George Walker is charged with turning Goldman Sachs’ hedge fund unit, the fabled former Commodities Corp., into a top earner. But touching up an icon isn’t easy.
By Hal Lux
February 2003
Institutional Investor Magazine
George Herbert Walker has a hard act to follow -- and not because the leader of the free world is his second cousin.
Walker, just 33, took over 23 months ago as co-head of Goldman, Sachs & Co.'s Hedge Fund Strategies Group -- the business formerly known as Commodities Corp. In its heyday Commodities Corp. was a breeding ground for some of the hottest traders in the hedge fund industry -- including Bruce Kovner and Paul Tudor Jones II -- and produced glittering compounded annual returns of 24 percent over 27 years (see below at the end of story). When Goldman bought it in 1997, as part of a belated effort to build up asset management, the firm hoped some of the Commodities Corp. magic would rub off on its own results and reputation.
It didn’t happen. Pursuing a policy of benign neglect, Goldman was slow to restructure the new subsidiary’s operations, notably failing to put Goldman Sachs Asset Management’s marketing muscle behind the hedge fund unit, even though raising money had never been Commodities Corp.'s forte. Worse, the business was losing its ability to attract top new talent.
Goldman’s hedge fund division is a fund-of-funds operation, as was Commodities Corp. from the mid-1980s on. It doesn’t run its own hedge funds but instead has outside hedge fund managers invest its money. In the past decade the fund-of-hedge-funds industry grew even faster than the hedge funds themselves, with assets under management mushrooming from $400 million in 1987 to $115 billion in 2002, according to Connecticut money management consulting firm Casey, Quirk & Acito.
A number of financial institutions have jumped on the fund-of-funds bandwagon. London-based Man Group, selling aggressively to mostly retail investors, has transformed itself from a garden-variety commodities futures brokerage into a fund-of-funds brand name and now manages $12.4 billion in the area, the most in the industry, according to Institutional Investor’s 2002 ranking of funds of funds. And the buyout specialist firm Blackstone Group has gathered $4.3 billion in institutional assets in its fund-of-funds operation, good enough for the 15th spot on the II list.
Meanwhile, Goldman, which picked up about $1.8 billion of fund-of-funds assets through the Commodities Corp. acquisition, ranked just 14th in assets last year, with $4.4 billion under management. Given the head start the investment bank acquired with Commodities Corp., says one hedge fund executive with close ties to Goldman, “that’s an embarrassment.”
Enter Mr. Walker. A rising star who most recently ran an online venture for Goldman’s high-net-worth division, he joined the firm in 1992, fresh from the Wharton School, where he had graduated Phi Beta Kappa and gone on to earn his MBA. Since then he has rotated through 12 different positions in several divisions, starting as a banker in mergers and acquisitions and moving through investment banking assignments in Frankfurt and London. Walker served as cochief of staff for Goldman’s strategy committee as it prepared its initial public offering, and in 1998, on the eve of the IPO, Goldman named the 29-year-old a partner -- one of the youngest ever. Subsequently, as head of the U.S. institutional business for GSAM, he helped steer the unit through a period of skyrocketing assets. Insiders say he is being groomed for an even higher leadership position.
When he became co-CEO of the hedge fund unit in May 2001, along with now-retired former Commodities Corp. president M. Roch Hillenbrand, Walker moved quickly to shake up the division. Whereas the unit’s internal portfolio managers had always operated as generalists, working from Commodities Corp.'s old home in Princeton, New Jersey, Walker regrouped them into four trading specialties -- relative value, event-driven, long-short equity and tactical trading. He moved 20 Goldman investment and risk management professionals to Princeton from New York to replace some longtime staffers. Most significantly, Walker last year began quietly phasing out the time-honored Commodities Corp. requirement that external managers run the firm’s money in so-called managed accounts, subject to daily monitoring and sudden liquidation by the firm -- a tradition that had been scaring off new talent. Now some outside managers don’t give Goldman that unusual level of information about their trading books.
In terms of people, Goldman’s hedge fund unit dwarfs almost all other fund-of-funds operations, with 153 Goldman professionals, including 27 internal portfolio managers. “I honestly believe our hedge fund investment team is the best in the world,” says Walker. “In the past couple of years, Goldman has invested more aggressively than anyone in building hedge fund expertise. Hedge funds are where the puck is headed for our largest and most sophisticated clients.”
The head of a competing fund of funds says that Goldman does have an impressive infrastructure and talent base. “It’s great for marketing,” he says. “But will it get them better returns than anyone else? That’s the only thing that matters.”
So far, so good. Goldman Hedge Fund Strategies Group’s average institutional separate-account client saw a net return of 11.4 percent in 2002, on an asset-weighted basis. (Goldman declines to discuss its performance.) The average fund of funds, by comparison, lost 3 percent. Goldman won’t say how much in new hedge fund money it took in last year, but the inflow of assets seems to be accelerating, according to one of the firm’s external managers. “They’ve been sucking in a lot of cash,” he says.
Walker believes that this is only the beginning. He says the largest funds of funds could end up managing $20 billion each this decade. Can Goldman join that club? Commodities Corp.'s excellent record of risk management over three decades should be a strong selling point at a time when steep losses and ugly scandals have hit such big hedge fund groups as convertible arbitrage specialist Lipper & Co. and mortgage-backed securities operation Beacon Hill Asset Management. (Goldman’s pitch book to prospective clients features a collage of headlines about assorted hedge fund scandals, next to descriptions of the firm’s painstaking risk management process.)
The stakes are high for Goldman and its asset management business. With much of Wall Street going hungry -- brokerage, advisory and deal-making activity is moribund -- hedge funds represent one of the few growth opportunities around. At the same time, the fund-of-hedge-funds business appears to be headed for a classic shakeout. There are now about 450 funds of funds, though only about 30 run more than a couple of billion dollars. Goldman’s largest global banking competitors, including Credit Suisse First Boston and Morgan Stanley, are also committing big bucks to growing their own fund-of-funds operations. Many industry experts believe that the field will soon be winnowed to a handful of giant players that will run substantially more assets and wield more influence over individual managers.
“Big banks with distribution power will be able to offer hedge fund managers very stable assets, which is incredibly valuable,” says a partner of a small fund-of-hedge-funds organization. “The biggest hedge fund managers could decide to spend their time talking to the banks. For small funds of funds, the risk is that you start to get cut off from the information flow.”
Walker is betting that’s the way things will ultimately go -- to Goldman’s benefit. “Funds of funds is increasingly going to be a more concentrated business,” he says. “I believe that the industry leaders are likely to be attached to large financial institutions.”
But can Walker get his hedge fund unit’s groove back? Much depends on how he uses the tool that was one of Commodities Corp.'s greatest strengths but has become an occasional stumbling block for Goldman -- the insistence on managed accounts. Most funds of funds receive little information about the positions their external hedge fund managers hold, and if they want to redeem their investments, they generally have to wait at least a month, as cash is rarely available fast. The old Commodities Corp., by contrast, required that outside hedge fund managers segregate the firm’s assets into managed accounts that it could monitor continuously and liquidate at a moment’s notice.
Back when Commodities Corp. was one of only a small handful of investors willing to seed new talent, external managers were more than happy to put up with the requirement. Those days are over. Now hot hedge fund managers balk at the policy, which Goldman retained after the acquisition. That made it increasingly difficult to put money in the most promising new funds. “They would insist on a managed account,” recalls one hedge fund executive who met with Goldman in 2000 to discuss an investment in his fund. “You would say no. Then you would say good-bye. It made for a quick conversation.”
To gain access to desirable outside hedge fund managers, Goldman has begun to waive the managed-account requirement for some. But its marketing material boasts prominently that 70 of its 96 external managers still trade through managed accounts and that the firm monitors 6,500 trading positions per day. What’s unclear is how many managers will be held to the requirement a few years from now. The issue is so fuzzy that some external Goldman hedge fund managers are unaware that the managed-account requirement is no longer absolute.
Walker says Goldman is seeking the right balance between finding new managers and controlling risk. “We value transparency and liquidity -- those are attributes that are always helpful,” he says. “But for 15 years we were the only game in town. Now more investors are allocating to hedge funds. And we aren’t always able to get our ideal terms with every manager. We needed to make a change and be more flexible.”
The hedge fund group will certainly need fresh outside talent to grow. Its chief investment officer, Kent Clark, estimates that Goldman could take on a further $2 billion in assets without adding any new external managers but would have to find at least 30 more to run $20 billion. Nearly a third of Goldman’s current hedge fund managers, some of them Commodities Corp. veterans, are now closed to new external investors. And the mix of managers that Goldman inherited from Commodities Corp. -- 60 percent by assets were focused on tactical trading -- was underweight in the most successful hedge fund strategies of the 1990s, such as convertible bond trading and merger arbitrage.
Goldman’s hedge fund managers still include two of the most fabled names first staked by the old Commodities Corp. -- Jones and Kovner. (Last year Kovner’s Caxton Global Investments fund returned 26 percent; Tudor Investment Corp. returned 21 percent.) At the same time, Goldman has substantially increased its investments with relative-value managers. For example, since Walker took over, Goldman has become one of the largest investors in Sagamore Hill, a $1 billion multistrategy, market-neutral hedge fund. The fund was launched in 1999 by Steven Bloom, a founding partner of quantitative options trading firm Susquehanna Group.
Walker’s unit also seems to be betting on hedge funds run by former Goldman executives. It has invested in Silverpoint, a distressed-investing hedge fund launched last year by Ed Mule, a Goldman banker for 17 years who was chief of staff to former Goldman co-chairman Robert Rubin. Another new hedge fund in Goldman’s portfolio is Taconic Capital Advisors, run by Kenneth Brody, who spent 20 years as a Goldman Sachs banker before leaving to head the Export-Import Bank under the Clinton administration.
Goldman and the former Commodities Corp.'s trading technology and hedge fund relationships should be a powerful combination. People familiar with the operation say Walker has been trying to glean advantages from the firm’s expertise in global investment banking and trading. He recently drafted an advisory group of Goldman’s global proprietary traders to offer advice about asset allocation shifts between hedge fund strategies. “The hedge fund space is large, complex and changing rapidly,” says CIO Clark. “The days of the best research being conducted at cocktail parties are over. A larger asset base allows us to have two dozen serious investment professionals dedicated to finding, evaluating, accessing and monitoring managers.”
But potential conflicts abound, too. For years Goldman has been one of the leading firms on Wall Street supporting hedge fund groups through so-called prime brokerage services, such as providing financing for leverage and stock loans -- necessities for short-selling. The firm is competing fiercely with Morgan Stanley and Bear, Stearns & Co. to be No. 1 in this area. Since hedge funds are a growing and ever more lucrative market for traditional brokerage services, some fear that Wall Street will once again lose its moral compass trying to cater to them. Industry officials say Walker faces a delicate balancing act, trying to leverage Goldman’s resources while making sure the rest of the firm doesn’t force services on his outside managers.
Yet in today’s investment environment, adding hedge funds to their asset management mix seems like a no-brainer for Wall Street firms. Thanks to the three-year drop in global stock markets, more and more institutional investors are exploring alternatives to traditional investment styles.
“The problems with long-only managers in the last few years raise questions about what portfolios for institutional investors are going to look like going forward,” says Carrie McCabe, a hedge fund consultant who has worked on strategic issues for the Goldman group. “So I think the importance of the Princeton group for Goldman is more than hedge funds. A lot of the innovation for all of GSAM is going to be coming out of the hedge fund group.”
Walker says that’s largely because of the Commodities Corp. legacy. “We’re standing on the shoulders of giants,” he says. “This was absolutely not a business in crisis. But by adding resources and enhancing the investment process, we’ve been able to take it to a different level.”
Besides the old firm’s expertise, Walker inherited a loyal cheerleader. His hedge fund unit’s biggest client and Commodities Corp.'s former parent, Bermuda reinsurer Stockton Reinsurance, already had $800 million invested in the group’s managed-futures and macro trading strategies -- the old Commodities Corp.'s traditional strengths. Last year Stockton invested an additional $500 million in the group’s relative-value, event-driven and long-short equity strategies, areas that have received new emphasis under Walker.
It remains to be seen what hedge fund returns will look like once giant institutions like Goldman are through gathering assets from their largest customers. Commodities Corp., after all, earned its greatest returns in the early years, when the hedge fund business was in its infancy. “One thing that I liked about trading commodities,” says Commodities Corp. founder F. Helmut Weymar, “was that it was viewed as a sleazy business, so not that many people were doing it.”
Goldman insists it won’t have any trouble finding managers to keep returns high, and its massive fundraising ability should give it an edge when it comes to putting money with popular ones. Hedge fund managers are very concerned with finding “sticky capital,” which won’t flee during rocky moments in the market. “In trading, unusual events are always going to happen,” says Sagamore Hill chief Bloom. “So you need to have stable capital to do your job well.”
With 96 external hedge fund managers, a client base still learning about the products and an investment banking operation in New York that would love to market to his hedge fund traders, Walker will find his management skills put to the test. But people who have worked with him say he’s the right person for the job. “What’s impressive about George is that he’s good at figuring out what’s really important,” says a hedge fund industry executive who knows him well. “He’s flexible in the right way.”
There is one respect in which Walker is inflexible -- discussing his personal pedigree. “I’m very proud of my family, but I don’t talk about them,” he says. “That’s not something that is going to make our clients money.”
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The old Commodities Corp.: Academics and a limping dog
For 27 years the traders at Commodities Corp. did things their own way.
Founded in 1969 by former Nabisco Brands agricultural economist F. Helmut Weymar, a Massachusetts Institute of Technology Ph.D., Commodities Corp.'s vision was to bring rigorous economic analysis to commodities trading, still a relatively marginal field.
Weymar wrote his dissertation on the dynamics of the world cocoa market. As a graduate student, he had caught the trading bug when Minute Maid Co. hired him to develop a mathematical pricing model for the frozen orange juice market, in which he proceeded to make a killing one winter.
Weymar worked briefly full-time for Nabisco but was resolved to launch a trading firm. His early partners included Frank Vannerson, a Princeton University Ph.D. and wheat market specialist; Paul Cootner, an MIT economics professor and expert in pork bellies; and Amos Hostetter, a 70-year-old commodities trader from brokerage firm Hayden, Stone & Co. The new firm’s board included Weymar’s dissertation adviser, Paul Samuelson, the renowned economist and Nobel laureate. Commodities Corp.'s initial $2.5 million chunk of capital came from a group of investors that included Nabisco.
The brainy group got off to a horrendous start. Convinced that corn prices had been bid up too high because of a recent blight, the firm took on a big short position. Soon after Commodities Corp. put on the trade, CBS News ran a graphic prime-time report on the blight. As soon as the market reopened, corn prices began soaring until they wiped out 65 percent of the new firm’s initial capital. “It was important for Commodities Corp. to have this horrible experience,” says Weymar. “The most dangerous traders are the ones who have gotten big without getting creamed.”
After licking its wounds, the firm plunged back into the markets and began a historic trading run. The steadily accelerating inflation of the 1970s was a perfect environment for commodities trading. The firm made much of its profit from a computerized commodities-trading system developed by Vannerson. Its first star trader, Michael Marcus, earned annual triple-digit returns over many years, trading commodity contracts from cotton to plywood.
Commodities Corp. also had a flair for discovering new talent. In 1978 it gave a trading job to a Harvard University graduate student who wrote music reviews part-time. The trader was Bruce Kovner, now head of giant hedge fund group Caxton Corp. Several years later Commodities made one of its first external investments with a relatively unknown young quantity: Paul Tudor Jones II, who now runs the $5 billion Tudor Investment Corp. Yet the firm didn’t shower money on anyone in those days. “If someone looked promising, we would give them $30,000,” says M. Roch Hillenbrand, the retired co-chief of Goldman Hedge Fund Strategies Group, who remains on the investment committee. “Then if they delivered really good performance, we would give them 50.”
Commodities Corp.'s first decade was so spectacular that the traders suffered a deep crisis of confidence when the firm lost 2 percent in 1982 and then made only 6 percent in 1983. Weymar had to lay off two fifths of his people. “That sent me into psychotherapy,” he says. But returns soon rebounded, thanks largely to Kovner’s insistence that the firm push into new markets like energy trading.
Kovner’s trading success, however, led to the firm’s next dilemma when he announced in 1983 that he was leaving to start his own firm. Until then Commodities Corp. had never invested in external managers. Trading was conducted in an old stone farmhouse in Princeton, New Jersey, surrounded by fields full of rabbits and pheasant that were patrolled by a three-legged watchdog named Cocoa.
In 1986, after returns had averaged 45 percent for three years, the 45-trader shop became the manager for four public commodity-trading pools. And in 1989 Weymar and some other shareholders sold part of their equity to Japanese leasing company Orix Corp. in a deal that valued the company at roughly $260 million.
Then, in 1994, Commodities Corp. launched a Bermuda company, Stockton Reinsurance, that wrote policies in such relatively low-risk lines as workers’ compensation. Stockton reinvested all its premiums in hedge funds managed by Commodities Corp. Eventually, the Princeton firm created Stockton Holdings, which became parent of both the insurer and Commodities Corp.
Why would a proprietary trading company get into the insurance business? Weymar says he believed that a reinsurance company allied with Commodities Corp.'s trading record would be highly valued by the market. But it should also be noted that offshore reinsurance companies can generate tremendous tax breaks for hedge fund investors. Bermuda has no income tax, and investors in insurance companies, unlike investors in hedge funds, aren’t required to pay taxes on realized trading profits each year. Once again, Commodities Corp. was ahead of the curve: In the past several years, a number of U.S. hedge fund managers have launched Bermuda-based reinsurers.
By the mid-1990s Commodities Corp. was frustrated that it was still managing just $1.8 billion in assets -- half of that its own money. Then Goldman, Sachs & Co., which had a long relationship with Commodities Corp., came courting. Goldman sweetened its offer by promising to take Stockton public after the acquisition. Stockton’s IPO never happened, but Commodities Corp.'s original shareholders are doing fine without the proceeds. Anyone who had invested $10,000 with Commodities Corp. on day one and let it sit for 27 years would be worth $3.35 million today. -- H.L.
