Institutional Investor's Alpha Magazine - March 2009 - (Page 41) cial Markets since September 2007. Last year the committee released its guidelines for hedge fund best practices. D.E. Shaw also has close ties with Lawrence Summers, the former Treasury secretary who heads President Barack Obama’s National Economic Council. Summers worked as a part-time managing director at D.E. Shaw from 2006 to 2008. He would typically come in from Boston on Wednesdays and was involved in everything from risk management to new investment strategies. The members of the executive committee have all assimilated David Shaw’s obsession with risk management. Capital allocation is driven by the risk committee, which includes Dinning, Gaudio, Stone and Wepsic and is supported by chief risk officer Peter Bernard. At the beginning of every month, the risk committee meets with Bernard to discuss where the firm is placing its bets. They scrutinize risk at both the strategy and portfolio levels, using scenario analysis and stress-testing to determine if it is properly hedged. Stone in particular is known for having an especially vivid imagination for stressful scenarios. One of his favorites: The Great Depression Times Two. “Max is very good at coming up with Armageddontype situations,” says Neil Cosgrove, who spent six years in the New York office before moving back to London in 2005 to manage D.E. Shaw’s non-U.S. convertible securities investments. “They are very realistic.” Such careful planning failed to protect the firm from the sudden drop in U.S. equity prices at the start of the credit crisis in August 2007, although D.E. Shaw suffered less than many big quant houses. The sell-off caught many top quant investors off guard, including AQR Capital Management, Goldman Sachs Asset Management and Renaissance Technologies Corp. (Goldman was hit hardest; its Global Equity Opportunities Fund plummeted 23 percent.) D.E. Shaw’s multistrategy fund, which had about one third of its assets invested in equity and equitylinked quantitative strategies, fell about 5 percent in August 2007 — then its worse month ever — causing the firm to put much greater importance on the correlation between asset classes during periods of stress when evaluating how to allocate its capital. Risk management extends well beyond the executive committee. Each of D.E. Shaw’s portfolio managers is charged with performing the same kind of scenario analysis. “We view everybody in the firm as a risk manager,” says Beck, who started at the firm in 1993. D.E. Shaw also obsesses about operational risk. The firm has spent much of the past year trying to steer clear of events like the Lehman Brothers bankruptcy. One way it does that is by ensuring that the counterparties that lend it money have limited ability to change the terms of their agreements. Last summer the firm brought in Tom Levy, who had been co-head of global prime brokerage sales at Morgan Stanley, to manage its relationships with financing and trading counterparties. “We’re focusing on liquidity,” asserts Steckler. “This is still clearly a very stressful time. Diversification is ERIC WEPSIC OVERSEES: Systematic investment activities. JOINED FIRM: 1994 “THERE’S A HEALTHY PARANOIA THAT WE HA IN THE FIRM. VE ” especially important in these markets.” Steckler is referring to the diversification of both D.E. Shaw’s investments and its sources of funding. Last year D.E. Shaw moved assets and balances away from banks and brokerages it deemed fragile. Although the firm had little counterparty exposure to Lehman when the brokerage firm filed for bankruptcy protection, it will be watching the restructuring closely because what’s left of Lehman owns 20 percent of D.E. Shaw. In March 2007, Lehman agreed to pay $1.4 billion for the minority stake, which entitled it to 20 percent of the profits, according to an investment banker familiar with the deal. Lehman Brothers filed for bankruptcy just two days before D.E. Shaw’s September conference, sending the Dow Jones industrial average plummeting 504 points, its worst one-day drop in seven years. The day of the conference wasn’t much better, thanks to the Federal Reserve’s poorly received $85 billion bailout of troubled insurer American International Group. By 1:00 p.m., as D.E. Shaw investors began arriving at Espace, a chic event spot on Manhattan’s west side, the Dow was down 300 points on its way to a 449-point fall. But Gaudio, Salkind and Stone went ahead with the investor meeting while the rest of the executive committee held down the fort a ten-minute walk away at D.E. Shaw’s midtown headquarters — demonstrating the value of the firm’s unique management structure. “With six people, it always takes a little longer to reach a consensus, but we’ve learned over the years how to speed it along,” Salkind says. “But don’t try this at home.” MARCH 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 41
For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.