Home > Sowood hedge funds collapse on bond troubles.
Sowood hedge funds collapse on bond troubles.
By Jenny Strasburg and Katherine Burton
Bloomberg News
Wednesday, August 1, 2007
NEW YORK: Sowood Capital Management lost 50 percent in July, or about $1.5 billion, the biggest hedge fund manager to collapse after declines in the corporate bond and loan markets.
Sowood sold most of its assets to Citadel Investment Group and will unwind its two funds, Jeff Larson, founder of the firm, which is based in Boston, told investors in a letter Monday.
Sowood sought a buyer when it could not meet lenders’ demands for more collateral. Terms of the sale to Citadel, based in Chicago, were not disclosed.
"The transaction enabled us to avoid anticipated forced sales at extreme prices," Larson, a former Harvard University endowment manager, said in the letter. "The weakness in corporate credit, particularly focused on loans and loan credit-default swaps, accelerated sharply during the week of July 23."
The firm’s credit holdings plummeted in value as investors shunned riskier debt like subprime mortgages and bonds used to fund leveraged buyouts. Bond prices have dropped even as the global corporate default rate has hovered at the lowest level in 12 years.
Sowood’s Alpha Fund lost 57 percent in the month and Alpha Fund LP dropped 53 percent. The funds plunged 56 percent and 51 percent for the year, according to the letter.
A Sowood spokesman, Shawn Pattison, declined to comment, as did Bryan Locke, a spokesman for Citadel.
"It’s mind-boggling," said Bradley Alford, a former investment manager at the Duke University endowment who runs a money management firm in Atlanta. "This last week, the velocity of losses has picked up dramatically. The models work when they look at history, but not when history is all new."
The extra yield investors that demand to own corporate bonds has risen to the highest relative to U.S. Treasuries since 2003. As prices declined, losses forced Bear Stearns to close two hedge funds and Basis Capital Fund Management and Absolute Capital Group, both of Sydney, to freeze investor accounts.
Sowood used a variety of strategies, including trading in convertible bonds, commodities, bonds and stocks. It amplified its bets using borrowed money.
The firm will start returning money to investors "as soon as it can," the letter said. Sowood said it would hold meetings with clients next week and "seek to retain key staff to manage the distribution."
Losses were "exacerbated by a marked decline in liquidity" and no offsetting increase in equity prices, according to the firm’s letter. "Until the end of last week these developments, while reducing the value of our portfolio, were manageable."
The firm did not own subprime loans made to borrowers with poor credit histories or mortgage-backed securities, Megan Kelleher, Sowood general counsel and a managing partner, said in an interview Friday.
Sowood owned about $6.4 billion in stocks as of March 31, according to a U.S. Securities and Exchange Commission document.
The premium that investors demand to own investment-grade corporate bonds instead of U.S. Treasury securities rose 20 basis points last week to 128 basis points, according to data compiled by Merrill Lynch. Spreads on high-yield bonds widened 91 basis points to 428 basis points, the highest level since May 2005, Merrill indexes show. A basis point is one-hundredth of a percentage point.
In September, Sowood and JPMorgan Chase assumed the energy trades of Amaranth Advisors when the hedge fund, based in Greenwich, Connecticut-based, collapsed under the weight of more than $6.6 billion in losses on natural gas. Citadel later bought the positions held by JPMorgan.
Larson, 49, opened Sowood in 2004 and early investors included Harvard, which put in $500 million. He joined the university’s investment unit, Harvard Management, in 1991 from the finance division of Cargill, the largest U.S. agricultural company.
At Harvard, Larson managed foreign stocks and a commodities portfolio and ran about $3 billion of the university’s endowment.
Harvard’s $30 billion endowment was to increase its allocation to Sowood’s hedge fund and a separate private equity fund this year, according to a statement in December from Sowood. The private equity fund was spun off this month as Denham Capital Management, based in Boston.
John Longbrake, a university spokesman, declined to comment. Mohamed El-Erian, chief executive of Harvard Management, did not immediately return phone calls. El-Erian said in the December statement that splitting the hedge fund and private equity businesses would increase returns for both. The Harvard fund was the sole initial investor in the Sowood private equity fund, whose assets increased tenfold in two years to $2.3 billion as of December.
"We are very sorry this has happened," Larson said in the client letter. "A loss of this magnitude in such a short period is as devastating to us as it is to you."