GREENWICH, Conn. -- Too little disclosure, too much leverage and too high fees.
That's what kept institutional investors -- even aggressive ones -- from placing much money with Long-Term Capital Management LP, the beleaguered hedge fund shop founded by John Meriwether, a former Salomon Brothers vice chairman.
Long-Term Capital, which includes Nobel laureates Myron Scholes and Merton Miller as principals and limited partners, ran into trouble when its highly leveraged arbitrage strategies failed, leading to a Federal Reserve-coordinated $3.6 billion bailout by 14 banks and brokers Sept. 23.
While institutions had money invested with Long-Term, many of the players in the hedge fund world dodged the Long-Term bullet, with high-net-worth investors, banks and non-U.S. investors taking the biggest hits.
Heads rolled last week at UBS AG, Zurich, Switzerland, where senior officials resigned following the write-down of $679 million of an investment with Long-Term. Brinson Partners, a unit of UBS, had "no involvement whatsoever," a Brinson spokesman said, noting the investment was a bank-related matter.
Among the investors who listened to Long-Term's story, but didn't participate, were: Blackstone Alternative Asset Management, New York; Tremont Partners, Rye, N.Y.; Collins Associates, Newport Beach, Calif.; and Evaluation Associates Capital Markets Inc., Norwalk, Conn.
When marketing its fund to investors, Long-Term's executives stressed its brain power and technology.
One of Long-Term's selling points was its plan to run a consolidated book, meaning traders across the globe were working off of the same portfolio, trading for 23 hours a day, said Robert Schulman, president of Tremont.
Mr. Schulman said that Mr. Scholes and other Long-Term executives presented a picture of Long-Term offering the best financial talent available, as good as any from top Wall Street investment banks.
"The smarts they were putting into this was going to be second to none," he said.
But there were downsides that kept Tremont and others out: "They (Long-Term) insisted on complete opaqueness," said Todd E. Petzel, executive vice president and chief investment officer for The Common Fund, Westport, Conn., which has $800 million invested in hedge funds. It did not invest in Long-Term because of that opaqueness, and because of the firm's fees.
Long-Term's executives would not even say where they had made their returns after the fact, and charged higher fees than hedge funds normally do, Mr. Petzel said.
One corporate pension executive, who spoke on the condition he not be identified, said executives for his fund met with Long-Term executives, but took a pass.
They were put off by Long-Term's three-year lockup, high fees and "a great deal of secrecy" surrounding the investment style. (A lockup means investors can't ask for their money back until the lockup period is over).
"The terms just weren't attractive," he said.
But at least a few U.S. institutions did invest with Long-Term, including: the endowment fund of St. John's University, Jamaica, N.Y.; Black & Decker Corp., Towson, Md.; the University of Pittsburgh; and possibly TRW Inc., Cleveland. (The Republic Bank of New York also had been an early investor with Long-Term, although it couldn't be learned if it still was invested at the time of the bailout).
Also among the investors in Long-Term are partners of the consulting firm McKinsey & Co. Inc. and senior executives of financial services giant Merrill Lynch & Co., both in New York, according to industry sources.
St. John's University had 15% of its $75 million endowment fund invested with Long-Term, according to the 1997 Endowment Study of the National Association of College and University Business Officers, Washington.
St. John's executives didn't return phone calls.
Two St. John's professors who are active in the financial industry and the International Association for Financial Engineers said they were unaware of St. John's investment in Long-Term.
"I would be very surprised if we have any (direct) exposure to Long-Term Capital," said Vipul K. Bansal, a professor at St. John's and a director with the IAFE.
John F. Marshall, a director of the IAFE, a St. John's professor, and a financial consultant, said he was unaware of any St. John's investment with Long-Term.
Black & Decker and the University of Pittsburgh were invested with Long-Term, according to both the 1997 Money Market Directory of Pension Plan Sponsors and their Investment Managers, and the 1997 Nelson's Directory of Plan Sponsors.
Executives at Black & Decker declined comment. Pittsburgh endowment and administration officials didn't return phone calls.
TRW had identified Long-Term as a manager of its pension fund as of Sept. 30, 1994. With Long-Term's three-year lockup of assets, TRW might have gotten its assets out at the end of 1997, when Long-Term did return a chunk of capital.
Robert Hamje, president of TRW Investment Management, pension manager for TRW, declined comment. Carl G. Miller, chief financial officer and executive vice president, could not be reached.
The McKinsey partners that invested with Long-Term did so as part of a company-sponsored deferred compensation plan that allowed just about any type of investment the partner wanted, said one industry source. The amount McKinsey had invested with Long-Term was not available.
And Merrill Lynch executives apparently had invested with Long-Term through one of Merrill's deferred compensation plans, in which Long-Term was one of four funds in a hedge fund option, another industry source said.
TRANSPARENCY AN ISSUE
Among those who took a pass, lack of transparency was a major reason -- particularly following the implosion of Askin Capital Management in 1994.
With greater disclosure, "you would have known what the risks are, and now that's all coming out," said Budge Collins, president of Collins Associates.
The amount of leverage also played a role in institutions avoiding Long-Term. "Leverage at 100 to 1 is not modest leverage," said Carrie McCabe, president and chief executive for Blackstone. "We never placed money with them," she said.
The fees were high in an industry known for high fees. Long-Term charged 2% of assets and 25% of profits, compared with a typical hedge fund fee of 1% of assets and 20% of profits.
And the strategies that Long-Term reportedly was using at the time of the bailout were far different from the bond arbitrage strategies they described when they were forming the fund, said E. Lee Hennessee, managing principal with the Hennessee Group LLC, New York.
Congressional hearings on hedge funds already had begun by last week, putting Fed Chairman Alan Greenspan on the defensive.
"Had the failure of the LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations, including our own," Mr. Greenspan told lawmakers.
But investors interviewed largely argued against increased regulations of investment in response to Long-Term's fall.
"Regulations that force disclosure, I think (they'd be) good," said Louis Morrell, vice president and treasurer for Wake Forest University, Winston-Salem, N.C.
But he, and others, said they are not in favor of increased regulation of the actual investing.
"We're not trying to turn hedge funds into institutional managers," where well-defined, and benchmarked, investment structures lead to "no real victories, no real defeats," said Mr. Schulman of Tremont.
Wake Forest, an investor in hedge funds, demands disclosure from its managers, and keeps its investment committee informed about what's happening, Mr. Morrell said.
Mr. Morrell and other endowment officials did not meet with Long-Term's executives, but has a hedge fund investment with Tiger Management Inc., New York, a manager that has suffered in recent weeks but has solid returns for this year.
While Wake Forest gets a market valuation every two days from Tiger, "I have to press them a little to find out where they (make) their money," he said.
All the bad news related to Long-Term and other hedge funds is likely to make pension fund executives more hesitant about investing in hedge funds, some believe.
"I think they'll back away," Mr. Schulman of Tremont said, after edging so slightly toward using hedge funds.
The International Brotherhood of Teamsters is grilling financial institutions about their role in the bailout of the Long-Term Capital Management hedge fund and implications for shareholders.
In a Sept. 29 letter to Walter Shipley, chief executive of Chase Manhattan Bank, Bartlett Naylor, director of Teamsters' corporate affairs, asked if the bank might report losses from derivative transactions because of its exposure to Long-Term, and whether shareholders should consider those losses "an inevitable result of otherwise sound business transactions." Mr. Naylor also asked Chase about the bank's part in the bailout.
Mr. Naylor sent a similar letter to Jon Corzine, chief executive of Goldman Sachs & Co., and noted that "while not a public company yet, you may find such inquiries a useful exercise as you prepare for shareholder scrutiny."
A LEARNING EXPERIENCE
"Maybe investors will learn from this very visible example," said Roger Ibbotson, president of Ibbotson Associates, Chicago, and professor of finance at the Yale School of Management, New Haven, Conn.
"I feel there are hidden risks in hedge funds, generally," Mr. Ibbotson said. "You don't see it in the numbers until after the collapse."
While Mr. Ibbotson didn't expect Long-Term's positions to destabilize markets going forward, at least one source questioned whether the $3.6 billion rescue will be enough money.
With the flight-to-quality continuing, which is what reportedly hurt Long-Term's strategies, how long will that $3.6 billion last, the source asked.
And people were not happy that the Fed stepped in.
"I think what the Fed is doing in this Long-Term Capital thing is disgusting. I think it's outrageous," said Theodore Aronson of Aronson + Partners, Philadelphia.
Likewise, Robert Arnott, president and chief executive of First Quadrant, Pasadena, Calif., said the bailout makes the United States look bad, given the way officials have been "berating the Japanese government on its interventionist, protectionist approach" to fixing its ailing economy.
And the contradiction between investors' typical free market advocacy and the government's role in saving Long-Term was not lost on investors: "What's incredibly ironic (is) these Chicago-school free market advocates got bailed out by the Fed," said Bruce Jacobs, a principal of Jacobs Levy Equity Management Inc., Roseland, N.J.
Vineeta Anand contributed to this story.