California's hedge fund king
Thomas Steyer sits atop Farallon Capital Management, a $33 billion San Francisco hedge fund. So why does he still drive a Honda, wear old plaid ties, and support Barack Obama, whose tax policies would take money out of his own pocket?
September 22, 2008: 4:01 AM EDT
(Fortune magazine) -- As the summer of 2008 drew to a close, many hedge fund managers were worried about coaxing their returns out of negative territory by the end of the year. Thomas Steyer, who founded the giant Farallon Capital Management, was worried about his hedge fund, but he was also losing sleep over getting Barack Obama elected president. For the first time in its 22-year history, Farallon was on track for a calendar-year loss. At the end of June the firm's flagship fund was off a little more than 5%, according to an investor report obtained by Fortune, and Farallon hasn't made up the lost ground since.
So Steyer cancelled his vacation plans this summer - as he did last year when the credit crisis began - to stay abreast of Farallon's $33 billion worth of investments. But he also spent a good part of the time preparing for an Aug. 17 fundraiser at San Francisco's Fairmont hotel, with performances by Jackson Browne and Graham Nash. The event collected $7.8 million, the biggest single-night haul of Obama's nearly two-year-old campaign.
Many of Steyer's sort - that would be financial masters of the universe - want nothing to do with a candidate who promises to boost every imaginable kind of tax they pay. Steyer, instead, is the type who thinks his crowd ought to be pitching in more. "There is definitely a strain in American capitalism where people believe that they have made the money on their own, basically working single-handedly as an individual to create wealth for themselves," he says in a rare interview at Farallon's downtown San Francisco offices with commanding views of Alcatraz and the glimmering bay. "I completely disagree with [that line of thinking]. I mean, they are the beneficiaries of literally over a thousand years of people creating a system and sacrificing."
One sacrifice Steyer embraces, for example, is Obama's intention to boost personal tax rates from 34% to 40%, a move abhorred by many on Wall Street. He notes that the increase merely returns those taxes to Clinton-era levels. "We have to get back to a sense of shared national purpose and that we are connected and responsible for each other," he says, at times choking up with emotion over, believe it or not, tax policy. "The taxes proposed by Obama seem completely consistent with the idea we would actually try to do something together as opposed to scratching out the most for ourselves as individuals."
This soak-the-rich mindset is one of the many ways that the 51-year-old Steyer embodies a different breed of investment professional than the Gucci loafer-wearing, Range Rover-driving, Bordeaux-inhaling traders who have made Greenwich, Conn., and Manhattan bubble over in recent years. In contrast, Steyer is a self-made billionaire and unreconstructed liberal, a financial whiz with a hankering for social justice, an athlete as well as a mathlete. He's a guy's guy who requires guests at his annual Christmas lunch to bring a poem to read.
It should come as no surprise, then, that Farallon, during its 22 years in business, has always looked for investment ideas that are outside the New York feedback loop. Steyer's strength has been applying a philosophy known as "absolute return" to different investment ideas including risk arbitrage, distressed debt, real estate, and emerging markets.
Despite his business success and political connections, he is virtually unknown outside of hedge funds or California politics. Operating quietly is easier in a town where tech titans like Oracle (ORCL, Fortune 500)'s Larry Ellison and VCs like Kleiner-Perkins's John Doerr grab the attention. Still, running a mega-hedge fund in one of the world's most important financial centers has caught the attention of his peers. "He's done everything he can to keep his head low, and I highly respect that," says Jim Coulter, the San Francisco-based founding partner of private equity heavyweight TPG. "He's like the best restaurant in town that only the locals know. They tend to have the best food."
Typically, Steyer agreed to speak with Fortune only about politics and the philanthropies he supports with his wife, Kat Taylor, the granddaughter of a prominent San Francisco banker. (A dynamic duo on the progressive San Francisco philanthropy scene, their TomKat Foundation precedes by several years the similar-sounding SoCal phenomenon that is Tom Cruise and Katie Holmes.) A typical passion project for the Steyers is One California Bank, a community bank in Oakland whose mission is to provide capital for small businesses and mortgages in a neighborhood other banks avoid.
Farallon (which takes its name from a chain of shark-infested islands in the Pacific Ocean, 27 miles west of the Golden Gate) operates around the world, but its vibe is California cool. Steyer, a New York City native, professes the love of a convert, praising his adoptive state's "incredibly positive attitude about the future, its open-mindedness, and its people's willingness to take a chance." Steyer and his partners at Farallon were not open-minded when it came to discussing the firm's operations. They refused to be quoted about Farallon, its funds, and investments for this story, but plenty of friends, associates, and competitors did agree to talk, especially about what makes the firm stand out.
What does make Farallon's corporate culture different from many funds is its California-ness. It's not so much that Farallon is laid-back as that it's reasonable. Fund managers who have a bad year do see their pay slashed, but they aren't fired. Independent thinking is highly valued. "Being out here in California has allowed Farallon to separate from the pack," says Meridee Moore, a longtime Farallon partner who now runs her own firm, Watershed Asset Management.
That independent thinking led Steyer to become a pioneer in using the "absolute return" concept for his hedge fund. In plain English, absolute-return investing might be called trying one's hardest not to lose money. In Steyer's argot, it means focusing not merely on the potential returns of an investment but, more important, on the risk-adjusted returns. It treats every investment - whether a residential mortgage, a common stock, or a parcel of land - as a bond, with an implied rate of return. The result is a strategy that neither shoots the moon nor tends to lose much in tough times. It also uses relatively little leverage, further protecting against losses. Absolute-return devotees include investing rock star David Swensen, who manages the Yale endowment and who was an early investor in Farallon. The philosophy also helps explain how Farallon has achieved a 16% compound annual return since 1986, compared with about 10% for the S&P 500 index.
California's hedge fund king
September 22, 2008: 4:01 AM EDT
Farallon sometimes make bad bets, of course. But with hedge funds imploding left and right, a look at Farallon's method show how the game is played when it's played shrewdly - this year's possible hiccup notwithstanding. What's more, depending on the November election, Steyer's days of obscurity could soon be over.
As a prot�g� of former Treasury Secretary Robert Rubin and an early Hillary Clinton supporter who stayed with her until the end, Steyer certainly would have been on the short list to succeed Hank Paulson at Treasury if Clinton had gone all the way. In an Obama administration, he'd be a long shot for the top fiscal policy job, but could still find a significant role. Rubin sees Steyer as someone who could make the rare shift from business to politics in the mode of a Michael Bloomberg. "He really has a strong sense of what the country ought to do," says Rubin, who is currently a director at Citibank (C, Fortune 500). Rubin invited Steyer into his public-policy clique, the Hamilton Project, sponsored by the Brookings Institution. The membership includes some of the left's leading financial minds including former Treasury Secretary Lawrence Summers. Steyer has fans on the other side of the aisle. Says Tom Lister, a Republican who heads the U.S. arm of European private equity firm Permira: "Just knowing that Tom Steyer could have been her Treasury Secretary would have been enough to make me vote for Hillary."
Matthew Barger, a retired partner at the San Francisco buyout firm Hellman & Friedman, takes credit for convincing Tom Steyer to move to California - twice. The two were buddies on the Yale soccer team, roommates in New York City when they worked for Morgan Stanley out of school, and then again when Barger convinced Steyer to pass on Harvard Business School and attend Stanford with him instead. Barger, a California native, ended up working for Warren Hellman and Tully Friedman's private equity firm, and he urged them to hire Steyer, who in 1986 was a rising risk-arbitrage star at Goldman Sachs in New York under Rubin. "I told them you only run across a Tom Steyer once in a career," he says.
It helped that Steyer's soon-to-be wife wanted to move home to California. Steyer moved west, got married, and set up shop within Hellman & Friedman's offices as HFS Partners, with the mission to invest a small amount of H&F's money in the merger-arbitrage game. "I told him I didn't want him to get too large," says Hellman, still H&F's chairman and a dean of the San Francisco financial community. "I suggested $75 million; he said $100 million."
Together with a small team operating initially out of a single cramped office at H&F, Steyer did well, until the merger business collapsed in 1989. Decreased merger activity meant fewer opportunities to bet on the likelihood of deals closing, so Steyer had to find new investment ideas. It is a process he's gone through repeatedly since. He expanded his hedge fund's focus by hiring Moore, then a young bankruptcy expert. Her mission? Comb through the books of failed companies for opportunities to buy distressed debt. Following the S&L crisis, Farallon invested heavily in distressed real estate.
Today, there's a name for what Steyer was doing in the early '90s: multi-strategy. Vague though it sounds, it's not just throwing darts to choose an investment thesis. In Farallon's case it involves applying the same decision-making process to different areas of investment. Steyer, for example, had no background in real estate. From his risk-arb experience, however, he had faith in his ability to value the probabilities of expected returns and the paramount importance of estimating cash flows. By preaching these precepts placing bets only if a bottom-up analysis predicted acceptable returns adjusted for potential risk - Steyer could replicate his experience repeatedly in different sectors. In the Farallon model, relative value - what others are willing to pay for a security - is meaningless. In other words, the firm's approach is to calculate an expected return based on its analysis and have that - and only that - drive its valuation. Steyer's innovation was to apply what investors call "intrinsic value" to each new investment sector Farallon entered. "Tom hates to lose money," is how Katie Hall, Steyer's first partner at Farallon, describes Farallon's strategy. (Today, Hall runs a firm that manages money for wealthy individuals.)
For the benefit of its investors, Farallon compares its performance to the S&P 500 index. But beating a benchmark isn't the goal. Making money and, in a bear market, preserving capital are the objectives. After all, famous mutual fund manager Bill Miller, Legg Mason Value Trust chief, was praised for beating an index for 15 years - only to see his fund plunge more than 30% so far in 2008. Steyer's reputation is predicated on never having a year like that - with the understanding that investors also never will have an 500%-plus year like investors in one of John Paulson's funds did recently. His massive bet against subprime mortgages has made him the hedge fund star of the moment. "If somebody has good performance over three to five years, that's something, and people take notice," says Rubin, who is an advisor to Farallon. "After 22 years, that's something else altogether. It takes on statistical significance."
So where are Farallon's chips stacked now? The portfolio of public securities it discloses to the SEC is worth $8.9 billion - bigger than most hedge funds - and contains household names including Sherwin Williams (SHW, Fortune 500), Cablevision (CVC, Fortune 500), and Marriott International (MAR, Fortune 500). The fund's real estate interests include housing tracts picked up on the cheap from struggling homebuilder Centex earlier this year. Farallon also co-owns a collection of regional malls with Simon Property Group, which it bought in 2007 for nearly $8 billion.
Farallon is active abroad too, having opened its first international office in 1998. Today it has offices in Singapore, Hong Kong, Moscow, and London. Non-U.S. successes include the restructuring of Indonesia's largest bank; the funding of Indiabulls, a publicly traded real estate company in India; and most recently an investment in the second-largest coal company in Indonesia, Adaro, which went public this summer.
Farallon doesn't offer its investors the ability to bet on specific markets, though. Instead, all are getting a slice of the same investment pie, with Steyer playing the role of master asset allocator. There is no India Fund or Emerging Markets Commodities Fund, and that is a significant difference between Farallon and other supersized hedge funds like publicly traded GLG Partners, which manages multiple products, effectively pitting fund managers against each other for firm resources.
It's worth asking, of course, if Farallon is so good, why are its investments down this year? In his midyear report to investors, Steyer observes that valuations throughout the portfolio are declining, even for good companies. "We witnessed that almost across the board in the last few months," he writes. "For the long-term investor with dry powder and conviction, nothing could be better. The fact that, in the short term, undervalued assets can become even more undervalued frustates the short-term investor, however." Even longer-term, Farallon faces a bigger risk than current market conditions. Hedge fund watchers universally believe that mega-funds are increasingly stumbling over one another seeking out investments suitable for their size, and as these funds grow, the dynamic founders who built them get stretched too thin trying to cover the globe rather than exploit a familiar niche.
California's hedge fund king
September 22, 2008: 4:01 AM EDT
There is an Everyman quality about Tom Steyer. He drinks Coors Light, drives a Honda hybrid, and flies commercial - often on a redeye when headed East on business. That way he can have dinner at home preflight. He wears the same ratty, red plaid tie to work every day. (A successful-trader superstition, say some; a fetish, say others.) His earnestness has its advantages. "Some people feel great leaving a meeting with Tom, and then they realize they didn't learn a thing from him," says Moore, Farallon's early distressed-debt expert. "It's not Machiavellian. But it's deliberate. You don't always know what he's thinking because he's more interested in learning about you."
This intellectual curiosity might be genetic. Steyer is the son of a Wall Street lawyer and a mother who taught for decades in public schools in Harlem. The Steyers were comfortable but not wealthy New Yorkers, says James Steyer, Tom's older brother and the head of a nonprofit in San Francisco. (They have an eldest brother as well, Hume, a trust and estates lawyer in New York.) Tom Steyer did, however, go to the best schools: the Buckley School, Exeter (where he was class president), and Yale. Friends tell stories about the rigorous debates over social and foreign policy at the Steyer family dinner table on the Upper East Side.
Steyer's wife, Kat Taylor, rubbed shoulders with an equally tony crowd on the opposite coast. Her grandfather, Paul Hoover, was chairman and CEO of Crocker Bank, an old San Francisco institution bought by Wells Fargo in the 1990s. Taylor earned a JD/MBA at Stanford, and the two were introduced by Steyer's brother James, a law school classmate of Taylor's. They've been married 22 years, and Steyer is the kind of beaming husband who once told a female colleague after she tried dragging him onto the dance floor that the only woman he dances with is his wife. They have four children, three sons and a daughter. The eldest son, Sam, a sophomore at Harvard, took a year off from school partly to do charity work in Peru.
Steyer always intended to give back after he made his pile. Similarly, his wife considered a career in civil rights before devoting most of her attention to her growing family and various nonprofit boards. "When we were engaged, we thought there'd have to be a significant part of our lives devoted to service," says Steyer. "I don't think we've changed. I would definitely have to think I've been delayed." As Steyer's wealth has grown - he's reportedly worth $1.2 billion; hedge-fund competitors assume that is a conservative estimate - he has become more involved in causes. Last year he wrote a check for $171,000 to help kill a Republican-backed ballot initiative in California that attempted to dilute the Democrats' dominance of the state's Electoral College votes.
One California Bank is a greater undertaking for Steyer and his wife. It is an example of their using finance as a tool to create a better society. Following what they describe as the "devastation" of John Kerry's defeat by George Bush in 2004, the two held a "wake" at a popular San Francisco nightclub. They resolved to do something to help those they saw as injured by the Bush administration's policies and settled on commercial banking as the way to do it, "because of the many ways it intersects with an ordinary working person's life," says Steyer's wife.
Started with just one branch and owned by a new foundation funded solely by the Steyers, the bank behaves exactly like any community bank. It takes deposits and lends between $200,000 and $2 million to local businesses. It aims to make a profit but also to behave as "patient capital." One California Bank also plans to live up to its name. "The ambition is to be statewide in all low-income communities," says Taylor. Adds her husband, who has amassed a fortune as a financier: "This bank is a statement that we believe that capitalism works."
Actions may speak louder than words when it comes to Steyer's goals for Farallon's future (or his getting a shot at directing the nation's economy). In August 2007 he installed for the first time a co-managing partner of Farallon, Andrew Spokes, an ex-Goldman banker who had been with Farallon for ten years. Spokes' elevation coincided with the increasing momentum of Hillary Clinton's presidential campaign, prompting observers to assume Steyer was preparing for the day he'd leave Farallon. Promoting Spokes also was an acknowledgement by Steyer that the firm had become too big for one person to manage.
Indeed, one of Steyer's singular accomplishments has been to keep so much bankable talent under one roof, or at least nearby. When Spokes and another early employee, David Cohen, wanted to strike out on their own in 2004, Steyer cut them a deal: Start your own firm, but do it with Farallon's money. The result was Noonday Asset Management (Noonday is a western outcropping of the Farallon Islands). Noonday eventually became the international operation of Farallon. More recently Chun Ding, a longtime Farallon partner in San Francisco, set up ChinaRock Capital, another separate fund staked by Farallon. These arrangements are unique in the fund world. (When buyout shop Hellman & Friedman set up Steyer in his own hedge fund, it was in a business that was different from their own.) The Farallon spin-offs have their own branding and make their own investments, but Farallon supplies all the capital and back-office support. It enables Farallon to grow and its employees to branch out. What's more, even those who leave Farallon don't go far. Steyer is an investor in Katie Hall's firm, Hall Capital Management. Farallon farms out capital to Meridee Moore's Watershed. Both are on lower floors of One Maritime Plaza, where Farallon, Hellman & Friedman, and a host of related firms are located.
If only Steyer were as good at picking presidential candidates as he is at backing fledgling fund managers. He raised money for Bill Bradley in 2000 and John Kerry in 2004. Then he went to bat early for Clinton, remaining loyal to her even after he judged the nomination battle over in February, when Obama won the Iowa caucuses and the hearts of progressive Democrats nationwide. Of the switch from Clinton to Obama, Steyer says only that it has been easy, that he's focused on November, and that he's given no thought to a role in Washington.
So what's a Mr. Smith-type do for fun while he's awaiting the call to serve his country in D.C.? Steyer always has poetry to fall back on. One of his favorite poems is Alfred Lord Tennyson's "Ulysses," which he says his grandmother read to him as she lay dying. The words, he says, contain the lesson "that you never give up, that you're always trying to do the next thing regardless of how much people want you to rest on your laurels." Suffice it to say that Tom Steyer - who allows that his "ambition is to be an ambitious 80-year-old" - has some fight left in him. Or as Tennyson might put it, he will continue "roaming with a hungry heart," looking for the next great investment, the next worthy cause.
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