Clarium Hedge Fund Shrinks 90% as Thiel Has Third Losing Year

Peter Thiel got rich investing in PayPal and Facebook Inc. before most people knew them, built a hedge fund that at its apex managed $7.2 billion, and forecast the collapse of the U.S. housing market. He also lost almost two-thirds of his clients’ money.

Clarium Capital Management LLC, which Thiel started in 2002 in San Francisco, fell about 23 percent in 2010, the third straight year of declines, according to investors. His fund’s assets are down about 90 percent and clients who stuck with him suffered losses of 65 percent from the mid-2008 peak.

“It doesn’t matter if a manager is correct in his long-term views if they don’t get the timing right or manage volatility along the way,” said Don Steinbrugge, managing partner of Agecroft Partners, a Richmond, Virginia-based consulting firm that advises investors and hedge funds.

While Thiel’s views, including predictions that the U.S. would face the threat of deflation and that the dollar and oil would rise, mostly came true, the losses reflect poor market timing and a lack of risk controls, according to several current and former clients. Thiel, 43, has stepped up measures to monitor risk and last year closed his firm’s New York office. He is still betting that the current economic recovery is unsustainable and that 30-year Treasuries will gain, said a person familiar with his outlook.

A self-styled freethinker, Thiel practiced securities law, traded derivatives, co-founded PayPal and started his hedge fund, all before the age of 40. A U.S. chess master, he co-wrote a book criticizing political correctness, backed an unsuccessful Nascar magazine and was executive producer of the 2005 movie “Thank You for Smoking,” a satire about the culture of spin.

Track Record

“If he was Joe Hedge Fund Manager, he would have to live and die by his track record, but that’s not the case with Peter,” said Tammer Kamel, president of Toronto-based Iluka Consulting Group Ltd., which advises clients on investing in hedge funds. “He’s got his fingerprints on two of the most successful web services ever developed.”

Clarium managed about $681 million as of the end of last year. Its Clarium LP lost investors 25 percent in 2009, when hedge funds overall had their best year in a decade, and 4.5 percent in 2008, according to investor letters.

Even with the recent losses, the Clarium fund has returned an annualized 12 percent since it was started in October 2002, according to an investor letter.

Three Themes

Thiel declined to comment for this story.

His fund seeks to profit from broad economic trends by trading everything from currencies to commodities, a strategy known as macro investing. Such hedge funds returned an average of 2.2 percent last year, 12.6 percent in 2009 and 5.9 percent in 2008, according to data compiled by Bloomberg.

In investor letters and interviews, some predating the global financial crisis, Thiel identified three broad economic bets he planned to let ride: 30-year U.S. Treasury bonds would rise as the U.S. economy slows and deflation sets in; the dollar would strengthen against the euro as investors scale back investments in emerging markets funded by borrowing dollars; and energy stocks would climb along with oil prices as production peaks.

In the first half of 2008, the worst year on record for hedge funds, Thiel produced a gain of 59 percent, helped by a 46 percent surge in oil prices.

Turning Point

Then things started to sour. Oil, which had risen to a record $147 a barrel on July 11, 2008, slumped 28 percent that quarter, as evidence increased that the slowdown in the U.S. housing market was hurting global demand. By the end of the year, oil was down 70 percent from its peak and U.S. stocks had posted their biggest annual decline since the Great Depression.

Clarium lost about 40 percent in those six months. While Thiel’s forecast for a rising dollar proved correct, its 13 percent surge against the euro in the second half of 2008 wasn’t enough to offset the fund’s losses from oil. Nor was a jump in 10-year Treasuries that pushed yields down by almost half within six months.

“We succeeded in trading the peak oil-driven macro environment in the first half of the year, but then gave back our gains in the second half by underestimating the speed and ferocity of collapse,” he said in a December 2008 letter.

‘Peak Oil’

Thiel said in the letter that the “peak oil” theory would remain relevant in the coming years because the 2008 recession would cut investments in alternative energy. He also said deflation would be a risk in the coming years, along with stagflation.

In an interview a month later, Thiel said the U.K. pound would weaken and reiterated that the dollar would gain. He also said investors should stay “very underweight” equities.

Some of those calls proved less prescient. The pound fell 2.1 percent against the euro to its low point seven weeks after the interview, before climbing 12 percent to its high for the year in the following three months. The dollar fell about 13 percent against the euro in the 10 months after the interview.

As for stocks, the Standard & Poor’s Index of 500 large U.S. companies tumbled 23 percent in the six weeks following the interview, reaching its lowest since September 1996 on March 9, 2009. It has surged 88 percent since then, giving hedge funds two years of gains.

Thiel, who had told clients in the December 2008 letter that fear would drive investors into cash in 2009, didn’t believe the rally would last. By May 2009, just as markets started to rebound, Clarium said in a note to clients that investors should be wary of forecasts for a V-shaped economic recovery.

Contrary View

“With the consensus equity view projecting one of the most dramatic V-shaped recoveries in history, odds are we have a long way to go,” Andrew Garvin, a vice president at the hedge fund, wrote in the note.

Treasuries had more gains that year, and oil surged 78 percent, the biggest annual increase in a decade. And while Thiel had said he was sticking to his view that crude production had peaked and oil prices would continue to rise, Clarium still ended the year with a loss.

Thiel told a conference in New York in October 2009 that the declines resulted from wagers that the stock market would mirror a worsening economy.

“He’s definitely more of an investor as opposed to a trader,” said Iluka’s Kamel. “The draw to Clarium is that Peter is an extremely intelligent and insightful thinker whose views are often 180 degrees away from the market consensus.”

PayPal Fortune

When Thiel interviews job candidates, he asks them what they can say about the world that nobody believes and how they can trade their view, according to people familiar with the hiring process.

Thiel, who was born in Frankfurt, has a fortune of $1.1 billion, according to Forbes Magazine’s September 2010 issue. He graduated from Stanford University in 1989 in philosophy and then went onto Stanford Law School, where he is teaching for the spring semester.

Thiel made his personal fortune by investing in the predecessor to PayPal, the Mountain View, California-based online-payment-processing company that EBay Inc. bought in October 2002 for about $1.5 billion. He started Clarium that year.

In 2004, he invested $500,000 in Facebook, the website created by Mark Zuckerberg that has grown to the world’s most popular social-networking service with more than 500 million users. Actor Wallace Langham plays him in “The Social Network,” Sony Corp.’s movie about the founding of Facebook.

Facebook Investor

Thiel had a 3 percent stake in Facebook after selling about half of his stake in 2009, mostly to Digital Sky Technologies, according to “The Facebook Effect,” a chronicle of the social network’s origins by David Kirkpatrick published in June.

Goldman Sachs Group Inc. bought a $450 million stake in Facebook and Russia’s Digital Sky added $50 million to its investment, valuing the website at $50 billion, three people familiar with the matter said earlier this month. Facebook’s sales rose to about $2 billion last year from $700 million to $800 million in 2009, other people familiar with the matter said last month.

Thiel also co-founded Palantir Technologies Inc. in 2004, a Palo Alto, California-based firm that analyzes data for the government and hedge-fund industry, and the following year co-founded a venture-capital firm called the Founders Fund. That firm’s principals include Ken Howery and Luke Nosek, both co-founders at PayPal, as well as Sean Parker, who helped start Facebook and Napster, the music-sharing website.

Client Fees

At his hedge fund, Thiel charges clients fees of 25 percent of profits, compared with the industry standard of 20 percent. Unlike rivals, it doesn’t charge an annual management fee, meaning he doesn’t make money from the fund unless it recoups earlier losses.

The bulk of Thiel’s losses last year came in April, June, September and November. The Clarium fund declined 6.5 percent in April, as losing bets in U.S. equities and overseas debt offset gains made in commodities, according to an investor letter. Two months later it slumped 7.7 percent through stocks and currencies.

The biggest losses came in September, when the fund slumped 8.4 percent on stock bets, according to a letter. Two months later Clarium dropped 7.8 percent because of currencies and fixed income.

Thiel had underestimated the impact on markets of the U.S. Federal Reserve’s decision to buy an additional $600 billion in Treasuries to lower borrowing costs and stimulate the economy, said the person who was briefed on his thinking.

Favoring the Flexible

“Last year favored the more flexible, nimble macro managers who, as the markets changed, were able to quickly change their minds and turn their portfolios around,” said Philippe Gougenheim, head of hedge funds at Geneva-based Unigestion SA, which invests $3.5 billion of client money in hedge funds. “It was difficult for managers who usually have investment ideas that last from six months to two years.”

While he has stuck to his main themes, Thiel can change his portfolio aggressively on a monthly basis. The Clarium fund had a gross exposure to bonds of 98 percent in September, which was cut to 51 percent the following month and then to 27 percent in November, according to investor letters. In October, the Clarium fund had a gross exposure to currencies of 33 percent, which increased to 45 percent the following month.

Gross exposure is the total value of bets on and against securities.

Risk Committee

Weak risk-management and trading skills at Clarium may have contributed to the firm’s losses, according to four current and former investors, who asked not to be named because the information is private. One investor withdrew money from Clarium because Thiel failed to make a larger profit when the markets went in his favor.

Thiel is too committed to his views, lacks the flexibility to get out of investments in time when they go against him and doesn’t have adequate hedging in place to mitigate losses, the investors said.

In 2009, Thiel hired Patrick Kenary from Man Investments as chairman of Clarium’s risk committee. The firm changed its risk policy by introducing a value-at-risk limit, a measure of how much a firm could lose in a single day of trading, of 4 percent, according to a May 5 investor letter.

Clarium also said it was implementing a “conditional risk reduction” policy designed to cut risk when VaR underestimates potential losses over longer periods. The firm said it will monitor daily returns for “statistically unusual” movements, either up or down.

Silicon Valley

Thiel closed his New York office in June and relocated employees to the firm’s San Francisco headquarters because it wanted to have them in one location, according to Jim O’Neill, a spokesman for Clarium. He said Clarium wanted to be closer to Silicon Valley, where it can monitor technology innovation, an early indicator of the economy at large.

“Access to Silicon Valley thinkers has been important to Clarium’s thinking since inception, and we expect it to be even more important in the years ahead,” he said.

Patrick Wolff, a managing director in Clarium’s research team, left the firm at the end of December to start his own equity hedge fund called Grand Master Capital, O’Neill said. Thiel will invest about $50 million in Wolff’s new fund, O’Neill said.

Intellectual Challenge

Thiel reiterated in a Sept. 24 interview that he viewed the dollar as undervalued, and that he would be “very worried” about investing in emerging markets and gold. Emerging markets, as measured by the MSCI Emerging Markets Index, have gained 8.5 percent since the interview, while bullion has appreciated by 6.6 percent.

While the losses have eroded most of his firm’s assets, Thiel has no plans to give up. In 2009, he added $200 million of his own money to the hedge fund, according to people briefed on the investment.

Thiel told clients last year that he intends to remain in the hedge-fund business for the next 20 years.

“Peter is not in the hedge-fund industry to get rich, he already is,” said Iluka’s Kamel. “The draw for him is the intellectual challenge.”