Quant Who Shook the Financial World Tries More Humble ApproachYuji Nakamura
More than 16 years after the collapse of the hedge fund he co-founded in Greenwich, Connecticut, Victor Haghani is, understandably, still a bit risk averse.
The implosion of that fund -- Long-Term Capital Management -- did, after all, require the Federal Reserve to orchestrate a rescue by Wall Street banks. So when asked about the strengths of his new fund, Elm Partners, Haghani is quick to point out the differences from LTCM: It has no leverage, no short positions, and charges fees that are a fraction of the industry norm.
Elm Partners’s reliance on computer models to split its money between stocks, bonds, commodities and real estate is about the only visible tie to Haghani’s days as a quant at LTCM and Salomon Brothers Inc. before that. While the returns have been just OK so far -- 9 percent a year, trailing the fund’s benchmark -- Haghani says he’s learned that it’s much easier to promise, and deliver, low costs than big gains.
“My LTCM experience is a constant reminder that investment managers have much less control over returns than we would like,” Haghani, 53, says. “We do, however, have complete control over what we charge, and setting fees that are fair over the long term -- both in good times and bad -- is a pretty safe bet.”
Elm will make about $433,000 this year from its 0.12 percent management fee. Haghani stretches that to pay for a Jackson Hole, Wyoming, office and three employees overseeing $361 million on behalf of 80 investors.
Elm stands in contrast with LTCM, which by August 1998 had amassed more than $125 billion of assets, or more than 25 times its equity, according to a government report. It charged a 2 percent management fee and got 25 percent of any profits, Roger Lowenstein wrote in “When Genius Failed.” Haghani followed John Meriwether from the bond-trading floor at Salomon Brothers to LTCM, where other partners included Nobel laureates Myron Scholes and Robert Merton.
After Russia defaulted in 1998, investments that LTCM had seen as diversified declined in unison and leverage multiplied the losses. The founding partners lost $1.9 billion in five weeks, according to Lowenstein. Wall Street banks took over the fund in September 1998.
“Sometimes I reflect if I had been investing my earnings in something like Elm rather than Salomon stock and LTCM, I’d have done much, much better,” says Haghani.
The new fund isn’t a complete departure from Haghani’s past. Elm employs some aspects of the approach he picked up while trading under Meriwether.
Computer models analyze data as varied as population growth and earnings yields to decide how much to invest in each region and asset class. Haghani also considers technical signals to fine-tune the size and timing of each investment.
His new credo is don’t borrow money, only hold publicly-traded securities and avoid short-selling.
“Leverage and shorting were integral to what we did at Salomon and LTCM, and were the proximate causes of LTCM’s collapse,” says Haghani. “It’s quite natural that as a result of this experience, at Elm Partners we stay clear.”
Elm invests in low-cost exchange-traded funds and mutual funds, and has about 65 percent of its assets in equities. Its 2014 total expense ratio -- which includes management fees and investing costs -- was 0.24 percent, according to Haghani. BlackRock Inc. charged 0.88 percent on a global multi-asset mutual fund, company documents show.
The usual hedge fund takes a 2 percent management fee and 20 percent of investment gains.
“To justify such high fees, a manager has to do an unbelievable job of outperforming the market,” said Richard Dunn, one of Elm’s investors and a former Merrill Lynch executive who said he’s known Haghani for decades. “Unfortunately only very few of them do.”
Twenty percent of mutual funds that pick U.S. stocks beat their main benchmarks in 2014, and 21 percent topped the indexes in the five years ended Dec. 31, according to data from Morningstar Inc. Strategies that occupy a middle ground between passive and active management -- some call them smart beta, while Haghani describes his approach as “active index investing” -- attracted $69 billion in inflows over the past year, data compiled by Bloomberg show.
The idea for Elm began when a family friend asked Haghani, who taught at the London School of Economics after leaving LTCM, for advice on managing savings. After co-authoring a research paper on the subject in 2009, Haghani started the fund in late 2011 to see if his theory held up.
Elm is now his full-time job, with the New Yorker spending most of his time working remotely from London, with stints in Jackson Hole. Elm is currently only available to institutions and wealthy individuals, with friends or former colleagues of LTCM and Salomon making up the majority of investors. Haghani hopes to open it to a broader group as assets grow.
Elm returned 9 percent annually from the start of 2012 through February this year, after fees, according to figures from a letter to investors. BlackRock’s fund returned 9.6 percent in the same period, according to calculations by Bloomberg using data provided by the asset manager. While Elm has underperformed its benchmark, which made an annual 11 percent, Haghani is confident that will change.
“The biggest problem with long-term investing is not staying the course,” he said.