52. Biggs, Hedgehogging, p. 84.
53. Kaplan and Welles, The Money Managers, p. 113.
54. The Russian-Yugoslav connection dominated a dinner mentioned in Kaplan and Welles, The Money Managers. On Jones’s social contacts at the United Nations, Mary Jones recalls, “I knew most of the secretary generals and their staff. A lot of the ambassadors too.” Mary Jones interview with Henry Street Oral History Project.
55. The first segment manager to defect from A. W. Jones was Carlisle Jones (no relation). He says of his former boss: “I don’t think he knew the difference between a stock and a bond…. I was very jealous. He would nap for an hour. Then he would read the books or papers. The books probably didn’t have to do with investment…. A lot of times I didn’t feel as though I was properly compensated.” Carlisle Jones interview.
56. The defector was Richard Radcliffe. (Radcliffe interview.) See also Biggs, Hedgehogging.
57. The estimate for 1968 comes from “Heyday of the Hedge Funds.” The range for 1969 reflects estimates given at the Practicing Law Institute’s forum on Investment Partnerships, held on March 7, 1969, and quoted in Joseph P. P. Hildebrandt, “Hedge Fund Operation and Regulation” (unpublished J.D. thesis, Harvard University) April 15, 1969. I am grateful to Craig Drill, an indefatigable collector of historical gems, for giving me a copy.
58. “Hedge Funds: Prickly,” Economist, May 25, 1968, p. 91. Other estimates from the time put the number lower.
59. Jones considered the popular term for his style of investing a grammatical outrage. “My original expression, and the proper one, was ‘hedged fund,’” he told friends in the late 1960s, when the expression in its corrupted form entered the language. “I still regard ‘hedge fund,’ which makes a noun serve for an adjective, with distaste.” Brooks, The Go-Go Years, p. 142.
60. Loomis, “The Jones Nobody Keeps Up With.”
61. Alex Porter recalls: “I read Carol Loomis’s article in Fortune, and I called up Mr. Jones and didn’t get him but got Don Woodward, who was the chief operating officer, and told him I wanted to come and work for him.” Porter first ran a model portfolio, then went to work for Jones in 1967, remaining until the early 1970s. Porter interview.
62. This partner was Dean Milosis. The guess about Jones’s personal income comes from “Heyday of the Hedge Funds.” p. 76.
63. A comprehensive description of the regulatory questions asked about hedge funds in 1969 is given in Hildebrandt, “Hedge Fund Operation and Regulation.” See also Carol Loomis, “Hard Times Come to Hedge Funds,” Fortune, January 1970.
64. By contrast, the S&P 500 average gained 1 percent in the year to June 1, 1966, 7 percent the year after that, and 10 percent in the following one. The Jones funds were run on a financial year ending May 31; hence the comparison with S&P 500 returns ending June 1.
65. Clark Drasher recalls: “I don’t think I really took this volatility thing seriously. Maybe I didn’t give a hoot about it. I told Jones it was not a real measure of risk. I didn’t like it because often something I wanted to do in bulk was restricted because of the volatility factor. A lot of mathematical baloney went on. All this attempt to be scientifically precise makes you feel good, but at the end of the day you made money if your selections were good or not…. Most of the time we were not balanced. We would get carried away in rising markets. You’d hate to be short much of anything in the 1960s. So when the bad times came in 1969 we got hit.” (Drasher interview.) Similarly, Banks Adams recalls: “When the 1960s came and the markets were going straight up, those [volatility] numbers were just useless. Let’s take Texas Instruments: It didn’t fluctuate, it was going straight up. Telephones proved to be more volatile than Texas Instruments, which was doubling and tripling every year. A. W. Jones’s thinking came out of the 1940s and 1950s.” (Adams interview.)
66. Bernstein, Capital Ideas Evolving, p. 9. See also Edwin Burk Cox, Trends in the Distribution of Stock Ownership (Philadelphia: University of Pennsylvania Press, 1963), pp. xiii, 211.
67. Smith, The Money Game, p. 209.
68. The S&P 500 fell 23.4 percent over the same period. Jones’s larger losses reflected the fact that he was more than 100 percent long.
69. Dale Burch interview.
CHAPTER TWO: THE BLOCK TRADER
1. This number comes from the Securities and Exchange Commission’s “Institutional Investor Study Report,” published in March 1971. See Wyndham Robertson, “Hedge Fund Miseries,” Fortune, May 1971, p. 269.
2. The estimate of 150 hedge funds as of January 1970 comes from the painstaking census conducted by Carol Loomis. See Carol Loomis, “Hard Times Come to Hedge Funds,” Fortune, January 1970. In 1969, the annual report of the Securities and Exchange Commission stated that the number of hedge funds was “approaching 200” but as noted in the previous chapter, estimates ranged up to 500.
3. In the spring of 1971, the Securities and Exchange Commission released its long-awaited report on institutional investors. It reiterated the doubts about performance fees and called for hedge funds to register under federal law. But the fire had gone out of the campaign. In particular, the SEC had found no evidence to support the idea that hedge-fund trading was disruptive to markets. See Wayne E. Green, “SEC Finds No Link of Institutions to Price Swings: Doubts Needs for Curbs,” Wall Street Journal, March 11, 1971, p. 6.
4. In an article published in January 1968, Donald Woodward put the size of the Jones funds at “well past” $100 million. According to notes kept by Clark Drasher, assets in 1969 came to $107 million and assets in 1973 came to $35 million. According to Jones’s grandson, Robert L. Burch, internal records kept by the Jones partnership show that the capital had shrunk to $25 million by 1984. See “The Heyday of the Hedge Funds,” Dun’s Review, January 1968, p. 78; Clark Drasher, interview with the author, April 10, 2007. Robert L. Burch, e-mail communication with the author, May 18, 2007.
5. Michael Steinhardt, No Bull: My Life In and Out of Markets (New York: John Wiley & Sons, 2001), p. 81.
6. The lawyer was Paul Roth. He recalls: “They wanted to have their names in the firm and pulled straws to see the order. I was there that day in Howard Berkowitz’s Manhattan apartment. I told them that ‘Steinhardt, Fine, Berkowitz’ sounded like a Jewish delicatessen. I was somewhat concerned—how do you go out with a name like that?” Paul Roth, interview with the author, October 3, 2007.
7. Jerrold Fine, interview with the author, August 29, 2007.
8. Steinhardt, Fine, Berkowitz & Company reported results for years to the end of September. To facilitate comparison, the S&P 500 numbers given here are also for the years to September.
9. See Robertson, “Hedge Fund Miseries,” p. 270.
10. Howard Berkowitz interview, August 28, 2007. Jerry Fine interview, August 29, 2007. For the Spacek quote, see John Bogle’s forward to Adam Smith, Supermoney (New York: John Wiley & Sons, 1972), p. xiii.
11. David Rocker, an analyst with Steinhardt, Fine, Berkowitz, recalls: “To make money on the short side you have to be a scrapper. The government is against you. The media was against you; it was un-American to be short. The company management was against you. Advances in stock prices tend to be long and gentle, whereas falls are sharp and short. And so most days when you go in the office, the short seller is taking it in the nose. There were not a lot of people at the time who were willing to take it in the nose.” David Rocker, interview with the author, July 31, 2007.
12. Steinhardt, No Bull, p. 127. Elaborating on this point in an interview with the author, Steinhardt says, “We did seem like gunslingers and wise guys. I was concerned that they’d pass legislation to outlaw short selling because there was talk about that. But to the specific answer to your question [on how he responded to being resented], I felt very good that I had the wisdom, judgment, and courage to put myself in that position.” Michael Steinhardt, interview with the author, October 4, 2007.
13. Steinhardt interview.
14. John LeFrere, interview with t
he author, August 28, 2007. The LeFrere story is not an isolated incident. When an analyst named Oscar Schafer joined the firm, Steinhardt called him the first day and asked what he was up to. Schafer replied that a friend of a friend fancied Commonwealth Oil, so he might take a look at it. Steinhardt immediately bought a huge block of the stock. Schafer was terrified. Oscar Schafer, interview with the author, August 29, 2007.
15. Michael Steinhardt recalls: “Tony was, as you’ve heard, very unusual because of his ability to express himself unequivocally. In such a way that he was vulnerable…It was that vulnerability that made you respect him when he was right and when he was wrong, and made you think he was a man of courage and conviction.” Asked about the sources of Cilluffo’s conviction, Steinhardt says: “It could be a mystery because we were dealing with a person who had lots of street smarts and who was intelligent, but wasn’t intelligent in the way that the rest of us were in having taken economics 101 and 102 and finance and that good stuff; he didn’t have that. His intelligence came from a different source and his judgments came from a different source. To talk about Kondratiev waves and put overwhelming emphasis on it, that was something only he could do. With conviction and a little bit of naïveté. I don’t think he knew too much. But he knew what he had to know. Why he felt as he did was a mystery because he couldn’t articulate it.” Michael Steinhardt, interview with the author, September 10, 2007.
16. Tony Cilluffo, interview with the author, September 25, 2007. See also Steinhardt, No Bull, p. 122.
17. Steinhardt, No Bull, p. 128. Steinhardt adds: “I especially was influenced by him. I was prepared to give him his head.” Steinhardt interview, October 4, 2007.
18. Steinhardt, No Bull, p. 186.
19. Steinhardt interview, October 4, 2007. See also Steinhardt, No Bull, p. 187. In an interview with Jack D. Schwager, Steinhardt approvingly cites a fellow investor who says, “All I bring to the party is twenty-eight years of mistakes.” See Jack D. Schwager, Market Wizards: Interviews with Top Traders (New York: New York Institute of Finance, 1989), p. 211. It should also be noted that when Steinhardt tries to give examples of his feel for the markets, he can sound underwhelming. “Often listening to an idea led me to an entirely different conclusion than the proponent of that same idea,” he writes, as though the experience of realizing what you think by listening to someone who thinks otherwise were remotely unusual. Steinhardt, No Bull, p. 187.
20. Ibid., pp. 189–90.
21. One former Steinhardt colleague says: “There was no upside to Michael’s aggression. In the end it drove me away. I would not treat a dog that way.”
22. Howard Berkowitz says, “We were all research analysts, we were all very intense in our management process, we knew about the companies we visited, we understood what was going on. Markets were less efficient back then.” (Berkowitz interview.) Jerry Fine insists, “We were, in my opinion, 100 percent research driven.” (Fine interview.)
23. Other examples of hedge-fund success based primarily on stock picking include Julian Robertson’s Tiger fund and its offshoots. See chapter five and the appendix.
24. One of the few money-supply watchers in the 1960s was Henry Kaufman of Salomon Brothers. He describes his profession in the 1960s as having “a handful” of members in the entire country. These tended to advise bond investors, not equity investors. Henry Kaufman, interview with the author, September 10, 2007. Another exception was James Harpel, a hedge-fund manager who ran Century Capital. Harpel recalls that his focus on the bearish implications of high interest rates was considered unusual in the early 1970s. James Harpel, interview with the author, October 2, 2007.
25. Cilluffo was watching the data on net free and borrowed reserves. Tony Cilluffo, interviews with the author, July 23 and September 25, 2007.
26. Interviews with six of Cilluffo’s colleagues produced this picture of a man whose opinions were followed but whose reasoning could be mysterious. For example, Oscar Schafer recalls, “Tony, for a long time, had an amazing ability to say, ‘Tuesday the market will go down.’ And on Tuesday the market would go down.” (Schafer interview.) David Rocker says of Cilluffo, “He did his own thing. Nobody else could figure it out.” (Rocker interview.) Michael Steinhardt says of Cilluffo’s monetary analysis, “I think it was an edge. The question was, was it blind luck or something different?” A bit later, he adds: “Maybe he could have been talking moonbeams or something else, but the fact is that he was right. When anyone questioned him deeply about these things, you immediately got the sense that his knowledge was superficial and that he was totally uneducated in these areas.” (Steinhardt interview, October 4, 2007.)
27. William J. Casey (chairman of the Securities and Exchange Commission), “The Changing Environment for Pension Plans” (address to the American Pension Conference, October 7, 1971).
28. In 1960 the big savings institutions had accounted for just a quarter of the turnover on the New York Stock Exchange. By 1969 they accounted for more than half of it. The share rose steadily from then on. By the mid 1980s institutions were reckoned to account for 80 to 90 percent of stock-exchange turnover. See Charles J. Ella, “Modern Moneyman: A Hedge Fund Manager Mixes Research, Risks to ‘Perform’ in Market,” Wall Street Journal, October 31, 1969, p. 1.
29. Block trading was to reach 30 percent of total turnover by 1980 and 50 percent by 1984. New York Stock Exchange data presented graphically in Randall Smith, “Street Hazard,” Wall Street Journal, February 20, 1985, p. 1.
30. “It was rare for someone who was running the firm, like me, to be sitting on the desk, getting block indications and speaking to senior block traders, in contrast to most other firms, which had people who were nothing but clerks doing the same thing. So if you are a senior guy at a brokerage firm, who would you rather speak to? Me or some clerk? You would rather speak to me, open up to me, have me on your side. By being there, I got a better call than most others.” Steinhardt interview, October 4, 2007. See similar remarks in Schwager, Market Wizards, p. 213.
31. Steinhardt interview, September 10, 2007.
32. Steinhardt, No Bull, p. 97.
33. Steinhardt recalls: “There were opportunities created by dealing with [Salomon’s] Jay Perry. There were times he was eager to get his print on the tape. When you knew that, you offered him the wrong price. The wrong price on 300,000 shares is three eighths of a point. That’s a lot of money in your pocket. That’s what I did really well.” Steinhardt interview, October 4, 2007.
34. Steinhardt interview, October 4, 2007.
35. Explaining their assumptions in a seminal article in 1961, Franco Modigliani and Merton Miller included the condition whose real-world absence Steinhardt exploited: “No buyer or seller (or issuer) of securities is large enough for his transactions to have an appreciable impact on the then ruling price.” Merton H. Miller and Franco Modigliani, “Dividend Policy, Growth, and the Valuation of Shares,” Journal of Business 34 (1961), p. 412. Meanwhile, Eugene Fama acknowledged that stock-market specialists, armed with privileged knowledge of unfulfilled buy and sell orders, could outperform the market. But he failed to see that this apparently minor qualification had become more significant with the rise of block trading. Now it was no longer just the specialists who knew what trades were coming down the pike; block traders like Steinhardt also had access to market-moving information. And the value of this information had gone up, because the big block trades were likely to move the price more than the small orders handled by the specialists. Eugene F. Fama, “Efficient Capital Markets: A Review of Theory and Empirical Work,” Journal of Finance 25 (1970): 409–10.
36. For an elegant exposition of this point, see Richard Bookstaber, A Demon of Our Own Design (New York: John Wiley & Sons, 2007), pp. 183–84.
37. “I used to generate vast amounts of commissions relative to my capital because I did all sorts of things that generated huge commissions for my own purposes that I felt had some circular benefit: You generate commissions, you get good ideas, yo
u have the ability to be more liquid than the next guy because the broker will buy your stuff when he needs to and not the next guy’s stuff; and you get a better call on new issues and research.” (Steinhardt interview, September 10, 2007.)
38. In another example of preferential treatment in 1986, a Goldman Sachs analyst recommended Southwest Airlines Co.’s stock to Steinhardt’s traders the night before he gave the recommendation to the rest of Goldman’s clients. George Anders, “Investors’ Investor: Powerful Trader Relies on Information Net, Timing and a Hot Pace—Michael Steinhardt in Action; One Eye on His Screens, One Ear to Rumor Mills—Fees Alone Cost $22 Million.” Wall Street Journal, March 3, 1986.
39. Steinhardt describes one instance in which he demanded to know the identity of the seller and even canceled his buy order after the fact. “Usually the seller doesn’t know his ass from his elbow. Are there occasions when he does? You bet. We once bought a block of Equity Funding, a big dislocated block, and we sensed right away that something was wrong. And we went to Goldman and they had bought some stock too. And we asked and we found out who the seller was, and it was clear to us that the seller knew something…. It was an insider thing. Who am I to stop payment on that trade? I’m not supposed to know the seller, and even if I do, I’m not supposed to have proof that he knew anything. But I did.” Steinhardt continues: “At one point, in the early eighties, we were Goldman Sachs’s largest account. To be Goldman’s biggest account, a mere hedge fund. Can you imagine the turnover we must have been doing? It required me having intimate relationships with the people at the trading desks at the major firms where I could trust them and they could trust me. Where they could give me information that was almost always to my benefit. And to their benefit as well. It was another source of income for us.” Steinhardt interview, October 4, 2007.
More Money Than God_Hedge Funds and the Making of a New Elite Page 48