Monthly Archives: October 2009

HealthSouth to Reimburse for Proxy Fights

By Joann S. Lublin (WSJ)

In a major breakthrough for investor clout in the boardroom, HealthSouth Corp. is moving to become the first big U.S. business to reimburse activist shareholders for the expense of unseating management-backed directors.

The move may spur other companies to follow suit, corporate-governance specialists said. It comes as the Securities and Exchange Commission considers “proxy access” rules that would give investors greater leeway to nominate directors.

HealthSouth is attacking a knotty governance issue: Many boards remain insulated, but it can cost hundreds of thousands of dollars or more for an outside contender to run against a director. A campaign can involve repeated mailings to every investor. Directors endorsed by management, meanwhile, use company coffers to finance their candidacies.

On Monday, HealthSouth plans to announce that its directors authorized a corporate bylaw requiring reimbursement of “reasonable” expenses for a successful dissident board candidate. The bylaw also will partly cover the tab for those gaining at least 40% of the votes cast. Final board approval is likely by midweek, company officials said.

The new reimbursement rule takes advantage of a recent Delaware law allowing such bylaws. More than half of U.S. public companies are incorporated in Delaware.

Due to the cost of proxy fights, few dissidents bother to make board challenges. Just 75 shareholder contests for board seats have occurred so far in 2009, according to RiskMetrics Group Inc., a proxy-advisory firm. Challengers won at least one seat through votes or settlements in 58 of those fights.

Reimbursement could change the “balance of power in director elections” by tackling the expense of the contests, said Charles Elson, who promoted the HealthSouth bylaw as chairman of its board’s nominating and corporate-governance committee. Mr. Elson runs the Weinberg Center for Corporate Governance at the University of Delaware’s business school.

HealthSouth overhauled its management and board after a six-year, $2.6 billion accounting scandal was uncovered in 2003. Five former chief financial officers pleaded guilty to various crimes. This past June, former Chief Executive Richard Scrushy was ordered to pay $2.88 billion in a suit brought by shareholders of the Birmingham, Ala., rehabilitation concern.

The reimbursement bylaw will let “the voice of all shareholders—not just well-funded ones— be heard,” said Jay Grinney, HealthSouth’s president and chief executive.

HealthSouth’s action may encourage other companies, especially those under pressure from activist investors, to follow suit, said Patrick McGurn, special counsel for RiskMetrics.

The American Federation of State, County and Municipal Employees submitted proposals this year to change bylaws at Office Depot Inc. and Dell Inc. to reimburse successful board challengers for “reasonable” outlays. The proposals received 39.1% and 35.2% of the votes cast respectively, strong showings for such a measure. Spokesmen for Office Depot and Dell declined to comment.

AFSCME plans to propose at least six similar bylaws in 2010, including at some prior targets, said Richard Ferlauto, the union’s director of corporate governance and pension investment.

Without proxy access, mandatory reimbursement represents “a good substitute for holding boards more accountable,” he said.

The SEC this month said the agency will wait until next year to vote on whether to adopt proxy access. Its proposal would let owners of at least 1% of a company with a global market value of at least $700 million include information about their board nominees incorporate proxy materials. Shareholders of midsize companies would need a 3% stake and investors at smaller concerns would need to own a 5% stake.

Business groups oppose the idea, saying it would give activist investors too much power.

If other companies start reimbursing board challengers, “that reduces pressure on the SEC to do something about proxy access,” suggested Robert J. Giuffra Jr., a partner at Sullivan & Cromwell LLP. He represented CA Inc. during a closely watched reimbursement case brought by AFSCME’s pension fund. Last year, the Delaware Supreme Court sided with the software company.

Delaware lawmakers later revamped the state’s corporate law to permit reimbursement bylaws. The legislation took effect Aug. 1.

Meriwether setting up new hedge fund

By Samual Jones (FT)

John Meriwether, the hedge fund manager and arbitrageur behind Long-Term Capital Management, is in the process of setting up a new hedge fund – his third.

The move comes barely three months after Mr Meriwether decided to close his second fund manager, JWM Partners, which was wound down after clients saw the value of their investments fall by more than 44 per cent over the course of the financial crisis.

JWM Partners was set up soon after the collapse in 1998 of Mr Meriwether’s first – and most infamous – fund, LTCM, which triggered a wave of panic across the world’s markets and prompted the US Federal Reserve to take the then-unprecedented step of orchestrating a multi-billion dollar bail-out.

Mr Meriwether’s new venture, named JM Advisors Management, will, like both of his previous hedge fund management companies, be based in Greenwich, Connecticut.

People with knowledge of the situation say the fund has not yet started accepting outside investments, however. According to HFMWeek, an industry publication, the fund will open to investors in 2010.

The fund is expected use the same strategy as both LTCM and JWM to make money: so-called relative value arbitrage, a quantitative investment strategy Mr Meriwether pioneered when he led the hugely successful bond arbitrage group at Salomon Brothers in the 1980s.

The strategy, described by the Nobel Prize-winning economist Myron Scholes as being akin to a giant vacuum cleaner “sucking up nickels from all over the world”, can be highly successful in periods following market dislocations.

Relative value trades profit by betting on unusual pricing relationships between securities, anticipating a return to an historically modelled “normal” state between them.

Traders say the strategy has the potential to deliver huge returns in the current market, with many banks’ proprietary trading desks having scaled back their operations and far fewer hedge funds in existence.

Their absence is leading to “inefficiencies” according to many market participants.

The swap spread on 30-year Treasury bonds – the difference between the cost of a 30-year bond and the cost of an interest-rate hedge against it – is still negative.

However, as Mr Meriwether’s experience shows, relative value strategies are not without their pitfalls.

The strategy typically has a high “blow-up” risk because of the large amounts of leverage it uses to profit from often tiny pricing anomalies.

At its peak, LTCM borrowed 25 times more than it had in investor’s capital in order to ratchet-up its returns.

JWM boasted a more conservative 10 times leverage ratio.

The hedge fund industry average is estimated at between two and three times.

Value Investing Congress – Day 3

5th Annual New York Value Investing Congress Day 1: Part 3

Julian Robertson, Founder, Tiger Management
Question and Answer Session

Investing legend Julian Robertson took questions for a half hour; an extremely pleasant surprise for this Congress.  Here are some of Robertson’s thoughts:

Concerns about the current state of affairs:

  • Big concern is that we are still spending more than we earn, which is not sustainable. 
  • Debt must be paid back, and we are not even thinking about that. 
  • More focused on borrowing more from the Chinese, and hoping they won’t decide they have better things to do with their money.

On Energy:

  • Although bullish on oil stocks, he is impressed by advances in solar energy. 
  • Believes that solar will continue to improve, wind power too, and this will ultimately help the environment and hurt oil companies.

On China:

  • Might be a bubble
  • Consumption not enough to pull the world out of recession

On Gold:

  • An anti-gold bug-”none has been used since it was discovered”

On Norway:

  • The most prosperous/sound country in the world

Companies he’s bullish on:

  • Visa, Mastercard, Ryanair, Intel

What He’s Learned/Best Advice:

  • Never be overconfident
  • Don’t get overly enthusiastic about your business

Lloyd Khaner, Khaner Capital
The Key to Turnarounds

First time presenter at the Value Investing Congress, Khaner, who has compounded 445.4% since 1991 (versus 295.2% for the S&P 500), looks for the following attributes in potential investments:

  • Unique management
  • Strong decision making ability
  • Avoid value traps
  • Debt/Equity less than 70%
  • Avoid dying industries
  • Franchise companies with manageable debt

Khaner is a big believer in the concept of “CEO family trees,”placing value on those that have been trained or worked under other successful CEO’s.

Khaner listed the signs of a successful turnaround, including:

  • Cutting unprofitable sales
  • Cutting headcount
  • New senior managers
  • Fix customer relationships
  • CEO sets plan within 3 months
  • Gross Margin up
  • SG&A down
  • Focus on Return on Capital
  • Restructure Debt-Push out maturities.

One of Khaner’s favorite ideas is Starbucks (SBUX):

  • Slowing new store openings
  • Improving service
  • Expects positive comps fiscal 2010
  • ROIC growth 100-200 bps next 3+ years
  • FCF $500-$750 million 3+ years

Value Investing Congress – Day 2

William Waller & Jason Stock-M3 Funds
The U.S. Banking Sector: Chaos & Opportunity

M3 was founded in 2007, and invests (long and short) in small and mid cap names in the US bank and thrift sector. There are 1300 publicly traded banks, and 93% have market caps less than $500 million.  Stock presented his view of the current state of the banking sector:

• Significantly undercapitalized
• Credit quality still deteriorating
• More bank failures
• Unemployment rate will continue to rise
• Commercial real estate is in trouble

Stock believes that there will be in excess of 150 bank failures in 2009.  Still, he and Waller are still finding opportunity on the long side, and look for the following:

• Low Price/Tangible Book
• Excess capital
• Low loan/deposits
• Attractive markets
• Bearish management team
• Share repurchase plan
• Attractive deposit base

One long name Waller and Stock like: First of Long Island (FLIC: $21.00)

• 140% of tangible book
• 11 times LTM earnings
• Excess Capital; 8.5% tangible equity/assets
• 68.5% loan to deposit ratio
• $1billion high quality deposits with 1% cost
• Positive credit quality, just .01% non-performing loans
• Hidden value in branch ownership
• Near-term catalyst- R2000 index addition
• Could be worth twice current price

Scott Klein-Beach Point Capital Management
Opportunities in Stressed and Distressed Credit

Beach Point, which has $3.75 billion in assets, specializes in high yield bonds, distressed debt, and other credit related strategies. With the high yield market currently yielding 15-16%, Klein believes that the distressed market is currently offering opportunities of a lifetime.

Despite the acknowledgement that defaults will continue to rise, Klein sees this as a lagging indicator, and believes that continued forced selling of distressed bonds will create continued opportunity in an extremely inefficient market.

According to Klein, the high yield market has gained an average of 35% in the 2 years following monthly declines of 5% or more. Such declined have only occurred four times, with the latest, and most severe in late 2008.

With the average high yield bond trading at 70 cents on the dollar, with an 8% coupon, Klein sees ample opportunity in this area, even if the worst default scenarios we’ve ever experienced (Great Depression) are repeated.

J. Carlo Cannell – Cannell Capital
Hydrodamalis Gigas

Carlo Cannell always manages to surprise, and this Congress was no different. He brought with him a co-presenter, Karthik Panchanathan, a graduate student in Biology from UCLA who very articulately presented interesting examples of animals that had become extinct, or were on their way there. Before the audience scratched their head in wonder, Cannell very interestingly tied these situations to companies and industries that had followed a similar path.

Who knew that Hydrodamalis Gigas (the presentation title) is actually the scientific name for the Steller Sea Cow, a huge manatee-like animal that went extinct in 1741? Cannell tied the plight of this animal to that of the restaurant business: both had trouble adapting to environmental changes, the Steller Sea Cow faded into oblivion, and so have many restaurant chains.

The main point of Cannell’s presentation was that the laws of nature also apply to Wall Street, and investors would be wise to look for the “cockroaches” of companies – those that can survive nearly any situation. Look for businesses less prone to predators or extinction, says Cannell.

Currently, Cannell finds the following industries attractive: Oil and gas, agriculture, death care, precious metals, energy service.

Whitney Tilson and Glenn Tongue-T2 Partners
An Update on the Mortgage Crisis and a Discussion of Wells Fargo

The conference concluded with Whitney Tilson and Glenn Tongue.

Last year, conference co-founder Tilson and Tongue, his partner at T2, hit the nail squarely on the head with their bleak outlook for the housing and mortgage markets; it was one of those sobering presentations that you hoped would not come to fruition. But it did, and the T2 guys were astonishingly accurate both with their macro views, and list of shorts and longs.

This year they put it in print with their book More Mortgage Meltdown: 6 Ways to Profit in These Bad Times, which was the basis for much of their presentation. If their scenario continues to unfold as suggested, there is much more pain to come in housing land.

The reams of statistics and data they presented seem difficult to dispute, and they put it all in such easy to understand terms that they are well on their way to becoming the de facto experts on the crisis.

All is not lost though; this will not morph into the Great Depression in their view, and they still see opportunities in the markets, both on the long and short side.

Tongue presented the bullish case for Wells Fargo (WFC), which they were short earlier this year. Now they are long WFC:

• Capable of earning $3.35-$4.26/share, $17.1-$20.1 billion net
• Worth $40-$50/share at a multiple of 10-12
• Business has enormous yield spreads
• Buffet bought for his personal account
• The Wachovia portfolio already significantly marked down

Incidentally, waiting for the 10:35 flight back to Philly post Value Investing Congress West has become one of my opportune times to catch up on some reading. Last year, it was David Einhorn’s Fooling Some of the People All of the Time, a VIC giveaway, that I could not put down. This year it was Tilson and Tongue’s just released book (the giveaway at his year’s VIC). With all of the confusion about the genesis of the housing crisis, this book is a must-read.

David Einhorn Speech @ Value Investing Congress

David Einhorn has once again electrified the audience at the Value Investing Congress. In today’s speech, he touched on Japan, the US economy, macro risks, and a shift on his ivestment style due to the crisis. His speech is located HERE.

Value Investing Congress Coverage

The Value Investing Congress has just started, and we will covering some of the content presented at the congress to keep readers informed on speeches, ideas, etc. More info to follow.

It’s Miller Time

by Tom Sullivan (Barron’s)

DON’T WRITE OFF Bill Miller quite yet.

The aggressive manager of the Legg Mason Value Trust, whose remarkable run of success preceded a more recent patch of dreadful yearly returns, is again near the top of his peer group in 2009. Through last Thursday, the Value Trust (ticker: LMVTX) was up a whopping 37.52% so far this year, putting it in the fifth percentile (top 5%) of all large blended-fund returns. It’s an amazing about-face from early March, when his fund had lost 72% of its value in a matter of about 18 months.

“The shareholders who stuck with us believed in our process and have seen us underperform; it has happened before,” Miller told Barron’s in a recent interview. At least “we built up large tax-loss carry forwards, which will mean no capital-gains taxes, which may go up.”

Miller, 59, is best known as the only fund manager to beat the returns of the S&P 500 Index for 15 consecutive years. This unprecedented performance made him a financial-media star who was named “Fund Manager of the Decade” by Morningstar.com in 1999, the same year Barron’s selected him as a member of its All-Century Investment Team. In its best year, in 1998, the Value Trust gained 48%, topping the S&P 500′s 28.6% return. Among its big winners that year: AOL, Dell (DELL) and Danaher (DHR). By 2007, assets of Value Trust had soared to about $20 billion.

BUT MILLER’S WINNING streak actually ended the year before, followed by a precipitous fall from grace. Miller’s value style of investing — which he has referred to as “contrarian value investing” — didn’t do well in markets that favored oil and other commodity stocks. In 2006, the Value Trust rose 5.9%, lagging the S&P 500′s 15.79% gain; in 2007 it fell 6.7%, compared to the S&P’s 5.49% increase. And then, in 2008, Miller’s big position in financial stocks such as Lehman Brothers resulted in a 55.1% loss, well ahead of the S&P’s 37% drop.

Investors, not to mention financial publications like Barron’s (“Penthouse to the Outhouse,” Aug. 14, 2006), criticized his approach and commitment. Although we wouldn’t recommend chasing recent performance or making it a primary holding, Value Trust, as a small piece of a balanced portfolio, is worth revisiting.

Miller says his biggest recent mistake was misreading the financial crisis. He thought he was seeing a repeat of the liquidity crisis that precipitated the stock-market crash in 1987. “We bought financials after the Fed [first] injected liquidity” into the market by cutting the discount rate on Aug. 17, 2007, and then the fed-funds rate on Sept. 18, 2007, continuing into 2008. “That’s what you do in a liquidity crisis,” Miller says.

But this time was different. “This turned out to be a collateral-driven crisis caused by underperforming debt,” also known as toxic assets, Miller says. “We’ve analyzed that mistake and tried to make adjustments to risk management and the portfolio-construction process.”

His fund had 46 stocks as of June 30. Since 1991, the fund has had as few as 30 names and as many as 60.

Miller’s portfolio formerly included Bear Stearns, a long-time holding. “When it failed in March [2008], it had the highest capital ratios ever. There was no rogue trader” like the one who caused the collapse of Barings Bank in 1995, nor the legal problems that eventually brought down Drexel Burnham Lambert in 1990, he says. “But that didn’t stop a run on the bank,” adds Miller. Bear was eventually purchased by JPMorgan Chase for $10 a share, leaving Value Trust with a huge loss.

Lehman’s collapse stunned the credit markets and undercut the money markets in particular. “Lehman was investment-grade Friday and worthless short-term paper on Monday,” Sept. 15, 2008, Miller notes. (Given the Federal government’s prior forced fire-sale of Bear, many thought Lehman would also be saved). Miller blames the feds for the Lehman debacle, saying their “pre-emptive seizure” of Fannie Mae (FNM), another ill-fated Value Trust position, and Freddie Mac (FRE) caused the other financial dominoes to fall.

The Bottom Line:

If you can live with a concentrated portfolio that tends to veer from index returns, Legg Mason Value Trust is worth a fresh look after a disappointing run.

“It was a gratuitous wiping out of equity capital,” says Miller, referring to the preferred shares issued by the mortgage giants as their troubles grew. The government, he adds, “told them to sell capital.” He bought the stock because they both met capital requirements and Fannie had been bailed out once before. “I expected forbearance like in the early 1980s, but they didn’t do it this time.”

THESE AND OTHER LOSING positions have given Miller a huge hole to climb out of. There has even been some speculation about Miller’s retiring after getting the fund on a better performance track. Miller brushes off the talk. “I should have retired three years ago,” he jokes.

Redemptions have continued this year, leaving Value Trust with just $4.7 billion in assets, down from its roughly $20 billion peak. For investors who held on during the markets’ collapse, a decade of gains was wiped out. The fund has a three-year annualized loss of 14.6% through Monday; its five-year return amounts to a decline of 5.92%, and its 10-year performance is in the red by 1.82% a year, on average. The three- and five-year returns put the fund in the 99th percentile (or lowest 1%) in its category. The 10-year performance inches it up to the 91st percentile.

Legg Mason ‘s (LM) share price has also suffered in recent years, along with many asset managers’. The stock closed Thursday at 31.64, after having traded as high as 140 in the past five years.

Miller says he’s been through this kind of snapback before. His previous consecutive years of underperformance relative to the S&P 500 came in the 1989-1990 period. Overall, he’s beaten the benchmark in 20 of his 27 years running the Value Trust (He began managing it at its inception in 1982.) “We’re coming off a financial crisis; those things do end. Then we’ll have a recovery,” he says. He points to 2003, when the Value Trust rebounded 43.5% after a selloff in markets that bottomed in 2002. The downturn was sparked, says Miller, by Fed Chairman Ben Bernanke, who vowed to throw cash from helicopters to boost spending. He calls that statement “a preview of the motion picture,” referring to the Federal Reserve’s current policy of quantitative easing, or printing money.

Miller’s timing was also much better in late 1999, just prior to the dot-com bust, when Value Trust got out of technology positions it had established in 1995. But “if you do this long enough, the market has a way of making you look stupid from time to time,” Miller says.

Professor George Comer of the McDonough School of Business at Georgetown University, and the chief academic officer at MUTUALdecision, an online tool that ranks 3,000 equity mutual funds, calls Miller’s recovery this year and his previous 15-year run “amazing.” His firm gives Miller an “A” for investment skills, its highest grade. “Even the best have bad stretches,” Comer says. “The bounce back is no fluke.”

Miller has “always had clunkers, but his winning stock picks always made up the difference in the past,” says Bridget Hughes, senior analyst at Morningstar. “He’s an aggressive, bold manager. A lot of research goes into the portfolio, which is very concentrated. He has high conviction,” she says.

But Hughes doesn’t see signs of a fundamental shift in management. The portfolio “may be a bit more diffuse than in other times,” she says, but “he hasn’t changed his approach. He went back into financials, but this time they didn’t blow up on him.”

Still, “a little bit of Bill Miller goes a long way” in a portfolio, Hughes says. “He will perform differently than the indexes and that comes with risk.”

Miller says his form of value investing takes “both words seriously.” He invests “in businesses, not just stocks” and tends to hold shares for a long time — usually about five years. His portfolio, he explains, consists of names that are “cyclically mispriced” (traditional deep value) as well as stocks that are “secularly mispriced.” All the securities trade at a discount to the firm’s assessment of their intrinsic business value. He defines that as the present value of the future free cash flows.

Miller notes that one observer has said Value Trust’s investment style is to be “long headline risk and short conventional thinking,” a description that he claims is apt.

SO WHAT STOCKS DOES MILLER like right now? A little more than 25% of the portfolio remained in financials as of June 30, 2009. Positions included State Street (STT), NYSE Euronext (NYX) and Goldman Sachs (GS).

But he also is enamored of Aetna (AET), UnitedHealth (UNH) and Aflac (AFL).

“This is the best time to buy health care since HillaryCare,” in the early 1990s when the prospect of national controls on the industry sent the stocks reeling, says Miller. The possibility of a public option in ObamaCare, where the federal government competes with private insurers, is receding. At the same time, more people will be getting managed care.

Aetna, trading around 26 with a price-to-earnings ratio of 8.1 times forward earnings, is a top pick. “It has a great balance sheet, it is buying back stock, and it has good management,” he says.

Another favorite is eBay (EBAY), the online-marketplace operator, which also sells online payment and communications services. Barron’s profiled the company favorably in a cover story in the summer (“Make a Bid!” Aug. 3, 2009). It trades around 24, or about 15 times forward earnings. Miller has faith in the new management and sees the beginning of a turnaround. “It’s more buyer-centric than seller-driven; it has a dominant position and no inventory risk,” he says.

He’s also a big fan of IBM (IBM), which he likens to Edgar Allan Poe’s “The Purloined Letter,” hidden in plain sight. “It’s cheap and safe and grew 15% during the financial crisis,” he notes, adding that its dividends nearly doubled since 2006. IBM also has “a dominant global position and isn’t levered” with debt. The stock trades around 124, or 11 times forward earnings. Another tech play Miller likes is Hewlett-Packard (HPQ), trading around 47, also 11 times expected earnings. It has “great free cash flow and a strong balance sheet.”

AES (AES), the global power company, is Miller’s biggest single holding. It trades around 15, or for 12 times forward earnings. “It’s had lots of ups and downs,” Miller says. “It was one of our favorites in the 1990s but after the Enron collapse at the start of this decade, it fell out favor. But it is widely diversifying, including into wind and solar power, and most of its earnings are locked into growth contracts.”

Overall, Miller believes the market in the next five to 10 years will see “a long-lasting rally in very high quality mega-caps after this one-year ‘dash to trash.’” He still sees bargains despite the incredible run-up since March. “You can buy the best in the market and still outperform for many, many years,” he says.

If Bill Miller is right, that’s wonderful news — for him and most investors. 

Hedge Fund Manager Simmons to Retire

by Jenny Strasburg and Scott Patterson (WSJ)

James Simons, who’s led one of the world’s most profitable hedge funds for nearly three decades and helped pioneer computer-driven trading, will retire as chief executive of his firm, Renaissance Technologies, at the start of next year.

In an afternoon meeting Thursday at his firm’s offices on New York’s Long Island, Mr. Simons, 71, told employees of his decision and named his successors.

“I have led the organization and its predecessor for thirty one years, and it is definitely time to pass the torch,” Mr. Simons wrote in a letter sent to investors Thursday.

Current co-presidents Peter Brown and Robert Mercer will be co-heads. The veteran insiders joined Renaissance in the 1990s from International Business Machines’ speech-recognition group, and have been considered likely successors to the CEO post.

They’re taking over one of the biggest, and most secretive, hedge-fund firms, with $17 billion in assets. At its peak, Renaissance assets totaled $36 billion, but that number declined as 2008 losses and redemptions took their toll.

Renaissance’s Medallion fund has been one of the most consistent money-makers in the hedge fund world, returning an average of more than 30% a year since its 1988 inception.

Mr. Simons built a reputation as one of the first managers to pursue “quant” investing. The approach involves judging securities by mathematical measures of their value rather than by fundamental research, for example about a company’s management skills or market share. Medallion has been a pioneer in quantitative and high-speed trading, which involves using computer-driven programs to capture fleeting changes in markets.

Mr. Simons plans to remain nonexecutive chairman and keep billions of dollars invested in Renaissance’s hedge funds, he told investors Thursday. He’ll continue to attend Renaissance executive-committee meetings.

Unlike many firms led by their founders, Mr. Simons has been honing his succession plan for several years, insiders say. About two years ago, Mr. Simons promoted Messrs. Brown and Mercer from executive vice president to co-presidents, directly under him in the Renaissance hierarchy.

Mr. Simons has discussed stepping aside in the past, only to back off the plan.

“The reality is he’s gradually been stepping back for some time,” Robert Frey, a former Renaissance managing director, said in an interview Thursday. Mr. Frey, an investor in several Renaissance funds, said the move by Mr. Simons won’t impact his investment plans.

As he built Renaissance, Mr. Simons himself became a billionaire several times over. He poured big chunks of his wealth into math and science education and autism research, interests that will claim more of his time after retirement.

Mr. Simons is an award-winning mathematician who worked for a time in the 1960s as a code-breaker for the Institute for Defense Analyses, a research group. He later became head of Stony Brook University’s math department on Long Island, turning it into a world-class institution by drawing some of the best talent from around the country.

An avid poker player, he began investing full time in the 1970s and soon became interested in using his math skills to make money. Along with several other mathematicians, he launched Medallion, becoming an early practitioner of quantitative investing along with David Shaw, founder of D.E. Shaw Group.

Renaissance employs scores of Ph.D.s focused on developing computer models to identify when to buy and sell stocks, bonds and other securities. Many employees who join the firm don’t leave until they retire.

This year, Mr. Simons and fellow Renaissance executives have faced questions from some clients over the disparity between their returns and the big profits of Medallion, held primarily by Renaissance insiders.

Renaissance executives say Medallion employs a different strategy from the newer funds, called Institutional Equities and Institutional Futures. The equities fund, with $5.5 billion, is down 9% this year through September, and the futures fund, with close to $3 billion, is up roughly 2%, according to a person familiar with the matter.

Among missteps in his career, Mr. Simons helped lead some investors into the Ponzi scheme masterminded by Bernard Madoff. He helped steer Stony Brook University’s investment committee into a $500,000 allocation in 1991, and later recommended withdrawal. The school eventually faced a multi-million dollar loss in the fraud.

In September, a Securities and Exchange Commission watchdog report revealed that a Renaissance fund had invested indirectly in Mr. Madoff’s operation. Executives at Renaissance eventually became suspicious and pulled their money out.

Cornell Student Fund Out-Performs Market Through 2008

It started out with a $10,000 investment by the class of 1998, but Cornell’s student-run Cayuga Fund now operates as an enhanced index fund and has made an 85 per cent return since October 2002.

Not many hedge funds outperformed the market in 2008, but the Cayuga Fund ended the year in the black, up 0.42 per cent. The fund now has $12m of assets under management, making it one of the largest students-run funds in the U.S.

Each year, between 20 and 30 second-year MBA are selected to enroll in the Applied Portfolio Management class, taught by Professor Sanjeev Bhojraj, who says he had to “disappoint” half the applicants this summer due to the popularity of the class.

The lucky ones act as portfolio managers of the fund. Under Professor Bhojraj’s supervision, each member participates in one of seven teams that cover key economic sectors in the S&P 500 share index, and has the opportunity to put investment ideas before a class vote.

Being a member of the Cayuga Fund is a big selling point with recruiters says Stephen Kapsky, one of last year’s portfolio managers. Prior to attending Johnson, Kapsky was on the sell-side of the financial business at JP Morgan and Citi respectively; now his career’s shifted over to the buy-side, and he’s working as an analyst at a hedge fund covering financial institutions.

“Running the Cayuga Fund helped to catch the attention of recruiters,” says Bronx-born Kapsky. “Cayuga Fund experience is as close to real-world experience as you are going to get from a business school education… [the school provides] state-of-art facilities and applications to conduct intensive equity research such as Bloomberg and FactSet, which you will find at most firms on the Street.”

But getting into Professor Bhojraj’s class wasn’t easy, recalls Kapsky: “You need to articulate your personal story and provide examples based on your prior experience that will convince the interviewer you have something to add to the fund,” he says. Applicants were asked to deliver a “serious” stock pitch, for which Kapsky says not many were prepared.

For Kapsky, who did his first degree at the University of Virginia, the Cayuga Fund is the reason he came to Johnson: “Working with Professor Bhojraj made my entire business school experience,” he says. “Professor Bhojraj built an entire curriculum that married academia with real world practice, and brought in guest lecturers that provided unique perspective into the world of asset management.”

Another feature of the Cayuga Fund is the level of team effort involved. Students and professors challenge portfolio managers on their stock recommendations and investment theses so that only the best ideas are voted into the portfolio.

Despite its success, the Cayuga Fund is now closed to outside investors. Professor Bhojraj says the action was taken to emphasize the fund’s educational purpose: “Our original purpose was educational, but people have been investing based on performance… Now we’re starting to feel that people are just taking advantage of the return.

“Education is what we focus on and the only thing we care about,” he explains.

Investors are mainly Cornell alumni. However, since Johnson doesn’t charge any fees, there have been many other outside investors. All the returns from the fund will be returned to them.

Though there are several of student-run funds in the US, Professor Bhojraj says Johnson’s Cayuga Fund is different: “Most of the other funds are run by clubs or advisors, and many are paper-money. Because… running this fund is not an activity but a part of a course, it makes us seriously unique.”

And Johnson School students love it. According to Professor Bhojraj, students are “seduced” by the experience. “They realize the pleasure of running the fund and even losing the money, and a lot of them end up wanting to pursue a profession in fund-management,” he says.

Year Return AUM*
2008 0.42% $14.4M
2007 5.95% $14.4M
2006 14.2% $13.5M
2005 10.4% $10.3M
2004 18.6% $6.8M
2003 19.2% $2.8M