted, and the evidence is strong enough for a conviction.  The fund would likely wind down. But markets, regulators, banks and investors must weigh the impact of a liquidation.

Would the impact cause as much market chaos as the frightening collapse at Long Term Capital did in 1998. Its stunning, sudden implosion pushed markets to the brink of apocalyptic turmoil and forced government overseers to assemble a bank group to help settle the chaos.

In this case, would regulators step up in the same way to ensure the disposition of assets, positions and employees is handled in an orderly manner and with minimal impact to markets? Or would a group of neighboring hedge funds, down the expressway in Connecticut, sweep through to bid for the portfolios and positions and hire its expert traders?

Stay tuned.  This is a summer-time saga, likely to drag out through the fall and long enough to bore most market observers, until one day months from now government investigators surface one late Friday afternoon to catch everybody off guard with surprise announcements.

Tracy Williams

See also:

CFN: Ray Dalio's Cult at Bridgewater Associates, 2011
CFN:  Quants and Quant Funds, 2010

No comments:

Post a Comment