By JENNY ANDERSON
July 31, 2007
SourceAt the beginning of the summer, Sowood Capital was a $3 billion hedge fund run by a money manager who hailed from the team that built Harvard’s endowment into the $30 billion giant that it is today.
Yesterday, Sowood sent out a letter to investors indicating that heavy losses in the credit market had caused the fund to lose more than half its value, prompting it to sell its portfolio to another hedge fund and return the remaining $1.5 billion to investors.
With that, Sowood becomes the latest hedge fund hit by a tightening of the credit markets that started in subprime mortgages and has expanded into the broader market, including the loans and bonds used to finance leveraged buyouts.
At one time, using leverage, or borrowed money, the fund had $12 to $15 billion worth of positions.
“Today we made the painful and difficult decision to sell substantially all of the funds’ portfolio to Citadel Investment Group,” said a letter from Sowood’s founder, Jeffrey B. Larson. “Given what we were facing and our uncertain ability to meet margin calls, we sought other buyers for some or all of the positions. Citadel offered the only immediate and comprehensive solution.”
Like Amaranth Advisors, the $9 billion hedge fund that last year lost $6 billion in one week, Sowood Capital got caught with leveraged positions — bonds and derivatives — whose value plummeted in a remarkably short time in markets with few buyers and with lenders that started demanding more collateral.
Hedge funds are lightly regulated investment vehicles with generally expansive investment guidelines. They can invest in different kinds of securities; they can make money when the market falls by shorting stocks (betting the price will fall); and they can use leverage or borrowed money.
Hedge funds manage about $1.7 trillion, more than double the amount five years ago.
Sowood’s portfolio started to experience losses in June, as credit spreads — the difference in the risk to holding an entity’s debt compared with the risk-free rate of United States Treasuries — got wider and the stock market remained strong.
In July, its positions eroded even further as the credit market worsened, especially for loans and for so-called credit default swaps, which are derivatives that enable investors to bet for or against the value of credit.
“Until the end of last week, these developments, while reducing the value of our portfolio, were manageable,” Mr. Larson said in the letter.
But at the end of last week, Sowood’s counterparties — those holding the other side of the trade — discounted the value of the collateral, meaning the fund had to post more. At the same time, there were very few buyers.
After a weekend of marathon meetings in Boston with a small team from Citadel, the fund opted to sell the portfolio at a significant discount.
“We believe that the arrangement with Citadel provided our best option under the circumstances, since we were unable to find other sources of liquidity,” Mr. Larson wrote.
Mr. Larson joined the Harvard Management Company in 1991. By the time he left to start Sowood in 2004, he managed $3 billion of the university’s endowment in international stocks and commodities, according to Bloomberg. His pay, along with that of his boss, Jack R. Meyer, was considered outlandish by some alumni (Mr. Larson earned $17.3 million in 2003). When Mr. Larson left in 2004, Harvard gave him $500 million to help start his fund.
A spokesman for the university endowment declined to comment.
Sowood’s start was considered a huge success, raising $2 billion from investors. The fund was up a little more than 1.5 percent through March, according to an investor letter, showing how quickly the markets — and a fund’s returns — can turn.
When Sowood started to have problems, one of its prime brokers, Morgan Stanley, put it in touch with Citadel, a well-known opportunistic buyer of distressed assets.
The Boston-based fund is not the first distressed fund purchased by Citadel, a $14 billion hedge fund based in Chicago and run by Kenneth C. Griffin, a 39-year-old who started trading convertible bonds in his Harvard dorm room. Last year Citadel bought Amaranth’s distressed energy book with JPMorgan Chase & Company; Citadel later bought JPMorgan’s positions. After the collapse of Enron, Citadel hired several of its energy traders and started an energy-trading business amid dramatic dislocations in the market.
Regarding Sowood, Mr. Griffin said: “This transition provides for an orderly transference of risk between the parties.”
Mr. Griffin’s penchant for taking advantage of these opportunistic transactions has led some in the hedge fund industry to refer to him as a grave dancer.
Other funds are also taking advantage of dislocations in the credit markets to quickly raise funds to put to work.
Silver Point Capital, a multibillion hedge fund in Greenwich, Conn., started by two Goldman Sachs executives, is seeking to raise opportunistic funds, according to one person familiar with the fund’s activities. A spokesman for Silver Point declined to comment.