Damaged Goods

It's an ideal market for hedge funds. But it's not so easy to raise money if you're name is John Meriwether

Wall Street groaned when supertrader John W. Meriwether, founder of busted Long-Term Capital Management, began raising $1 billion for a new hedge fund in November, 1999. Barely 14 months earlier, LTCM had crashed and burned, losing some $4 billion, almost dragging down world financial markets and the hedge-fund industry in its wake.

Now stripped of the two Nobel laureates and a former Federal Reserve Board vice-chairman who once worked at his side at LTCM, Meriwether is struggling. His newly minted JWM Partners has raised little more than half of its $1 billion goal after more than a year of marketing, industry sources say. And that's when the rest of the industry is cleaning up as institutional investors rush to buy hedge funds to diversify portfolios that were painfully overinvested in big tech stocks. Total hedge-fund assets rose by $84 billion, to $408 billion, in 2000, according to the Hennessee Hedge Fund Advisory Group.

TRADING TOUCH. Times couldn't be better, either, for Meriwether's signature deals--profiting from very small differences between the interest rates paid on various bonds. JWM should be raising money hand over fist as the Federal Reserve cuts short-term interest rates amid doubts about economic recovery. That's because fast-paced bond market action leads to all sorts of pricing distortions that Meriwether is a wiz at exploiting. Apparently, he hasn't lost his trading touch. Although he won't reveal JWM's performance, industry sources say its recent results were ahead of the 12% average gain for similar funds in 2000 and again beat the crowd's 2.4% average in the first four months of 2001.

The stigma from the LTCM debacle remains strong even though it repaid an emergency $3.6 billion infusion from major banks in little more than a year by trading its way out of trouble. That capital had been supplied at the behest of the Federal Reserve Bank of New York in September, 1998, to prevent a terminal meltdown at LTCM. "He did a phenomenal job paying back the banks, but the problem is that he nearly single-handedly caused systemic problems in the market and ruined the livelihoods of everybody in the hedge-fund world," says Charles J. Gradante, managing principal of Hennessee. "The industry would be better off if he kept a low profile."

Meriwether, who in palmier days once set out to buy the rights to every known picture of himself, declined through a spokesman to be interviewed. But his need to raise money seems to have driven him from cover. In December, for example, he spoke to an association of investment professionals in the Netherlands. Then, in February, he gave a keynote speech to the Managed Funds Assn. And in May he spoke in Manhattan at a $1000-a-head benefit for a cancer charity, the Tomorrows Children's Fund.

At the benefit, he didn't pitch JWM directly, but showed a slide giving his e-mail address and phone number. He said nothing of the LTCM debacle, but instead offered "a way of thinking about a style of investing we've been involved in for a number of years that we find quite interesting."

Hedge funds like his with portfolios that are neither long nor short, but market neutral, he said, are attracting new interest because of the tech-stock bust. "I've seen an explosion in demand for this product," Meriwether told the well-heeled audience. "This asset class, at least historically, has performed very well." As proof, he cited a February, 1999, study by two professors at the London Business School.

But one of them, Narayan Y. Naik, told BusinessWeek: "That is going a bit too much." The study was a "starting point" in analyzing fund performance. It used only averages of results funds reported to a tracking service for January, 1994, through September, 1998, too short a period to be called "historical." Also, he noted, scholars doubt that hedge-fund results are as steady, or safe, month-to-month as the funds tell tracking services. That's because their values are often simply estimated as many of their holdings aren't priced daily in the markets. "I wouldn't have expected him to use this paper," said Naik.

Meriwether described his own product as "a form of relative value investing." The firm looks for pairs of securities, such as a newly issued 10-year Treasury and one issued months before, that have the same underlying risks and cash flows but are trading at different prices for some transient reason.

Part of Meriwether's legend is that he was one of the first to arbitrage bonds by selling one and buying the other in anticipation of their prices converging. Because the differences in price, or spreads, are so small, he must use lots of borrowed money--or leverage--to make his trades worthwhile. LTCM used leverage of $30 of loans to each $1 of its own capital. JWM uses a ratio of only about 12 to 1, though it is unclear whether that is Meriwether's choice or the most JWM investors and lenders will allow.

Using less leverage might reassure investors who fear another bust, but it means JWM is unlikely ever to achieve the 40%-plus annual returns that LTCM once racked up. Besides, a rash of copycats, who now imitate the same trading tactics he used at LTCM and at Salomon Brothers before that, will crimp his profit potential. So sophisticated investors understand that they're unlikely to earn the superprofits they did during Meriwether's glory days. "It is a hard sell," says Michael Ocrant, editor-in-chief at fund tracker MAR, a division of Metal Bulletin PLC. Barry H. Colvin, chief operating officer of Tremont Advisors Inc., says: "It is not just Mr. Meriwether, many other fixed-income money managers are having a difficult time gathering new assets."

"STAR STRATEGY." When raising money for LTCM, Meriwether had the marketing advantage of a trio of celebrity partners behind him--David Mullins, a former Fed vice-chairman, and Myron Scholes and Robert Merton, both winners of the Nobel prize for economics. None of the three is with him now, leaving him alone to battle the suspicion that LTCM's risk-taking blindsided past investors. Jane Buchan, a managing director at fund-of-funds firm Pacific Alternative Asset Management Co., says she invests in other hedge funds doing Meriwether's type of trades but not with JWM. Why? Because she doubts Meriwether will ever want to show her exactly what he's doing.

In his charity speech, Meriwether said hedge funds need "an emphasis on star strategy vs. star management." Fund managers, he said, have "become much more transparent in our approach because we recognize that investors need to know not only the style of investing, but the riskiness." He's saying the right things, but still not making enough converts among the investors who once flocked to him.

By David Henry in New York

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