For sheer arrogance, the confidential offering memorandum of John Meriwether and his associates at the recently launched
Relative Value Opportunity Fund
deserves a prize.
Long Term Capital Management
? That was Meriwether's shop in Greenwich, Conn. The firm nearly brought the world's financial system to its knees in late 1998 when it blew up and threatened to take many of its creditors and trading-counter parties with it. Only a rescue by the
Federal Reserve Bank
saved Long Term Capital Management and, by implication, you and your investments.
So you would think that Meriwether would be modest, even chastened, now that he and his crew of geniuses have returned to the wacky world of investing. Far from it, according to a copy of the confidential private placement memorandum for Meriwether's latest investing vehicle, which was given to me by several sources.
Let's quickly review Meriwether's trading style. He is basically a brainier-than-average bond
arbitrager, a guy who bets that two similar debt instruments will at some point trade at similar prices. He buys the cheap bond and sells short the expensive one and then waits for their two prices to come into line when rationality ultimately prevails.
Meriwether's wrinkle back in the bad old days was to use oodles of borrowed money to place his paired bets. This highly leveraged approach generated outsized returns for several years.
But in 1998, political and economic crises caused by Russia's default on its debt triggered panic in financial markets worldwide. All those bond bets, and a bunch of stock arbitrage bets as well, suddenly went sour. (Spreads always widen in times of panic, and most of Meriwether's bets presumed that spreads would narrow.)
Overwhelmed by sudden losses, Long Term Capital Management threatened to default on
debt obligations. Those obligations were huge -- the firm carried a $100 billion balance sheet of bets at the time -- and it could have imperiled confidence in the banks and brokerages at the core of the financial system. To preserve the system and to some extent the global economy, the
Fed and some of Wall Street's largest firms bailed out Meriwether.
So you'd think that, after all this, the guy would be a bit more humble about his investing prowess. Not at all, according to what I read in his new fund's private placement memorandum.
First off, Meriwether is charging an arm and a leg for his investing services. And on Wall Street, where money truly is the measure of all things, what a guy charges is the best way to tell how good he thinks he is.
How much? Two percent of the money under management, plus 20% of any profits, according to the documents. A "2/20" fee structure is normally reserved for top-performing
hedge funds promising outstanding returns for their clients -- north of 20% net of fees a year. According to the documents, Meriwether is promising to offer investors a far more plebian 15% to 20% return per year. (For the eight months ending July, the fund was up 7.8%, net of fees. Good, but not great.)
In short, Meriwether is asking people to pay up for relatively small beer. To put that in context, you could have gotten 19.4% a year over the past decade from
Vanguard's S&P 500 Index Fund
, and it charges only a 0.18% fee. Or if you wanted to pay for performance, you could have put money in recent years at
with Stevie Cohen, who takes no management fee but half of the profits; Cohen has earned more than 100% a year for the past two years, according to other hedge-fund managers and traders. (He isn't taking new money, however.)
It is also striking that there is not a single
about 1998 in the entire document. Not even some boilerplate admission of "past problems." The closest you get is in the "Risk Control Framework" section. It says:
"The market events of late summer 1998 produced extreme, simultaneous, adverse movements in G-10 relative value relationships on a global basis. Positions in different markets, different instruments and different parts of the world, while largely unconnected in terms of their underlying cash flows, nevertheless moved sharply in tandem driven by the flight to more liquid assets and by the force of simultaneous liquidations by a broad range of global investors and institutions."
That's a pretty bland and self-exculpatory analysis of what happened in 1998. You have to wonder what it takes for this man to admit a mistake. (Mr. Meriwether, meet
There is one unintentionally hilarious sentence in the document. "Past performance is no guarantee for the future,'' it says. Potential investors should certainly hope not.
Should we expect Meriwether to threaten the financial system once again? (You have to assume that the Fed is on top of this start-up.)
The memos say that the fund will limit its borrowing to
"12:1 to 18:1." Hey guys, that is not low. It's only low compared with the bad old days when Long Term Capital Management used to lever up to 30:1 with borrowed money.
In addition, the memo says that Meriwether has set up new risk controls. "
Meriwether's investment-management firm, which guides the fund intends to have an independent internal risk-control unit, whose head reports directly to the CEO. The unit's mandate will be to set risk-control constraints for the fund without assessing the merits of individual strategies,'' says the document.
That sounds good, but should we buy it? After all, the risk controllers report to Meriwether, not to some nonexecutive chairman.
Perhaps the best reason not to worry about the new, improved Meriwether is that he doesn't command as much money as he used to. The document talks about a "hypothetical $1 billion," but hedge-fund managers and traders say that, in fact, Meriwether raised less than half that. So, if you assume he levers $500 million 15 times, he could still only get to $7.5 billion in positions. That is far less than the $100 billion in bets he once commanded.
Why didn't he raise more dough? As one potential investor who declined the offer says, "Their fees are too high, and they have not promised to limit leverage enough for our comfort."
Sometimes markets are rational.
Brett Fromson writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to