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The stock-market collapse of 2008 claimed many victims in the hedge-fund industry, as portfolio values plummeted and a cascade of redemptions made the losses permanent for some investors. One manager who survived the mayhem and has prospered since is Bill Ackman, the 45-year-old chief of Pershing Square Capital Management. His funds under management have risen from $6.7 billion in August 2008, just before the crash, to $10.3 billion. Nearly all that growth has come from superior performance -- his Pershing Square LP fund is up 16.64% a year compounded for the period 2008 through 2010 -- rather than new money.
"We have found a niche -- large-cap stock activism -- in which we have little competition and aren't likely to have any," Ackman tells Barron's. This niche requires a lot of capital and what he calls "reputational equity," a successful track record that gives Pershing influence with management at big companies.
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Hedge Funds 1-50
The Pershing fund's performance is remarkable, not only because the typical hedge fund returned 2.45% a year over three years, but also because Ackman runs a traditional equity hedge fund that invests both long and short. Only 12 such funds qualify for Barron's Top 100 Hedge Funds ranking this year, and several of them focus solely on Asia or Europe.
Our list is dominated by various types of debt- and -commodities trading advisories, with the top spot going to Providence MBS Offshore Ltd., an arbitrage fund in Providence, R.I., specializing in mortgage-backed securities (see story, "Leaving Stocks in the Dust."). The fund posted a 51.46% annual return from 2008 through the end of 2010. Another mortgage-trading outfit, SPM Structured Servicing, finished No. 2 with a 49.25% annualized return, while Medallion, a quantitative fund, came in third with a 48.16% annual gain in that time. Medallion is run by Renaissance Technologies, the Long Island, N.Y., firm founded by mathematician James Simons.
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Hedge Funds 51-100
Many well-known funds' performances still haven't fully recovered from 2008, when the Standard & Poor's 500 dropped 37% and credit markets froze. The subsequent performance of big names like Citadel, Drake and Och-Ziff wasn't enough to push them on to the Barron's 100 list, where the average three-year return is a robust 17.61%.
Ackman took some lumps in 2008 as well but kept the losses to 12% in his two main funds and didn't put up any of the unpopular new barriers to investors looking to leave. Reducing the pain were successful positions in Longs Drugs, which was taken over that year by CVS Caremark (ticker: CVS) and in McDonald's (MCD), one of two Dow stocks to rise in 2008, along with large short positions in mortgage insurers like MGIC (MTG) and troubled municipal-bond insurers such as MBIA (MBI) and Ambac (ABKFG). But he suffered a very public hit in a separate fund outside his primary hedge funds that torched nearly all of a $2 billion leveraged bet made on the retailer Target (TGT). He's also suffered a sizable loss on Borders Group (BGPIQ), the bankrupt book chain.
Yet he was able to come back strongly the next two years, notching gains after all fees of 41.3% in 2009 and 29.7% in 2010. The biggest score came in shopping-mall REIT General Growth Properties (GGP), which he rode into and out of bankruptcy over the period, with a total profit of nearly $3 billion.
PERSHING'S RESURGENCE has been mirrored by much of the hedge-fund business as institutional investors have returned. Hedge-fund assets now total nearly $1.8 trillion, still below their $2.1 trillion peak of 2007, but well ahead of 2008's trough of $1.5 trillion, according to researchers at BarclayHedge of Fairfield, Iowa. In all, there were 7,285 single-manager hedge funds as of March 31, up from 6,883 on Dec. 31, 2009, according to another data gatherer, Hedge Fund Research in Chicago.
What makes the accomplishments of Ackman and his counterparts at places like Providence, SPM and Medallion stand out is the brutally efficient environment in which they thrive. An average of about three new hedge funds a day were hatched in 2010--935 in all -- after 784 arrived in 2009. At the same time 743 funds shut down last year, following 1,023 liquidations in 2009. With all that, demand still exceeds supply, notes Kevin Quirk, a partner at Casey Quirk & Associates, a management consulting firm in Darien, Conn.
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Although many come and go unnoticed, well-known names also disappear each year. Just Friday ProntPoint Partners, following allegations of insider trading, said it would shutter most of its funds. Other recent casualties include Level Global Investors of San Francisco, which was ensnared in the Galleon Asset Management insider-trading scandal. Stanley Druckenmiller's Duquesne Asset Management closed its doors August 2010 after a bout of losses, and PSQR Capital's Paolo Pellegrini, John Paulson's onetime right-hand man, told investors that same month that he was giving them back their money, after a losing season. Stark Investments, Shumway Capital Management and Clarium Capital Management have each had to cope with big losses or other problems in the last year or so. Even Carl Icahn said he'd only manage his own money going forward.
Volatile performance, not to mention scandals--particularly the waves of deceit revealed in the recent jury conviction of Galleon founder Raj Rajaratnam -- make high-net-worth investors wary. Individuals, who must have $1 million in investable assets to participate in hedge funds, own only 52% of all hedge-fund assets, down from 61% at the end of 2007; the rest is owned mostly by institutions, says Quirk.
Their reluctance shouldn't prevent them from diversifying their portfolios in a meaningful way. "The industry gets painted with a wide brush by the actions of a few," says Neil Sheth, director of hedge-fund research at NEPC, a financial advisory firm in Cambridge, Mass. that manages $32 billion in hedge-fund assets for high-net-worth individuals, family offices and institutions. Sol Waksman, president of data-gatherer BarclayHedge, says the well-to-do shouldn't wait for another meltdown to diversify. As he bluntly puts it: "You want to avoid everything getting flushed down the toilet simultaneously."
Barron's Top 100 Hedge Funds gives investors an idea of what's possible--though these funds are designed to offset possible losses elsewhere in a sizable portfolio, not as a way to bet the ranch. To avoid one-year wonders, our list is based on three-year returns. We also delete funds that invest in a single sector or country. Our minimum fund size is $300 million, to offer stability. Barron's worked with two hedge-fund database companies, BarclayHedge (www.barclayhedge.com) and Morningstar (http://alternativeinvestments.morningstar.com), to sort through thousands of funds and firms. We also consulted Bloomberg figures. A freelance journalist, Eric Uhlfelder, then checked to confirm each number and added many others with his own reporting.
Major firms like Appaloosa, Bridgewater Associates, Paulson & Co., Soros Fund and Tudor Investments are all represented this year. One London-based firm, BlueCrest Capital Management, has three different funds in the Top 100.
ACKMAN HAS USED HIS curious amalgam of talents to remain in the Top 100 (he's No. 41 on this year's list). On the one hand, he has a sharp eye for undervalued companies, even in the closely followed, large-cap universe in which he must now operate because of his size. But rather than passively waiting for the market perceptions of his holdings to change, he can be an activist investor pushing for extreme corporate makeovers to unlock the underlying values.
Yet he's anything but belligerent and blustery like so many activists. Nor does he engage in the slash-and-burn tactics of the leveraged-buyout crowd, loading target companies with debt and firing employees, often rendering them roadkill after the raiders have departed with hefty gains following the inevitable initial public offering.
Ackman instead practices a kind of soft power, relying on white papers and contacts with the financial media to convey his ideas while showering a target management with as much charm as he can muster. More often than not, he has some success winning over the management team with his preternatural enthusiasm and the logic of his arguments. A case in point might be McDonald's, where back in 2005 and 2006, under pressure, the company sped up its sales of company-managed outlets to independent franchisees. This resulted not only in a sharp rise in income, but also a nice boost in the stock price for Ackman and his fellow shareholders. Interestingly, the company's CFO at the time later joined the Pershing Square board after his retirement. Apparently there were no hard feelings.
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Bill Ackman
His strategies often revolve around getting companies to focus on their highest-return operations while selling or spinning off extraneous units. Capital-allocation decisions should follow a similar path. He has proven particularly inventive in employing assets sitting inertly on balance sheets, such as real estate, as sources of inexpensive capital. He preaches liberation, business growth and enhancing operations rather than just cost-cutting.
All these tactics were on display during Pershing Square's two-year involvement in General Growth Properties. When the REIT descended into bankruptcy in the spring of 2009, Ackman contended the company's woes were a liquidity problem -- its inability to roll over its debt -- and not the result of negative net worth in its 200 leading regional shopping centers.
During General Growth's year-and-a-half in bankruptcy, Ackman joined its board, helped it get debtor-in-possession financing when credit markets were largely frozen and to lengthen maturities on its debt, and ultimately to emerge from bankruptcy with $6.5 billion in equity financing that Pershing Square put up along with Bruce Berkowitz's Fairholme Fund (FAIRX) and Brookfield Asset Management.
The stock now trades above $16, a far cry from Ackman's average price of around 50 cents a share. Moreover, Ackman is chairman and a major shareholder in Howard Hughes (HHC), a spinoff that includes most of General Growth's land- and -development assets. Since these holdings generate only modest cash flow, Ackman believed they would fare better on their own. The market apparently agrees: The stock has risen more than 40% in about six months.
ACKMAN IS HOPING for similar--if not as spectacular-- magic in the stock of retailer J.C. Penney (JCP), in which he shows a 50% gain so far. "The company is well capitalized and has an iconic brand name, good consumer mind share, great overseas sourcing and decent deals with outside brands like Sephora cosmetics," he contends. Earlier this year he joined the Penney board with his close ally Steve Roth, chairman of the real-estate powerhouse Vornado. Both men know retail well and have lots of ideas for sharpening Penney's operations.
Ackman is also enthusiastic about another major Pershing holding, the old-fashioned conglomerate Fortune Brands (FO). Late last year, just six weeks after Ackman had made a 13-D filing disclosing Pershing's 12% interest in Fortune, the company acquiesced to his suggestion that it suffered from an unwieldy, unfocused structure. To wit, Fortune decided to sell its sports-products business (Titleist golf balls and clubs) and to spin off to shareholders its home-products division (Moen Faucets among other things) while retaining its spirits operations (Jim Beam and other labels). The stock is already up nicely from his average purchase price last fall of 46 to 64 and should head even higher in the months ahead.
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He has disclosed no restructuring ideas yet for Alexander & Baldwin (ALEX), another conglomerate in which he recently purchased an 8.6% stake. But he contends the company is deeply undervalued by dint of owning everything from the Matson shipping line, which has a dominant position in transporting products between the Hawaiian islands and the U.S., to large interests in the ports of Seattle, Oakland and Long Beach, to commercial properties like strip malls and office buildings in the U.S. and valuable raw-land holdings in several major Hawaiian islands. "The pieces of this company are clearly worth much more than the whole," Ackman insists.
In the past, other raiders and corporate-breakup artists have approached the company about doing a major restructuring. But Ackman, with his amiable manner, may carry the day where others failed.
"I believe in the power of logic and rationality," he observes equably. So should all hedge-fund investors.
Additional reporting by Michael Shari
E-mail: editors@barrons.com
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