Wednesday, May 14, 2008

Peleton's Fall From Grace

Monday's Wall Street Journal carried an in-depth description of the rise and fall of Ron Beller's Peloton Fund. It's very revealing as yet another story of a can't-miss idea put forth by impeccably-credentialed alumni of a top-flight Wall Street firm. In this case, Goldman Sachs.

The article opens by noting,

"In its sheer speed, Peloton's demise offers an illustration of the delicate relationships upon which the financial industry is built, and the breakneck pace at which they have been unraveling.

There is a widespread weakness in the hedge-fund business: Highflying managers sometimes fail to fully factor in broader risks, such as what happens when troubled banks pull back the borrowed money many funds need to make their investments. Peloton was particularly susceptible because it borrowed heavily to boost returns. For every dollar of client money, Peloton had borrowed at least another nine dollars to buy some bonds.

"If you run out of money, you can't stay in the game," notes Chris Jones of Key Asset Management Ltd., a hedge-fund management firm and early Peloton investor.

Mr. Beller, who personally lost about $60 million in investments, believes Peloton failed not because it made the wrong investments but because his bankers didn't stick with him when the prices of those investments were temporarily out of whack, according to people familiar with the fund. Among investors that lost money are New York investment firm BlackRock Inc., Swiss private bank Lombard Odier Darier Hentsch & Cie. and United Kingdom asset-management firm Man Group PLC."

So in just these few paragraphs, we learn some important facts about Peloton that are probably key reasons for its failure.

First, it was highly leveraged. Second, it would appear that Beller and his colleagues failed to realize how crucial the risk management culture and functions were at Goldman that were now lacking at their startup. Third, Beller is still angry at others, not himself, over the failure.

Failing to acknowledge what the term 'mark to market' means, he feels he should have been given more time and leeway to overcome the realities of borrowing short and holding complex, illiquid instruments long. Finally, some of the 'right' clients invested, which probably assured Beller and his partners that they were invincible.

Other elements in the article seem to point to Beller's lack of attention to detail, such as this one,

"His wife, fellow Goldman alumnus Jennifer Moses, is a policy adviser to U.K. Prime Minister Gordon Brown. In London, the Bellers were better known for the time a Goldman assistant stole more than £4 million, or $7.8 million at today's rates, from their account and that of another Goldman banker.

The episode became fodder for British media, which focused on the opulent lifestyle of expatriate U.S. bankers."

Would you feel comfortable letting someone who, himself, was bilked out of about $8MM by an underling, take responsibility for custody and management of your money?

Started in late 2005, Peloton used its Goldman connections to quickly attract seed investment from the lead partner's former employer, as well as necessary brokerage services. The Journal piece goes on to report,

"By that fall, Peloton's assets totaled $1 billion. Traders met weekly in what they called the "chill out" room, decorated in Moroccan-inspired red and orange colors and low-slung couches, at Peloton's London office. Mr. Grant joined by video link from Santa Barbara, Calif., where he had moved around the time of the fund's launch.

Mr. Beller's intense demeanor sometimes caused friction. He berated secretaries, and poor-performing traders kept quiet in meetings to avoid being humiliated by him, according to people familiar with the situation. Maxwell Trautman, a founding partner, quit in January 2006 after personality conflicts and differing views about strategy with Mr. Beller."

At this point, I briefly stopped reading and thought about some small company environments in which I've worked. The signs of brewing trouble seemed, to me, to be growing: one partner decamps to another country, now unavailable for in-person consultation; Beller's irritability and personality begin to cause problems among the staff; so much so that one of the founding partners quits only months after the launch.

By 2006, Peloton had moved into betting heavily on various mortgage-related securities. According to the article,

"Some investors weren't happy with the shift into mortgage securities. Several withdrew money, including Key Asset Management and Goldman's asset-management arm. In August, Goldman's prime-brokerage unit sharply increased the amount of collateral Peloton had to put up for short-term loans.

The move infuriated Mr. Beller, according to people familiar with the situation.

He berated some investors who decamped, questioning why they would forgo Peloton's gains, which by November 2007 had reached a stunning 87.6%, largely on the bearish housing bet. In late January, Peloton won two awards at a black-tie ceremony hosted by trade publication EuroHedge. Some attendees gasped when Peloton's returns were announced.

At the same time, the relationship between Messrs. Beller and Grant soured, according to people familiar with the situation. Mr. Beller increasingly took credit for the ABS Fund's success -- he accepted the January awards alone -- while the Multistrategy Fund was still struggling. The two discussed a potential split."

Now we have a portrait of the leading partner in denial as customers depart and yet another partner seeks to end his association with him. As the mortgage securities debacle deepened, the situation at Peloton also began to deteriorate,

"In mid-February, Messrs. Beller's and Grant's investments took a hit when Swiss bank UBS AG said it had marked down the value of highly rated mortgage securities similar to those that Peloton held.

Peloton had $750 million in cash and believed its funding from banks was secure. That provided a level of comfort to Messrs. Beller and Grant that Peloton could cover banker demands, known as margin calls, to put up more collateral as the value of its investments fell."

Shortly thereafter, another day's pressure on the instruments shrunk their value to levels that consumed the remaining cash Peloton had in margin calls, and still more collateral was required. The end of the fund came shortly thereafter.

The Journal piece concludes with Beller's rather glamorous version of how the fund finally died,

"The next day, lenders seized Peloton's assets, bringing a chaotic end to the fund. Mr. Beller later likened the situation to the final scene in Quentin Tarantino's movie "Reservoir Dogs," when several actors, guns trained on each other, simultaneously blow each other away."

It's as if Beller saw the entire Peloton enterprise as a gilded joyride in someone else's car, isn't it? He and his partners managed billions in assets, recklessly pyramided investors' capital with excessive amounts of borrowed money, and managed it all with inadequate risk controls.

In the end, it sounds like just another typical end to a too-young, too-brash, too-wealthy asset manager from a name investment bank.

Makes you wonder why firms like Blackrock and Goldman continue to trust these types of newly-minted hedge fund whiz kids, doesn't it?

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