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Ospraie in a corner

Dwight Anderson built a $9 billion hedge fund empire betting on volatile commodities markets. His world came undone this summer.

By Telis Demos, writer-reporter
November 12, 2008: 9:39 AM ET

(Fortune Magazine) -- Years before Dwight Walter Anderson was running the world's largest commodities hedge fund from an office 27 floors above New York City's Park Avenue, he was on the road for a software consulting firm based in Chicago.

In that job, in the early 1990s, Anderson visited dairy and fruit companies. His clients made golf clubs and valves. He worked on the factory floor of a paper company near Schenectady, N.Y. He saw firsthand how businesses operated. Though he'd grown up in northern Westchester, N.Y., graduated from Princeton, and watched many of his peers head immediately to Wall Street, he relished his time in small cities around small-business men.

He would eventually enroll in business school, intern at Goldman Sachs, and become a hedge fund trader. But the movie he kept in his mind's eye throughout it all was Say Anything. Anderson loved the moment when John Cusack, playing a young suburban slacker, describes his career ambitions: "I don't want to sell anything bought or processed."

So in 1999, when the 32-year-old Anderson got his chance to create his own hedge fund, he did not merely resell or reprocess another manager's investing thesis. He created his fund to profit from the long upward move in the price of real things - commodities.

He already had a reputation. Julian Robertson of Tiger Management had recruited him out of the University of North Carolina's business school and sent him to faraway countries to learn about the copper and palladium markets. In return, Anderson made millions trading those metals. That knack landed him a job with Paul Tudor Jones, who set him up with his own commodity fund, Ospraie (a Latin spelling for the bird of prey).

Anderson's Big Idea was to make commodities markets less nerve-racking for investors through two tactics. The first was to trade not only commodities but also the stocks of companies whose prices would mimic the movements of the commodities markets. (Why buy only soybean futures and live with their inherent volatility when you can also buy shares of the barge company that shipped the beans?)

Second, Anderson instilled in Ospraie his passion for exceptional due diligence. He was the kind of guy who bragged that he had inspected a company's palladium mines "north of the Arctic Circle, not southern Siberia!" before he invested in the metal. He lunched with farmers in Brazil before taking a position in sugar. And when he worked at Goldman Sachs (GS, Fortune 500), he couldn't believe the other traders on the commodities desk didn't know what it meant to "spud" an oil well. (It means to start drilling.)

Lehman Brothers famously invested in Ospraie in 2005, and Credit Suisse (CS) did so in 2006. At its peak earlier this year, Ospraie had $9 billion in total assets under management across several funds, including the main Ospraie fund, a fund-of-funds business, and a private-equity-style Special Opportunities Fund. In June, Ospraie bought ConAgra (CAG, Fortune 500)'s trading division.

This summer, however, Anderson's world came undone when nearly all of the main fund's positions - longs and shorts, metals and grains - started to turn against it. On Sept. 2, Ospraie announced that it was closing its main fund, which began the year with $3.3 billion in assets but was down 38.6% by the end of August. Anderson, at the ripe old age of 41, seemed poised to join the ranks of humbled hedge fund managers.

Certainly Anderson is one of many hedge fund managers victimized by the market's terrible year. The average hedge fund has fallen 19% in 2008, and $31 billion in assets were yanked from funds last quarter alone, according to Hedge Fund Research.

But the fall of Ospraie is particularly telling. It is a vivid reminder that the best business minds of a generation were drawn to hedge funds, whether managing a portfolio through good times and bad - the definition, after all, of a hedge fund - was their special talent or not.

In a bull market Ospraie's focus on diligence was richly rewarded. But in an irrational bear market, Ospraie's buy-and-hold philosophy made it especially vulnerable. Anderson, who declined to comment for this article, acknowledged the worry to an interviewer in 2007: "I'm still on my learning curve as a portfolio manager when it comes to how to manage the volatility in the price path along the way. You've got a Point A and a Point C ... The problem is managing the path to get there."

"Dwight didn't wake up less intelligent," says Mark Yusko, a friend, fellow Julian Robertson prot�g�, and Ospraie investor. "He didn't do anything wrong, other than, like the rest of us, none of us saw the potential speed of the deleveraging." Or to put it another way, it is one thing to be a master of the universe in a bull market, but in a bear market every move is brutally magnified.

In hedge funds the road to ruin is often paved with traders who have the right investment thesis but time the markets incorrectly. Dwight Anderson was no exception. Last year he could see clearly where the commodities markets were heading. In May, speaking to hedge fund investors on the campus of the University of North Carolina at Chapel Hill, he said that the energy markets were entering a correction phase.

Ospraie in a corner (pg. 2)

By Telis Demos, writer-reporter
November 12, 2008: 9:39 AM ET

"The cure for high oil prices is high oil prices" is a favorite oilman's aphorism that Anderson uses in conversation. The meaning of it is that, as prices rise, economies grow more slowly and people use less fuel or switch to alternatives, which pushes the price down. Indeed, crude prices tumbled from a peak of $145 a barrel in July to current levels of about $60.

Through June, Ospraie was having a so-so year. On the minus side, Anderson's hunch that oil prices would drop had yet to pay off. On the plus side, he had bet that copper prices would fall - which was happening. Anderson had made the copper play because he felt that there would be an oversupply in the market based on his review of the reports of companies that bought and sold the metal.

Bets on rising prices for natural gas and soybeans were also paying off. Ospraie's relationships with players in the physical markets like oil and gas services firms and grain barge companies gave Anderson's analysts insight into the flow of commodities that traders trapped on desks in New York didn't have. By the end of June, though, the fund was overall down 2%, according to Bloomberg. (Ospraie would not confirm figures relating to fund performance.)

In July, however, several of Ospraie's positions in its main fund turned against it simultaneously. It was short oil when oil rallied in early July, and also short copper, which stayed flat in price. But it was long natural gas when the price dropped much more sharply than any of the fundamentals, like supply and weather, had suggested it might - more than 40% from July to August, the steepest drop in three years.

Prices of companies linked to natural gas, whose shares Ospraie also owned, took an equally precipitous dive. XTO Energy (XTO, Fortune 500), in which Ospraie owned $128 million worth of shares on June 1, had fallen 40% from its June high by the first week of August.

Soybeans peaked on July 3, then tumbled through the middle of August as worries about flooding in Midwestern farmlands subsided. The fund's large portfolio of mining company stocks also sank, echoing the one-third drop in the S&P Mining and Metals index from July to the first week of August.

The main fund was down 20% for the year by the first week of August. Anderson and his traders scrambled to cut exposure, moving some positions into cash and buying options to hedge exposure on positions that couldn't be sold quickly.

In markets like this, trading expertise can mean the difference between a fund's living or dying, and Ospraie's bench of traders had been thin since 2006, when its main fund suffered big losses on copper and oil. Many investors redeemed their money in the wake of those losses, and the bonus pool for Ospraie's traders shrank.

Though performance in 2007 had been strong, Ospraie lost talent, such as its best oil and gas trader, Steve Perry, and its top equities strategist, Jason Capello. "[Today] they don't have a trader of consequence," says one market observer.

With better traders, Ospraie might have been able to move out of the way faster this summer. From the first week of August until the fund closed, it fell about another 18%, to its 38.6% low for the year.

Adding insult to injury, Anderson's overall investment thesis began to crumble. The bulk of the firm's losses were coming in equities linked to commodities - 80% of the losses in July and 65% of those in August. For years Ospraie had held and wanted to continue holding many of those stocks. But the energy and mining sectors' swift drop, caused in part by selling from other struggling hedge funds, made the pain too much to bear.

Holdings like natural-gas power plant owner Calpine and coal miner Arch Coal plunged. No due diligence could have prepared Ospraie for such a move: The companies, after all, hadn't changed suddenly. They had the same managers and the same revenues, which in resources-based companies are typically written in stone through contracts. Panic, however, became the rule of the day.

Ospraie won't disclose what percentage of the main fund's assets were in equities last summer, even to its investors, though several of them to whom Fortune spoke estimate that equities accounted for around 60%. A large chunk was in liquid U.S.-listed companies like Alcoa (AA, Fortune 500) and International Paper (IP, Fortune 500).

But a little secret of commodities investing is that when it comes to the more unusual metals, like titanium or magnesium, you can't bet on their prices through listed futures, which are for highly standard products, such as gold, silver, and copper. Much of the time the way to profit from rising prices in less common metals is to bet on tiny companies digging stuff up from the ground.

That led Ospraie to take large positions in smaller companies with less liquid shares that were traded on foreign exchanges, particularly in Australia. Ospraie's bets included Iluka Resources, an extractor of rutile (a key ingredient of titanium), and Quay Magnesium, a producer of magnesium alloys used in cars and computers.

Those holdings created a problem. As other investors saw Ospraie starting to sell its shares, trading in the shares of the Australian companies seized up. According to a commodities analyst who works with Ospraie, the firm found it difficult to get full market prices as it tried to get out. In other words, long-term bets became short-term ulcers.

Ospraie in a corner (pg. 3)

By Telis Demos, writer-reporter
November 12, 2008: 9:39 AM ET

"If you are marked to market every day, and your investors have short time frames," explains Rus Newton, who manages British hedge fund Global Advisors, which Ospraie had invested in, "then the risk is that, as John Maynard Keynes famously said, 'the fundamentals can stay irrational longer than you can stay solvent.'"

In one publicly disclosed example, Ospraie unloaded a 13% stake in Mineral Deposits, a company that extracts metals from sands, to Red Back Mining, a Canadian company with mines in Africa. But Ospraie got about half the listed price of the shares at their July peak, according to a press release from Red Back.

"Everybody could see that Ospraie was building a fairly big position in mineral sands companies," says Peter Ruxton, a trader at Actis, a British investment firm focused on mining. "As the market caught on, Ospraie was quite exposed when it tried to get out of its positions."

What ultimately pushed Anderson and Ospraie's board to decide to close the main fund was a commitment made back in 1999, when Ospraie first raised money. Anderson had promised that investors could get their money back if the fund fell more than 30% for the year.

Rather than wait for investors to besiege the firm, it decided to close the fund and promised to return 40% of investors' money immediately, 40% by the end of the year, and the rest when possible. The hope was to protect the fund from a panic, which would require selling valuable assets into an already down - and still dropping - market.

"There are many other [funds] who chose not to liquidate, and they're down way deeper," says an Ospraie investor. Indeed, the Morgan Stanley commodity related index of stocks dropped a further 54% in August and September.

As of early November, Ospraie had returned more than 50% of investors' money, leaving the main fund, which started August with $2.8 billion in assets, with, by Fortune's math, about $1 billion of assets still to be liquidated.

Anderson could have thrown in the keys, as dozens of hedge fund managers did this year. He didn't, and it would be a mistake to conclude that he is going away. Aside from the fund that Ospraie closed, the firm's fund-of-funds business had $2.5 billion, and its Special Opportunities fund had $1.2 billion, as of August.

"Dwight might differ with me on this," says Yusko, "but he's an investor, not a trader. Some people take offense at that, and I don't." Unfortunately, he went on, "most markets are traders' markets, not investors' markets."

And therein may lie the lesson for Ospraie. Anderson himself acknowledged that the time spent traveling between countries to understand physical markets, plus the hours it takes to manage a hedge fund as large and complex as Ospraie, was draining.

"[Our] style requires a lot of work to stay on top," he told an interviewer. It takes just as much work to steer funds through troubled markets. Some managers relish the toughest, most irrational markets: That's when they love to roll their sleeves up and get their hands dirty.

One vehicle that might reward a more patient style of investing is Ospraie's Special Opportunities fund, which Ospraie and its primary investor, Credit Suisse, started. It is a private-equity-style fund that buys stakes in companies that Ospraie hopes to grow over time.

Right now it's bankrolling alternative energy and agriculture. Earlier this year the fund co-invested in a $2.8 billion deal to buy the trading operation of ConAgra, which also owns dozens of grain elevators, and the operation was renamed Gavilon.

In late September a company Ospraie co-owns was selected to build a wind farm in Rhode Island. Surely even John Cusack's character from Say Anything could take pleasure in buying something like that. To top of page

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