Daniel S. Och is one of the few men for whom the description steely-eyed is truly apt. In Mr. Och's case, it's not sternness that's causing the look of intense concentration, but rather, extraordinary discipline. It's a character trait that the chairman, CEO and senior managing director of Och-Ziff Capital Management Group LLC, New York, honed during his 12-year tenure as an equity trader at Goldman, Sachs & Co., New York, prior to founding Och-Ziff Capital Management in 1994. In fact, Mr. Och avowed that to this day, he still draws on his experiences at Goldman Sachs as head of proprietary trading (equities) and co-head of U.S. equities trading, and modeled Och-Ziff to offer a similarly disciplined investment approach, rigorous risk management and collegial atmosphere.
Mr. Och was lured away from Goldman Sachs by publishing heirs Robert, Dirk and Daniel Ziff, who gave him $100 million to manage for their family office, Ziff Brothers Investments LLC, New York, for a five-year period. Mr. Och set out to create an institutionally oriented hedge fund manager from the outset, accepting assets from outside investors, including many pension funds, endowments and foundations, in the fourth year of Och-Ziff's existence. The Ziffs remain investors to this day and own 10% of Och-Ziff.
Performance of the firm's flagship multistrategy hedge fund, OZ Master Fund Ltd., has been nothing short of spectacular, producing nearly double the return of the Standard & Poor's 500 index over the 15-year period, with very low correlation to the index and about one-third of its volatility.
What is Och-Ziff's investment philosophy? Our investment mandate is to produce consistent, positive absolute returns, clearly one of the more overused terms in the industry. In our view, consistent, positive absolute returns means “don't lose money.” If you do lose, make sure you lose a very small amount. Make sure that the loss doesn't correlate with or bleed the rest of the portfolio. Make sure your investors know what you're doing and, perhaps more importantly, what you're not doing.
We do not predict the market's direction. That is not the secret to our risk management. One of the mantras at Och-Ziff is that being disciplined most of the time is not that difficult, but being disciplined all of the time is. We believe that's one of the strengths of our firm.
How do Och-Ziff's investment and compensation models intersect? The incentive structure of most of Wall Street is to generate revenue within silos. At Och-Ziff, our philosophy is to compensate employees based on the overall profit and loss of the firm. That means that employees are incentivized to do the right thing for investors. People at the firm are incentivized to allocate the capital for the benefit of investors; to make individual investment and trading decisions on that basis; and to help others either in different investment disciplines or different geographies and to work together on investment ideas regardless of where that investment idea resides.
Can you provide an example of how the model works? In late 2005, we realized that credit spreads were getting very tight and that risk was increasing while return was decreasing. We also saw that other managers were starting to use leverage on the underlying credit instruments. What we did was to go in exactly the opposite direction, substantially reduced our credit exposure in response to that increased risk and decreased reward. We took our credit exposure down into the very low single digits and were very transparent to our investors about exactly where we were and why. Eighteen months later, the credit bubble burst.
The key was that as we discussed the concept of reducing the exposure and moving capital out of credit, everyone was on board with the idea, including the people in the credit area. If they were being paid based on revenue they were generating within their silo, it would have been very hard for them to have that reaction.
Where do you see interesting investment opportunities? Several of our businesses are secularly more attractive than they were three years ago.
For example, convertible arbitrage, where many participants were using large amounts of leverage, we believe is a much more attractive business than it had been. Long/short equity also continues to be appealing to us.
We're constantly thinking about where we can expand into new opportunities. Structured credit is a good example of that, consisting of residential mortgage-backed securities, commercial mortgage-backed securities and structured products with corporate assets as the underlying collateral. These are areas we were not involved in three years ago given the significant leverage and embedded leverage and the fact that virtually all of the risk management was based on what the rating was.
We built very deep and strong capabilities in structured credit. Now that the sector has dislocated, (we are able to) take advantage of opportunities. Number one, we think that banks and financial institutions will begin to be more aggressive in selling assets off their balance sheets. Number two, on the commercial side, we think that deteriorating fundamentals will impact the structured side, creating literally hundreds of billions of dollars' worth of distressed product.
Our expectation is that the opportunities are beginning now and will continue into 2010, although having said that ... it may take longer to emerge. I think another of the mantras of our firm applies here: Have capabilities everywhere and obligations nowhere.
What were your best and worst investments, and what did you learn from them? I don't remember the details of the winners, and I don't spend a lot of time teaching the new employees about the winners. But I do make sure they know about the mistakes or the things that we could do better.
In the 2002-2003 distressed credit cycle, we were about two months early. While that worked out very well for investors shortly thereafter, we clearly did learn from that experience. I think it helped us a lot in the current cycle.
What new strategies are you developing? Our main fund is our global multistrategy fund. There are some areas that we believe are attractive from an investment point of view that present different liquidity and risk (characteristics) that are not appropriate for a multistrategy fund. In those cases, we will consider creating dedicated strategies with different liquidity terms than the multistrat.
We are in the process of setting up single strategies that are more private equity-related and will have liquidity terms appropriate to that kind of investment. For example, commercial real estate, energy and alternatives energy strategies ... We will differentiate very clearly between a liquid multistrategy fund where investors have clear expectations and a private equity strategy where there are illiquid investments.