Highbridge Duo Survives Rout After Hedge Fund Sale to JPMorgan
By Richard Teitelbaum and Jenny Strasburg
Feb. 29 (Bloomberg) -- A black-and-white photo of Muhammad Ali stares down on Glenn Dubin's light-drenched midtown Manhattan office. A visitor once asked whether Dubin had met the boxing champ.
``You bet I have,'' Dubin told the guest.
As the public face and co-founder of hedge fund firm Highbridge Capital Management LLC, Dubin, 50, runs with such A- list celebrities. He dated Bianca Jagger in the 1980s, is wed to a former Miss Sweden, shoots pheasant with NBC News's Tom Brokaw and sits on philanthropic boards with actress Gwyneth Paltrow and buyout king Henry Kravis. Dubin, Highbridge's chief executive officer, is the guy who talks to investors and takes to the phones to reassure them, as he did this past August when one of his funds lost some 24 percent in a week.
Henry Swieca, the firm's other founder, works down the hall. Swieca, also 50, shuns publicity and draws the blinds as he scans computer monitors. He began keeping kosher about 10 years ago and helped to start an informal social network of modern Orthodox Jewish professionals, Club Kasher.
The pair, who grew up together in Manhattan's Washington Heights neighborhood, rocked the hedge fund industry in late 2004. They sold 55 percent of Highbridge for more than $1.3 billion to JPMorgan Chase & Co., the second-largest U.S. bank by market value. The deal enabled the stake to rise over time.
JPMorgan sold Highbridge's funds worldwide, boosting the firm's assets more than fivefold to $36.4 billion at mid-year 2007 from $7 billion at the end of 2004. Citigroup Inc., Lehman Brothers Holdings Inc. and Morgan Stanley each sank hundreds of millions of dollars into hedge fund firms after the deal.
In the Red
Now, Dubin and Swieca have to persuade investors that they can continue to turn those assets into profits -- and do so as part of a banking conglomerate. They, along with the rest of the $1.87 trillion hedge fund industry, are battling a U.S. economic slowdown and spiking stock market volatility that in November hit its highest level since 2003, as measured by the Chicago Board Options Exchange.
After a gain of 23 percent in 2006, Highbridge's $14 billion flagship, known as the Multi-Strategy fund, returned 7.5 percent last year. That trailed the 10 percent average return as calculated by Chicago-based Hedge Fund Research Inc., the fourth time in five years that the fund has lagged behind its peers.
Worse yet, two of the firm's most popular funds finished 2007 in the red, including Highbridge Statistical Opportunities. The fund, which invests in equities and once had $1.7 billion in assets, ended the year down 14 percent after its August rout, investors say. Such stat-arb funds, as hedgies call them, use computers to identify mispriced securities and other instruments and automatically pile in to the cheap ones and short the pricey ones.
Falling Assets
The $700 million Highbridge Event Driven/Relative Value fund, which among other tactics bets on mergers, fell 13 percent for the year, investors say.
``I worry about them becoming too big,'' says Brett Barth of BBR Partners, which invests in Highbridge and other funds. ``I worry about them becoming an asset gatherer rather than a performance-fee generator; I worry about cultural change.'' Nevertheless, Barth says he thinks Dubin and Swieca have so far managed their growth well.
JPMorgan Chase, which marketed two unleveraged mutual funds based on Highbridge's stat-arb strategy -- one for the U.S. and one for Europe -- suffered during the August meltdown too.
While both funds finished 2007 down less than 1 percent, investors fled. Assets in the two mutual funds plummeted to $4.6 billion at year-end from $12.7 billion on June 30, according to Chicago-based financial publisher Morningstar Inc. Highbridge's overall assets tumbled more than 20 percent to less than $29 billion at year-end from June.
`Subprime Problems'
Dubin, Swieca and officials at Highbridge and JPMorgan declined to comment for this article.
Highbridge wasn't the only one with a tough August. Goldman Sachs Group Inc., AQR Capital Management LLC and Renaissance Technologies LLC all got swept up in the stat-arb cataclysm. What once was Goldman's biggest hedge fund tumbled 40 percent for the year.
At their core, the events in August were old-fashioned financial panic magnified by borrowed money. As the subprime contagion spread beyond housing-related stocks and bonds and collateralized debt obligations, funds began selling shares to raise cash -- just as demand was drying up. Worse, the stat-arb funds held many of the same positions.
``Losses elsewhere, probably sparked by subprime problems, caused diversified firms to need to raise some cash,'' says Jim Simons, founder of Renaissance. ``Losses started to accelerate due to these liquidations of relatively similar portfolios.''
Standout Performances
Highbridge nevertheless benefited from two standout performances in 2007. The Highbridge Long/Short Equity fund, which bets on stock fundamentals, sizzled, with a 40 percent return. The Highbridge Asia Opportunities fund, which makes a range of stock bets in Asia, returned 19 percent, according to investors. Those returns are mixed into the performance of the $14 billion Highbridge multistrategy fund, which allocates its assets among 10 core strategies.
Now the pressure is on at Highbridge. Last year's money- losing funds must claw back the money they lost before they can begin earning their lucrative performance fee -- 25 percent of profit versus the standard 20 percent. Like other hedge funds, Highbridge's also charge a 2 percent management fee.
Rebounding is a challenge, as losses tend to sap employee confidence, says Bradley Alford, who runs Atlanta-based investment firm Alpha Capital Management LLC and isn't a Highbridge investor.
``A manager is tempted to increase risk to get above the high-water mark and begin sharing in the profits again,'' he says. ``This has an effect all the way down to personnel and morale, attracting and maintaining people for these particular funds.''
Working Overtime
Richard Schneider, who oversaw the event-driven relative- value fund, left in December, joining other high-profile departees. He didn't return phone calls seeking comment for this article.
Managing directors Bart Baum and Dan Stone quit in early 2006 to start Ionic Capital Management LLC along with Senior Vice President Adam Radosti. Chief Administrative Officer Ron Resnick left in 2006 to found hedge fund firm AlphaWorks LLC. And Managing Director Joseph DeLuca, former head of product strategy, departed in January.
At Highbridge's travertine and glass headquarters building at 9 West 57th Street, the team is working overtime. And the stat-arb fund has turned in a positive return since August.
As part of the sale, Dubin and Swieca insisted on offices separate from JPMorgan Chase, which is 10 blocks south. The pair also retained control of hiring and pay for their staff of about 350.
Neither Dubin nor Swieca manages money directly. Instead, Highbridge recruits from rivals such as Citadel Investment Group LLC and D.E. Shaw & Co. It sets managers free to run their funds -- giving them a cut of the performance fee when they turn a profit.
Casual Friday
The atmosphere at Highbridge headquarters feels like casual Friday at a smallish investment bank. In the 27th-floor conference room, about 20 or so managers and analysts gather on Monday or Tuesday afternoons as they did before the acquisition.
The founders set the tone, comporting themselves with slacks-and-sweater informality. Alec McAree, a former head of fundamental stock research at Citadel, might discuss U.S. consumer spending trends, according to a person who has attended.
Since the sale, Dubin and Swieca have pushed into new businesses and strategies at a dizzying pace. In August 2005, they hired William Eigen, who oversaw $10 billion at Fidelity Investments. He started bond fund Highbridge Fixed Income Opportunity and later a European mutual fund.
In January 2007, Highbridge announced a $1 billion joint venture with Louis Dreyfus Group, the commodities firm founded by Leopold Louis-Dreyfus in the 19th century that today has offices in more than 50 countries. Louis Dreyfus Highbridge Energy LLC trades gas and oil futures and physical contracts and buys storage tanks, pipelines and refineries along the U.S. Gulf Coast.
Dubin's Mantra
In June, Highbridge hired Scott Kapnick, former co-head of investment banking at Goldman Sachs, to start a private investment business that includes a $1.5 billion fund to invest in the debt of other firms' deals. Real estate and private equity funds are in the offing.
Highbridge's diversity benefits from two contrasting personalities. Dubin uses a whiteboard to map new strategies, funds and businesses. An extrovert, he's wont to serenade visitors with Rolling Stones tunes at his Manhattan apartment, which once belonged to Jacqueline Kennedy Onassis. At Highbridge, Dubin's mantra is repeated often enough that some employees roll their eyes.
``You must be able to invest across product, industry and geography -- seamlessly,'' he says.
Swieca (pronounced swee-EH-kah), as chief investment officer, carries out those strategies, giving him responsibility for making or losing millions of dollars each day.
`Benefits of Diversification'
A manager might visit his office half a dozen times in a few hours when the markets are cooking, one investor says. Swieca tracks portfolios and monitors risk. He consults with the investment committee each month before adjusting assets and leverage among the strategies that comprise the flagship fund. Five of the strategies also operate as independent funds that investors can buy separately.
The Highbridge multistrategy fund returned 14.7 percent annualized through December since its September 1992 start. That compares with 10.7 percent for the Standard & Poor's 500 Index.
Highbridge has put up those returns with less than half the volatility of the index. During the technology-led bear market in 2000, '01 and '02, it returned 27.3 percent, 12 percent and 8.2 percent, respectively.
``This talks to you about the benefits of diversification,'' says Howard Wietschner, managing director for Goldman Sachs's hedge fund industry group that provides advice to fund managers. ``It talks to you about their infrastructure, about how no one strategy will define them or make or break them.''
Intact and Thriving
Wietschner says 2007 validates the Highbridge organization.
``While certain funds may have experienced losses or redemptions, guess what? The entirety of the institution is not only intact but is thriving,'' he says.
As two poor kids chasing the American dream, Dubin and Swieca saw opportunity in the once-obscure hedge fund industry - - and seized it. They started a fund of funds to invest in other managers in 1984, helping to kick-start what's now an $800 billion market. In the early '90s, they were ahead of the pack again in combining investing styles to generate stable returns. Such multistrategy funds are now common.
Glenn Russell Dubin was born in 1957, the oldest son of Harvey Dubin, a taxi driver, and Edith, an Austrian Jewish immigrant who worked as a hospital administrator. Their apartment on Cabrini Boulevard in New York had views of the George Washington Bridge and Hudson River. Known at the time as Frankfurt-on-the-Hudson, Washington Heights was populated with refugees from Nazi Germany.
Early Calamity
Henry Alexander Swieca was the son of two Polish Holocaust survivors: Marion, an accountant, and Julia, a homemaker. They lived just blocks from the Dubins at 180th Street and Broadway in a six-story, redbrick apartment building. Dubin and Swieca were close friends, attending the local elementary school, P.S. 132, and exploring the steep cliffs of nearby Fort Tryon Park.
Dubin was the jock. He'd go on to become captain of the high school football team. Swieca liked photography and toyed with a harmonica. Money was tight. Dubin scaled fish and swept floors at Frank's Fish Market for $1.50 an hour. Swieca worked at a bookstore in the George Washington Bridge Bus Station.
Calamity swept into Swieca's life early. When he was 16, his mother was diagnosed with amyotrophic lateral sclerosis, commonly known as Lou Gehrig's disease, and died a year later. Six months after that, his father suffered a fatal heart attack, leaving Swieca an orphan who stayed with relatives and friends. The Dubins would often take him in, becoming surrogate parents.
Swieca and Dubin went to Stony Brook University, part of the New York state university system, where they roomed together as freshmen and sophomores. Dubin played running back and linebacker on the football team and majored in economics. Swieca majored in economics and French.
`Up and Comers'
``There were a lot of first-generation college students,'' associate economics professor William Dawes says. ``Many planned to follow in their parents' footsteps.'' Often that meant becoming shopkeepers.
Not Dubin or Swieca. After graduation in 1978, the two headed to Wall Street. Dubin went to E.F. Hutton Group Inc., and Swieca to Merrill Lynch & Co. Swieca left to get his Master of Business Administration in finance from Columbia Business School. He rendezvoused with Dubin at Hutton in 1982, where they set up an in-house asset management program.
Dubin dated Bianca Jagger, former wife of Rolling Stones lead singer Mick Jagger. Swieca met his wife, Estee, through Dubin. The two men had an entrepreneurial flair. They were executive producers for the 1982 movie ``Model Behavior.'' The film profiled Manhattan bachelors Dino and Richie, who pursue models in the bare-breasted world of high fashion. Dubin and Swieca quadrupled their investment, Dubin once told a Highbridge investor.
Fort Tryon
George Ball, then president of E.F. Hutton, recalls how Dubin and Swieca stood out.
``I remember both of them as enormously high achievers, up- and-comers,'' Ball, now 69, says.
In 1984, under E.F. Hutton's auspices, they created Dubin & Swieca Capital Management. With their chief information officer, Joseph Rosen, who's now president of RKA Inc., a technology consulting firm, they built a database that tracked monthly return, risk and risk-adjusted returns of commodity trading advisers. The idea was to find a mix that would provide the optimal combination of performance and volatility. In the process, they created one of the earliest funds of funds.
In 1987, they started the Fort Tryon Futures fund, harking back to their childhood. Louis Bacon of Moore Capital Management Inc., Bruce Kovner of Caxton Associates LLC and Paul Tudor Jones of Tudor Investment Corp. were portfolio managers. In spite of the October 1987 crash, the fund chalked up a 65 percent gain for the year.
Humble Roots
Dubin & Swieca Capital was spun off in 1989 after Shearson Lehman Holdings Inc. bought E.F. Hutton. The pair saw that successful hedge funds had fatter margins than their own fund of funds.
``I think they quickly realized the businesses they were investing in were very good businesses,'' says Lee Ainslie, founder of rival New York-based firm Maverick Capital Ltd.
They started Highbridge in 1992 -- naming it after the 19th-century aqueduct that connected their former neighborhood to the Bronx and that still exists today. Elizabeth Saltzman, who was briefly married to Dubin in the late 1980s, says the name was homage to their humble roots.
``Glenn became very proud of where he came from over the years,'' says Saltzman, who's now international social editor of Vanity Fair magazine.
Rosen says Dubin and Swieca set their sights on developing a technical strategy, seeking common signals such as 30-day moving averages, to gauge the market's direction. It didn't work.
Low-Risk Strategy
``We would run these programs overnight and not find anything that would overcome transaction costs,'' says Rosen, editor of the forthcoming ``Handbook of Electronic Trading'' (Capital Markets Media, 2008).
In late 1992, Dubin and Swieca hired Mark Vanacore, who'd worked with the late Fort Worth, Texas, investor Thomas Taylor, to start a convertible arbitrage fund, investors say. The strategy relied less on trading instincts than on valuing the components of a convertible bond.
At its simplest, convertible arbitrage involves buying a convertible bond and shorting the underlying stock, effectively hedging out the market risk to pocket the bond's yield. Depending on leverage, it can be a low-risk strategy. In 1993, the fund returned 21.7 percent, more than double the S&P 500's gain.
The next year proved seminal. The Federal Reserve raised its target rate six times, to 5.5 percent from 3 percent. Highbridge lost 2.7 percent with its lone fund.
Dubin and Swieca diversified. They added a merger-arbitrage fund, hiring Schneider from Paine Webber Group Inc. Highbridge's flagship fund hasn't had a calendar-year loss since.
Hands-Off Policy
In 2001, Highbridge developed a group that made loans to small businesses. The stat-arb business got under way in 2002. For that, Highbridge lured Evan Dick and Greg Howell from D.E. Shaw and Alain Sunier from Citadel. Traditional long-short -- that is, buying and shorting companies based on their fundamentals -- started in 2003.
Ainslie says JPMorgan Chase's decision to grant Highbridge autonomy has been critical. Early on, according to a person familiar with the talks, JPMorgan CEO Jamie Dimon agreed to a hands-off policy, telling Dubin, ``We recognize what made you successful is your culture. We're not going to touch it.''
The Highbridge/JPMorgan Chase partnership has provoked imitators. In 2006, Morgan Stanley bought less than 20 percent of Avenue Capital Group and all of FrontPoint Partners LLC. Last year, Lehman bought a 20 percent position in D.E. Shaw, adding to stakes it had in Spinnaker Capital Group, Ospraie Management LLC and GLG Partners LP.
Seeking Security
Also in 2007, Citigroup bought Vikram Pandit's Old Lane Partners LP for about $800 million. Old Lane's biggest fund returned less than 3 percent that year, and Citigroup shelved plans to market the fund through its private bank. In December, Pandit was named Citigroup CEO after the departure of Charles Prince.
LBO firms such as Blackstone Group LP are pushing into hedge funds. Even so, Ben Phillips, managing director of strategic analysis at the Putnam Lovell division of Jefferies Group Inc., says Highbridge's range of investments is the most diverse.
``Everybody in the industry is talking about convergence between hedge funds and long-only mutual funds and private equity,'' Phillips says. ``Highbridge and JPMorgan are the only ones who've done it to this extent.''
The hedge fund industry is evolving to the benefit of Highbridge and other big firms.
`Some Limit'
Hedge Fund Research calculates that 87 percent of capital invested in hedge funds is with firms managing $1 billion or more in assets. In addition to performance, large investors are seeking the security that can come through strong accounting, technology and compliance systems, Hedge Fund Research President Ken Heinz says.
``People are wanting to allocate their capital to those funds with better infrastructure,'' he says.
A company as big as Highbridge may already be pushing its limits to manage large amounts of money, says Theodore Aronson, principal of Aronson+Johnson+Ortiz LP, a $25.7 billion money management firm in Philadelphia.
``There's nobody who can go from $7 billion to $37 billion without addressing the issue of capacity,'' he says. ``Any active strategy has some limit.''
When growth comes after a sale, investors can become even more nervous.
``If you sell to a large investment bank, it is expected that performance will weaken and the focus will shift to asset gathering and fund development,'' says Alan Lenahan, executive vice president of Cincinnati-based Fund Evaluation Group LLC, which advises on hedge fund investments.
Lenahan says he's taking a wait-and-see attitude toward Highbridge.
Alpha Dogs
Beyond funds and strategies, Highbridge's success rests on the model that Dubin and Swieca built -- and the culture that sustains it. The terms of the acquisition encourage the founders to remain at the firm for five to seven years. That means Dubin and Swieca may be able to leave without penalty as early as 2009. Wall Street is wondering what happens then and whether their future lies together.
Historically, hedge funds have been dominated by their founders. When the alpha dog left, the firm closed. That was true when Michael Steinhardt effectively closed Steinhardt Management Co. in 1995.
Neither Dubin nor Swieca rules Highbridge in such a fashion. Former employees say they delegate the hands-on investing -- and at least some of the egotism that goes with it. According to one investor, when Kapnick joined Highbridge it was partly because of the promise that Dubin and Swieca wouldn't meddle.
``They've been able to create and maintain an environment where diverse investment talent has been able to flourish,'' says Andrew Lo, chief scientific officer of rival AlphaSimplex Group LLC, a Cambridge, Massachusetts-based hedge fund firm.
Conference Call
Ultimately, the acquisition may prove as transformational for JPMorgan Chase as for Highbridge. Dubin and Swieca's DNA can help JPMorgan enter or build businesses that have proven profitable for such firms as Goldman Sachs, analysts say.
The Louis Dreyfus venture, for one, places JPMorgan in the merchant energy and trading markets, where Goldman and Morgan Stanley have generated profits in recent years.
``Highbridge can influence what JPMorgan does,'' Merrill Lynch analyst Guy Moszkowski says. ``One of the reasons they bought it was to transfer expertise they were missing.''
In early August, JPMorgan Chase scheduled a conference call to calm its private banking clients and explain the market swings. The speaker wasn't Mary Erdoes, the private bank's CEO, nor asset management CEO Jes Staley. It was Dubin.
Talking calmly, he began by mentioning a compliment from Erdoes on his suit.
``It's my bar mitzvah suit,'' Dubin cracked, according to an asset manager on the call.
Deliver Results
The reason he could fit into it was because he'd lost so much weight worrying about the stat-arb meltdown. The listeners chuckled and relaxed as Dubin said he'd seen market turmoil like that before.
That familiarity, along with the decades that Dubin and Swieca have shared since childhood, may help put investors at ease -- provided that the duo from Washington Heights can again deliver results.
To contact the reporter on this story: Richard Teitelbaum in New York at rteitelbaum1@bloomberg.net .
Last Updated: February 29, 2008 00:05 EST
