Institutional Investor's Alpha Magazine - March 2008 - (Page 41) In Focus Liquidity Crisis Alarm Isn’tFalse By Dave Simons The B y all accounts, Jeff Larson wasn’t the type to flirt with disaster. As the leader of Sowood Capital Management, a $3 billion Bostonbased hedge fund, Larson was known as a prudent investor whose reputation had earned him a client roster of foundations and endowments, among them his former employer, Harvard Management Co., which topped the list with a $500 million initial investment. To fulfi ll his fiduciary responsibilities, Larson picked companies with strong balance sheets and highly collateralized senior debt, confident that their fundamentals would let him quickly unwind his positions should the markets decline. So sure was Larson of his strategy that he funded the majority of those positions with borrowed money, a method that had given him three consecutive years of 10 percent gains on average. But in a matter of days last July, Sowood was sapped of more than half its assets, forcing Larson to sell off the remainder of his decimated portfolio to Chicago-based hedge fund Citadel Investments and return what he could — $1.4 billion — to his stunned investors. “Jeff Larson was as honest as you can get,” affi rms Hilary Till, co-founder and principal of Premia Capi- tal Management, a Chicago-based proprietary investment and research firm. “That is why the collapse of Sowood was so startling.” Till says the sudden demise of Sowood had a canary-inthe-coal-mine urgency to it: Because of the fund’s Some experts envision relatively small size, Lara three-pronged son should have been able to unwind its positions at approach toward nondistressed levels. “But that’s not what reforming the hedge happened,” says Till, who knows Larson from her fund industry: greater days as a quantitative anatransparency, less lyst at Harvard Management in 1992 and 1993. leverage and more “Right then, I knew there must be a wider, more sysgovernment regulation. temic problem brewing.” Indeed, the failure of Sowood was one of the first indicators of a major shift in the risk tolerance of the markets, as uncertainty over the U.S. housing market raised fears among investors MARCH 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 41
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