Monday, April 24, 2006

Ex-Chicago economists are all the rage at Goldman

An article that I had meant to point readers to from the WSJ is pasted below. It sheds light on the ultra secretive Global Alpha. It's quite a story on how these guys came together, but more fascinating is the results they have produced. See below.

Goldman GurusStrike It RichWith Hedge Fund
Global Alpha's Stellar ReturnsMean Pay-Dirt for Ex-Academics; The Envy of Wall Street Firms
By RANDALL SMITHApril 20, 2006; Page C1

NEW YORK -- In early 1997, Mark Carhart was an academic at the University of Southern California. His big claim to fame was his doctorate work at the University of Chicago on mutual-fund performance.
Today, the 40-year-old Mr. Carhart and another former Chicago-school colleague run a big, secretive hedge fund at Goldman Sachs Group Inc. which, with an estimated $10 billion in assets, is the Cadillac of a fleet of alternative investments that have boosted the earnings at the blue-chip Wall Street firm. And the two men are making millions themselves.
Known as Global Alpha, the Goldman hedge fund was a leading contributor to a surge in "incentive fees," or performance-related fees, that Goldman reported for the first quarter ended in February. In that period, the incentive fees soared to $739 million from $131 million a year earlier, helping Goldman's earnings rise 64% to $2.48 billion, the biggest first-quarter gain of any major Wall Street firm.
Global Alpha's recent returns have been sizzling. In the 12-month period ended in March, the fund returned more than 48% before some fees, according to Goldman Sachs JBWere, an Australian affiliate of Goldman. It was closed to new investors last year. (On Wall Street, the word alpha refers to investment returns beyond those generated by the market.)
The bearded Mr. Carhart and his colleague, Ray Iwanowski, manage Global Alpha. A 50-member team they lead also offers a menu of services for Goldman clients based on statistical models first developed by a group led by Clifford Asness, another former Chicago student.
The Global Alpha fund was seeded in late 1995 with just $10 million, and in its first full year, 1996, the fund returned 140%, one former group member recalls. Mr. Asness left Goldman in 1997 with seven of the group's 13 members, to form his own hedge-fund business, AQR -- short for Applied Quantitative Research.
Partly to ease the risk of litigation, the Asness team decided against taking the entire group, leaving Messrs. Carhart and Iwanowski as the senior remaining members. In his own academic career, Mr. Iwanowski co-authored "Dynamics of the Shape of the Yield Curve," in 1997 in the Journal of Fixed Income.
One of the reasons the Asness group left was that Goldman at the time refused to pay members of its money-management group, Goldman Sachs Asset Management, bonuses linked directly to the performance of their business units. Instead, Goldman set bonuses on a more discretionary basis.
That changed a few years later, at the urging of some GSAM executives. The result is that Messrs. Carhart and Iwanowski are said to be among the firm's highest-paid employees -- with annual compensation estimated by some outsiders at $15 million to $20 million apiece.
GSAM also has other hedge funds, private-equity funds and "funds of funds," which offer a menu of hedge-fund investments to Goldman clients. One client, the Utah state retirement system, invests in Global Alpha as well as other quantitative strategies, aimed at beating different stock indexes.
GSAM has become the envy of some other Wall Street firms which have vowed to expand in hedge funds or private equity. For example, Morgan Stanley aims to grow in both of those areas, and both UBS AG and J.P. Morgan Chase & Co. are also pushing into the hedge-fund field.
Goldman, which shuns the creation of stars based on its culture of teamwork, declined to make Messrs. Carhart and Iwanowski available for interviews. A Goldman spokesman declined to provide information about the fund, citing regulatory restrictions.
Mr. Carhart hails from Washington state, according to Russ Wermers, an associate professor of finance at the University of Maryland business school. Mr. Wermers said he wouldn't have predicted the "unpretentious, down-to-earth" Mr. Carhart would become "a master of the universe."
When they met in 1996, Mr. Carhart was embarking on a 200-mile Portland-to-Seattle bike ride, Mr. Wermers said. Other colleagues say Mr. Carhart still brings his mountain bike on cross-country business trips, and sometimes cycles in Manhattan on workday evenings.
The Global Alpha group's lineage traces to a group of students of Professor Eugene Fama, an influential Chicago finance professor known for a belief in efficient markets. In the early 1990s, his former teaching assistant, Mr. Asness, was recruited to join Goldman by a college friend, and in turn recruited numerous colleagues from Chicago.
One of the group's early assignments was to build quantitatively oriented asset-allocation models. Part of the methodology, which underpinned the strategy of Global Alpha, was to select stocks selling at cheap prices based on their book value, earnings or other metrics, while betting on a decline in stocks selling at higher prices based on their growth prospects.
The Goldman group later used similar methods to choose not only stocks but also bonds, currencies, and entire country markets, former group members say. The models also included a "momentum" factor based on which stocks or markets have recently performed well. Although the models have evolved, the underlying "quant" methodology remains similar.
In addition to Global Alpha, Goldman employees manage two other hedge funds specializing in quantitative stock and bond investments with an estimated $8 billion in assets. While some competitors grumble that Goldman traders could gain an advantage based on possible access to client information, the Goldman funds don't have such access, former group members say.
The Goldman "quants" also offer a product similar to the Global Alpha fund known as global tactical asset allocation, which gives pension funds and other institutions the chance to boost returns using statistical methods. Goldman's 2003 annual report featured a team including Mr. Carhart which invested $1 billion for the General Motors Corp. pension fund using "active alpha investing."
The Goldman team continues to rely on the latest work from academia. Maryland's Mr. Wermers recalled a visit to Goldman about a year ago to discuss a paper he had written on whether the flow of investments into top-performing mutual funds could predict whether stocks they held would rise in price.
When he presented his findings in a boardroom filled with about 20 GSAM employees, Mr. Wermers recalls, "it was kind of a high-pressure event. They asked very, very tough questions."
Write to Randall Smith at randall.smith@wsj.com2

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