JEF - Jefferies Group

[Grenville]

Thanks for the heads up.

 

Here's the WSJ article title on it:

"Ex-SAC Capital COO Kumin to Start Hedge-Fund Firm"

[jay21]

You know it's kind of funny as I recall Ian Cumming & Joe Steinberg maybe 3-4 years ago after they had allocated funds to various "co-investment" vehicles - betting on other jockies, including Bill Ackman (in which LUK lost almost all their money) and David Winters' funds , that after that, selling it all at the AGM saying something along the lines of, we've learned our lessons. We're not going to diversify the capital allocation decisions anymore. Fast forward and it feels like deja-vu all over again with Top Water, and a slew of joint ventures in investment management firms. Perhaps this is part of the fundamental change that Jefferies brought to the new firm.

 

Most of the current asset management activities are much more GP like than LP like (i.e. they are investing in the asset management company, not giving assets to an asset manager).

 

It doesn't seem clear if they will own any of the GP in the SAC firm.

[benhacker]

What Jay said.  Owning Topwater (the GP) vs. investing with Ackman (as an LP) isn't really even in the same ball park from an economics perspective.

 

Not sure how the deal with SAC will be structured, but I would assume (hope?) that it's another GP ownership deal... I share Scorpion's concern that they do much passive fund investing, I think it's generally a suckers bet due to the fees.

[thepupil]

Not a lot of detail, but I read the former SAC COO deal as a seed investment where they will be the anchor investor at launch ,probably with less favorable liquidity terms in order to provide stability to the fund, in exchange for a stake in the management company or a revenue share.

 

An $800mm launch is huge, particularly for an equity fund.

 

I don't mind LUK building out a seeding business as part if it's asset management platform; you can argue it has synergies with Jefferies Prime Brokerage and trading business and maybe there's some advantage to having permanent capital ( although the other big players like Blackstone, GS, some endowments and family offices getting in the seeding business, probably have pretty stable capital also.

[scorpioncapital]

Do you mean that LUK would have veto power over the investment manager? Cause otherwise, losing money - or making it, is the same in any language :)

[Haasje]

Fwiw I don't think seeding capital pays fees or at least not the same fees.

[jay21]

Fwiw I don't think seeding capital pays fees or at least not the same fees.

 

No one knows the proposed structure of the transaction.  The bolded may mean it's more than just investing in the fund:

 

Solomon "Sol" Kumin, who was SAC's chief operating officer, is in advanced talks over a deal with Leucadia that would make the company Mr. Kumin's biggest investor and owner of a substantial portion of his firm, the people said.

 

The talks with Leucadia, which aren't finalized, picked up in the past week with discussions of detailed terms including investment size and profit-sharing arrangements, one person with knowledge of the talks said. Leucadia could invest around half of the starting assets, or an estimated $400 million, although any terms aren't yet ironed out, people familiar with the discussions said.

 

For Leucadia, which in 2013 acquired investment bank Jefferies Group Inc., backing Mr. Kumin would represent another push into the asset-management business. It also owns Topwater Capital, which gives money to traders relatively new to the business in exchange for a split of any profits, a person with knowledge of the firm said.

[thepupil]

Do you mean that LUK would have veto power over the investment manager? Cause otherwise, losing money - or making it, is the same in any language :)

 

https://www.caia.org/sites/default/files/5aiar-hedgefund-2012-q3.pdf

 

Scorpion, here is a good intro to seeding hedge funds. An SAC type of fund is a very lucrative potential seed because of the scalability of the multi-manager/ multi strat model. These funds can grow to having over 100+ PM's and $10B+ AUM so there is a lot of optionality in seeding that type of operation.

 

I doubt that this new operation will get to charge SAC's 3% and 50% though!

[scorpioncapital]

Come to think of it, Brookfield Asset Management has done just that - in infrastructure and resource investments. They manage some giant assets under management and take some % stake alongside the funds. That company has done very well over the years with this strategy, but of course it all hinged on investing in solid, quality assets.

[peter1234]

Oaktree's Howard Marks seeded Gundlach's Doubleline after he left Pimco. If you score a home run, this model is very lucrative.

 

;)

[stahleyp]

At least from a mutual fund perspective, Markel funded Goodhaven.

[fareastwarriors]

Oaktree's Howard Marks seeded Gundlach's Doubleline after he left Pimco. If you score a home run, this model is very lucrative.

 

;)

 

You mean TCW. =)

[Spekulatius]

Jefferies results:

http://www.sec.gov/Archives/edgar/data/96223/000115752314002577/a50887846_ex99.htm

 

Great - 174M$ in 6month earning or ~350M$ annualized with 5.5B$ in equity. This engine needs a good tuneup.

[peter1234]

Oaktree's Howard Marks seeded Gundlach's Doubleline after he left Pimco. If you score a home run, this model is very lucrative.

;)

 

You mean TCW. =)

 

Thanks for correcting.

:)

[topofeaturellc]

Seeding is basically a venture biz.  The seeders get an big piece of the economics (usually something like 20% of total revenue).  Historically even the "top-tier" seeders are pretty crap at selecting managers, but just having one big hit in your book is enough to make the IRRs for the entire fund look good.  That's also why they tend to have a strong preference for strategies that can scale - winners need to then be able to gather a lot of AUM.  If you know you can't really underwrite future investment performance you underwrite what you can. 

 

Usually the seed capital is locked for a period of time. Again, negotiable - but three years is pretty common.  $400 mil is an unusually large seed, especially for what sounds like an equity strategy, and especially when it sounds like the guy already has $400 mil soft committed (although that ending up a lot smaller wouldn't exactly be unheard of).  You don't need $800 mil to run that biz from a P&L perspective unless you are launching with an absurd number of teams, and while the cut off for institutions to look at you seems to be growing every day I've not heard anything that big.  The guys who want you to be that big also want 3-5 years of numbers as well.

 

Like anything else, its all negotiable. I'd imagine someone like this guy would be in demand so the terms might end up being a bit in his favor.  Often larger FoF who are in the biz might also negotiate future access for their non-seeding funds on what may or may not be preferential terms.

 

I'd be surprised if JEFs desire to drive PB biz or whatever would play much into this.

 

If you are a LUK shareholder I'd view this just like entering any other Venture biz. Especially given the strategy itself doesn't sound directional at all.

 

The flip side of it is I'd be surprised if they wanted to do this as a one off.  I personally think the seed biz only makes sense as a portfolio.

[txlaw]

Perhaps this is just another idea of how to shift excess capital to non-traditional fixed income strategies.  In this case an equity trading strategy.  I know that Jefferies has been hit hard by low interest rates (see, e.g., http://dealbook.nytimes.com/2013/09/18/jefferies-results-reflect-the-hazards-of-fixed-income ), and we all tend to think that fixed income is probably the least attractive asset class for the long term.

 

Last year, Alleghany bought a stake in Ares Management and agreed to seed (or at least invest in) some of the Ares funds, up to the tune of $1 billion.  The ideas was to get a better return on capital than with traditional fixed income investments and to gain additional return from the asset management biz by increasing Ares' insurance company AUM. 

 

New trend?

[plato1976]

Will higher interest rate be good for their fixed income business?

 

Perhaps this is just another idea of how to shift excess capital to non-traditional fixed income strategies.  In this case an equity trading strategy.  I know that Jefferies has been hit hard by low interest rates (see, e.g., http://dealbook.nytimes.com/2013/09/18/jefferies-results-reflect-the-hazards-of-fixed-income ), and we all tend to think that fixed income is probably the least attractive asset class for the long term.

 

Last year, Alleghany bought a stake in Ares Management and agreed to seed (or at least invest in) some of the Ares funds, up to the tune of $1 billion.  The ideas was to get a better return on capital than with traditional fixed income investments and to gain additional return from the asset management biz by increasing Ares' insurance company AUM. 

 

New trend?

[txlaw]

Will higher interest rate be good for their fixed income business?

 

Perhaps this is just another idea of how to shift excess capital to non-traditional fixed income strategies.  In this case an equity trading strategy.  I know that Jefferies has been hit hard by low interest rates (see, e.g., http://dealbook.nytimes.com/2013/09/18/jefferies-results-reflect-the-hazards-of-fixed-income ), and we all tend to think that fixed income is probably the least attractive asset class for the long term.

 

Last year, Alleghany bought a stake in Ares Management and agreed to seed (or at least invest in) some of the Ares funds, up to the tune of $1 billion.  The ideas was to get a better return on capital than with traditional fixed income investments and to gain additional return from the asset management biz by increasing Ares' insurance company AUM. 

 

New trend?

 

I'd actually be interested in hearing other people's opinions on this question.  Below is my guess on how this works.

 

We all know that if interest rates remain low for an extended period of time, FI trading returns are not going to be great.  If interest rates move up and then stay higher but stable, then FI trading might be better than the current environment, but could still be terrible versus other asset classes.  At the same time, rising interest rates seems to mean being forced into shorter duration bonds to avoid principal loss.

 

Doesn't seem like fixed income is that great going forward, which is why there are moves to equity funds and alternative investment strategy funds.

 

But, again, I'd like to hear others' thoughts on this.  I'm not really a bond guy.

 

[scorpioncapital]

I always thought the argument for FI was that the governments of the world are highly indebted and require the sale of debt by agents such as investment banks. Presumably, the higher the rate paid on this debt, the higher the commission cut of the broker?

[txlaw]

I always thought the argument for FI was that the governments of the world are highly indebted and require the sale of debt by agents such as investment banks. Presumably, the higher the rate paid on this debt, the higher the commission cut of the broker?

 

I think you're referring to the investment banking side at Jefferies.  But I was referring to the issues with performance at the FI trading desks.  (Also, I don't think commissions for debt underwriting are taken off the interest rate -- I believe it's a percentage of the principal amount.)

 

I'm thinking that JEF/LUK will be reallocating capital away from the bond desks to the equity trading venture being discussed.

[HJ]

In general I think people recognize that fixed income trading is a very challenged business.  As far as influence of rate level on fixed income trading revenue, it's not just the absolute level, but also the shape of the curve.  Most fixed income books are funded short term (inventory is considered "aged" if held for longer than 30 days), even though 2's-10's spread is still actually fairly steep in historical context, the funding spread for anything other than plain vanilla treasuries and agencies has blown out since the crisis, and hasn't really come back in (partly driven by money market funds continuing to shrink).  Last couple of years, everybody benefitted from the recovery trade, whatever inventory you carried moved up.  At this point, however, that trade has pretty much run its course.  In addition, the buy side has gained a lot of leverage against the intermediaries.  Inventories for most fixed income desks has come way down.  Quite a few buy side entities (GSO, ARES, Carlyle, Babson, etc.) run larger balance sheet than the intermediaries.  And in fixed income, ability to throw around balance sheet still wins business.  Often times these days when a corporate client look for financing, they can completely bypass the street, and go directly to these funds.  For an entity like Jefferies, there is no doubt that they are shrinking the capital deployed in this business.  In many ways them not being subject to same amount of regulatory oversight (the most recent leveraged lending guideline for example), could give them advantage over the big banks.  But these days their high yield desk is not just competing against desks of other banks, but also all the new credit funds, often times affiliated with private equity shops who control the borrowers to start with. 

 

The fixed income business on the street is going through structural changes, and it's still not quite clear what the new market structure, business models and return on capital will look like.  The only thing people are certain of is that the future looks quite a bit worse than the past.

[txlaw]

In general I think people recognize that fixed income trading is a very challenged business.  As far as influence of rate level on fixed income trading revenue, it's not just the absolute level, but also the shape of the curve.  Most fixed income books are funded short term (inventory is considered "aged" if held for longer than 30 days), even though 2's-10's spread is still actually fairly steep in historical context, the funding spread for anything other than plain vanilla treasuries and agencies has blown out since the crisis, and hasn't really come back in (partly driven by money market funds continuing to shrink).  Last couple of years, everybody benefitted from the recovery trade, whatever inventory you carried moved up.  At this point, however, that trade has pretty much run its course.  In addition, the buy side has gained a lot of leverage against the intermediaries.  Inventories for most fixed income desks has come way down.  Quite a few buy side entities (GSO, ARES, Carlyle, Babson, etc.) run larger balance sheet than the intermediaries.  And in fixed income, ability to throw around balance sheet still wins business.  Often times these days when a corporate client look for financing, they can completely bypass the street, and go directly to these funds.  For an entity like Jefferies, there is no doubt that they are shrinking the capital deployed in this business.  In many ways them not being subject to same amount of regulatory oversight (the most recent leveraged lending guideline for example), could give them advantage over the big banks.  But these days their high yield desk is not just competing against desks of other banks, but also all the new credit funds, often times affiliated with private equity shops who control the borrowers to start with. 

 

The fixed income business on the street is going through structural changes, and it's still not quite clear what the new market structure, business models and return on capital will look like.  The only thing people are certain of is that the future looks quite a bit worse than the past.

 

Excellent post -- thanks for sharing your insight.

[Grenville]

For whatever it's worth, I've decided to part ways with LUK. A couple of things in combination have driven my decision:

+ Ian Cumming leaving the board

+ CFO planning on stepping down (health reasons)

+ Potential business relationship with former SAC Capital upper management (FFH shorting/lawsuit)

 

I wanted to wait to see the results of the energy projects, but the above in combination pushed me to move on.

[LongTerm]

For whatever it's worth, I've decided to part ways with LUK. A couple of things in combination have driven my decision:

+ Ian Cumming leaving the board

+ CFO planning on stepping down (health reasons)

+ Potential business relationship with former SAC Capital upper management (FFH shorting/lawsuit)

 

I wanted to wait to see the results of the energy projects, but the above in combination pushed me to move on.

 

I think I have to agree with you on this, although what pushed me over the edge was the amount of leverage Jefferies has brought to the combined entity; the inherent risks of a financial institution which, in a liquidity event like 2008, can bring the whole company crashing down to zero is not what I originally signed up for when purchasing Leucadia. And of course I don't like Handler's whole NYC penthouse kind of thing. I'm slowly reducing my stake and will probably just leave a token position in case I can get more comfortable with the balance sheet in the future.

[valueyoda]

I personally think that the liquidity and solvency risk of Jefferies within the Leucadia structure is largely overblown given the holding company's financial resources. Furthermore, I think that Jefferies is a necessary - and of the more stable - profit and book value generators within the company right now. Leucadia was always a good investment because they had the balls to take large levered calculated bets on individual investments. This caused highly volatile return numbers, but very strong results over longer periods of times. The reverse is true at the moment. The company is currently drowning in liquidity and has too few meaningful investments that will cause large profits going forward. One of the more interesting long term bets they've made recently, was the Harbinger position. 

 

Given the large period of inaction and flat book value growth, I think that investors might be pleasantly suprised by new investments that will be added. I think that the right course of action should be a gradual accumulation rather than disposition of Leucadia shares at these valuations (maybe even some Leucadia LEAPS). The relative inaction shown by Leucadia is also noticeable at Loews (a company I always had a lot of respect for), as they have been hesitant to deploy their cash balances in new large investments.