As KPCC's Corey Moore reported yesterday, billionaire hedge fund king Steven Cohen wants to buy the Los Angeles Dodgers. You'll recall that owner Frank McCourt, mired in an acrimonious divorce proceeding and dueling with Major League Baseball Commissioner Bud Selig, put the team into bankruptcy in June. That desperate gambit failed and McCourt has given up the fight. The team now has to find a new owner by April 2012.
Enter Cohen, with an estimated net worth of $8 billion, but more importantly, a reputation as Wall Street's most successful — and controversial — trader. In fact, few men more perfectly represent the ascent of the swashbuckling trader on the Street than Cohen, who started his hedge fund, SAC Capital Advisors, in 1992. It's now worth $12-$14 billion.
With coin like that, Cohen could easily afford to bid for the Dodgers, whose value has been pegged at around $1 billion.
But let's back up. Who is Steven Cohen? And how has he made his billions?
Let's start with how hedge funds work. They're typically started by very successful investors who've distinguished themselves at established firms and want to turbocharge their strategies. How hedge funds make money can be complex, but their mandate boils down to a fairly simple premise: turn profits on very large amounts of money whether the markets go up or down.
Normal people don't invest in hedge funds, which before the financial crisis were barely regulated by the government. Hedge funds amass capital from rich individuals, institutions, and big pensions funds. They also borrow a lot of money, exploiting the power of financial leverage. If they can make a 20 percent return on $1, why not make it on $5, borrowing the difference at favorable interest rates and racking up profits on the spread?
For the privilege of participating in a "foolproof" fund, investors pay the managers a 2 percent fee. Managers collect 20 percent of the returns: "2 and 20."
Unless they invest with Cohen, in which case the cost is 3 and 50.
That's right. Cohen has made so much money for his investors that they happily let him keep half of what their investment enables him to earn.
Cohen essentially trades on carefully considered hunches on where the market is going to be tomorrow, not where it is today. And his funds trade a lot. Reports have estimated that SAC accounts for 1-3 percent of trading activity on all markets, every day.
And although SAC has evolved over time, at its core is a fairly old-school strategy: taking "short" positions, or betting that a stock's price will fall, rather than rise.
For a hedge fund managing enormous amounts of money, this is where the magic happens. It's also where Cohen's legendary ability to obtain information before anyone else, and then use that information to construct rapidly executable strategies, comes online. This is from a 2003 Businessweek profile of Cohen:
Colleagues praise Cohen for his intensity and singular focus on reading the tape -- identifying trends by studying money flowing in and out of stocks. He teaches his traders a strict discipline of cutting losses by bailing out of losing positions fast. His own ability to acquire and distill bits of seemingly innocuous information and then apply them to his trading is unparalleled. "He has incredible instinct and the uncanny ability, when faced with 100 facts, [of] knowing which one to pay attention to," says Jack D. Schwager, author of Stock Market Wizards, a book about world-class traders. Adds Laszlo Birinyi, president of Birinyi Associates Inc., an investment research firm in Westport, Conn.: "Cohen can absorb this huge amount of input and come out with music when most of us just come out with noise."
Short-selling at the scale that SAC practices it often leads to suspicion that a hedge fund is manipulating the price of the various stocks (when you control seriously big money, you can move markets in the service of an overall strategy). SAC has faced the charges over its existence. Additionally, several former SAC traders have run afoul of regulators — and this has not put Cohen in a good light, as he often takes a stake in the funds of traders who've worked for him.
I've provided this rundown of hedge funds and Cohen because in bidding for Dodgers, it's reasonable to expect that he may view the team as an investment opportunity — something of a distressed asset, emerging as it is from a ownership scandal and bankruptcy.
What's interesting is that Cohen's arrival on the scene will probably drive the price of the team up. If a guy who runs something like $14 billion and is personally worth $8 billion wants the team, could it be worth more than the $1 billion estimate?
Cohen might think so. In a strange inversion of his hedge-fund strategy, he could see the Dodgers are a great chance to go long on an asset, extracting value as the team's revenue grows over time. It's hard to come to another conclusion, given that there isn't much to be gained by betting that a sports team will start to lose money.
What I'm saying is that after a lifetime spent wagering that assets are overvalued, he's finally found a prestigious asset that's hugely undervalued.
Remember, this is a guy who hasn't actually ever really managed anything. He's run trading floors. It's hard to believe that he sees the Dodgers as a business, when he could think of the team as an investment.
Two other critical things to take into account: first, the hedge fund industry got hammered during the financial crisis, when panicked investors pulled their money out. Hedge funds are also going to be more heavily regulated, due to the Dodd-Frank financial reforms, so Cohen may not be able to look forward to 30-percent returns forever. He's also wants to capture the business that failed hedge funds have left on the table. This is from Bloomberg:
Amid the wreckage of the market crash, SAC and other survivors are trying to vacuum up money from pension funds and other institutions that must chase higher returns to meet obligations. Many of those investors are choosing big hedge funds with long track records such as SAC.
Second, Cohen is a major art collector. He's been at it for just over ten years and has already spent a reported $700 million on numerous blue-chip works. It's telling that he's yoked several Los Angeles art-collecting cronies — Including maybe David Geffen, from whom he brought a Jackson Pollack for $52 million? — into discussions about buying the Dodgers, and also that he's bringing in an architecture firm to propose renovations to Dodgers Stadium.
The hedge fund king may think of the Dodgers as the world's greatest, and most undervalued, work of art — soon to be for sale. Why wouldn't a trader from New York who lives in Connecticut want to add it to his collection?