How Lee Ainslie does it

As [Lee] Ainslie [founder of Maverick Capital Ltd. of Dallas] began attracting assets and adding investment staff, he created a business model that differs slightly from those of most large funds, which generally fall into two categories.

One is the Julian Robertson [founder and managing partner of Tiger Management Corp. of New York] approach, in which one or two guys run the show and make virtually all the investment decisions.

The other, the model preferred by Paul Jones’s Tudor Investment Corp. [of Greenwich, Conn.] and Steven A. Cohen’s SAC Capital [of Stamford, Conn.] is to have various desks, each more or less auton-omous, making investment decisions for their own books.

A leader at the helm of the firm takes care of risk management and asset allocation.

Maverick’s model is a hybrid of the two. The firm has six industry sector heads, most of whom are more or less the same age as Mr. Ainslie.

They are the experts in their respective industries: consumer, health care, cyclical, retail, financial, and telecommunications, media, and technology.

Mr. Ainslie talks to them throughout the day about new and current stocks in the portfolio. With that input, [he] ultimately has the final say.

“It really is a team culture. The sector heads are very experienced and talented individuals,” Mr. Ainslie said.

“I spend the majority of my day talking to them because they know so much more about each of their stocks than I could ever hope to,” he said. “We’re all peers.”

Last year, the tenure of sector heads at Maverick averaged seven years, each with investment or industry experience averaging more than 15 years. Every team has five to seven analysts typically covering 25 to 30 positions.

The industry sector teams are supported by the accounting, emerging markets and quantitative teams. With 54 investment and trading professionals in all, the ratio of investment positions to staff is three to one.

At the end of every day, Mr. Ainslie or Steve Galbraith, the former chief equity strategist at Morgan Stanley [of New York], who joined the firm in 2004, goes through the list of 160 to 180 stocks, and they come up with a plan of action based on their judgments and their conversations with the sector heads. Together, they decide whether to add to or reduce a position, buy new ones, or close one out.

They might suggest trigger points, such as selling shares of one company at 29, or buying more of another if it falls to 53.

“The plan of action reflects our view of those debates,” Mr. Ainslie said. “But it should also reflect the views of the sector heads.”

When Mr. Ainslie reviews the overall plan, he is thinking about the size of every position. Mr. Robertson [for whom Mr. Ainslie worked in the early 1990s] taught him to test his conviction by asking himself if the stock is a buy or a sell.

A hold isn’t an option.

“This is how I’ve come to think of it over the years: Either this security deserves incremental capital at the current price point or it doesn’t — in which case, let’s sell it and put the money to work in a security that deserves that incremental capital,” Mr. Ainslie said.

Maverick doesn’t use pre-assigned price targets. The world changes, Mr. Ainslie said, and his sector heads and their teams are continually re-evaluating their positions.

Sometimes, it makes sense to exit or reduce a bet even if they expect that there is still a profit to be made because they see a better moneymaking opportunity elsewhere. Maverick isn’t a trading fund so [sector heads and their teams] are willing to wait for the price they want before they buy or sell, meaning that not every order in the plan is placed the very next day.

Sector heads review the suggested trades each morning, and Mr. Ainslie expects them to be vocal if they don’t agree. Their feedback may be something as minor as “Let’s sell at 29.25, instead of 29,” or as significant as “we should be selling, not buying.”

When there is a difference of opinion, Mr. Ainslie discusses the issues with everyone involved.

He doesn’t make unilateral decisions. He thinks that matching the industry knowledge of the sector head with his judgment about the stock market and portfolio construction makes for a better result than having either party work solo.

Steven Kapp, who has been running the health-care sector at Maverick since 1997, said the system works extremely well. He and his team of six analysts produce investment ideas on the long and the short side in companies ranging from biotechnology to drug makers to managed care.

With input from his team, Mr. Kapp decides which stocks are the best moneymakers in his arena and should be included in the portfolio. He also makes the calls on when it is time to reduce or add to a position and when it is time to sell.

Mr. Ainslie’s job, as he sees it, is to balance all the input from the different sector heads to make sure the best ideas get the right amount of capital. [He] and his partners are true stock pickers. They aim to profit on both their longs and shorts.

They don’t short stocks just to serve as a hedge, nor do they use other hedging strategies such as buying puts on the Standard & Poor’s 500 stock index, which will make money if the index falls. Instead, to mitigate a macroeconomic risk, such as a move in interest rates or a spike in the price of oil, they try to balance their longs and shorts within each region — Maverick invests in Asia, Latin America and Europe as well as the United States — and within each industry.

Maverick’s core fund, however, is biased toward the long side. First and foremost, that is because the market tends to go up.

The majority of investors buy stocks based on the assumption that they will move higher. Shorting stocks also makes you unpopular with management teams.

Finally, the very mechanics of shorting can make it difficult to produce big gains. The upside is limited to a 100% return, yet the potential losses are limitless.

Plus, the more successful the short position is, the smaller it becomes as the stock price drops further and further; whereas, if you find a good stock to go long, you can own it year after year after year.

Although Maverick’s net long position can range from 25% to 75%, historically it has been about 49%, with 148% of the capital in stocks they expect to climb and about 99% in stocks they expect to tumble. The gross exposure, which includes borrowed money, has traditionally ranged between 190% and 280% of net assets.

Mr. Ainslie said that in the case of a market plunge, the way Maverick uses leverage makes for a safer, more balanced portfolio. If he is 150% long and 100% short, he is 50% net long and his ratio of long to shorts is 1.5 to 1.

If he chose to be 50% net long without leverage, he could wager 75% of assets on stocks he expected to climb and 25% on stocks he expected to drop. His ratio of longs to shorts would be 3 to 1.

Say, for example, the stock market falls 15%. If Maverick has done a decent job of stock picking, the portfolio’s longs are down only 10% and its shorts have plunged by 20%.

The portfolio using leverage would be up 5%. For every $100 of net assets, it would have lost $15 on the long side but gained $20 on the short side.

Without leverage, the fund would be down 2.5%, having lost $7.50 on the long side and making only $5 on the short side.

More assets under management means Maverick owns more of each position. Mr. Ainslie, estimates that on average, the fund could liquidate more than 75% of its holdings in a week of trading, without significantly moving the stock price.

For archived columns, go to investmentnews.com/advisersbookshelf.

Excerpted from Hedge Hunters: Hedge Fund Managers on the Rewards, the Risk and the Reckoning. Copyright 2007 by Bloomberg LP of New York. Published by arrangement with Bloomberg Press. All rights reserved.

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