Closer look in one of the most successful hedge fund SAC Capital run by hedge fund titan Steve Cohen – Big bets built fast.
Diving into a small stock it never before reported owning, the hedge-fund firm bought 1.2 million shares, which at the end of the first quarter were valued at $26.7 million.
Employees funnel ideas to founder Steven A. Cohen, above, for trading in an account called ‘The Big Book.’
Three weeks later, a stake of that size was worth $12.1 million more. On April 23, Britain’s AstraZeneca AZN.LN +2.15% PLC said it would buy Ardea, the culmination of two months of confidential negotiations. The deal sent the stock soaring 52% that day.
Such high-stakes trading over the years has made SAC the subject of admiration and envy on Wall Street. The hedge-fund firm—which a week ago agreed to a record insider-trading penalty of more than $600 million to settle two cases unrelated to Ardea—has generated returns averaging nearly 30% a year for two decades. It is among the industry’s best records, leading outsiders to ask: How does the firm do it?
Public visibility is scant, because hedge funds generally need to report their holdings only at the end of each quarter. Much other trading remains hidden. Within these limits, The Wall Street Journal measured how often SAC goes out on a limb with bets like Ardea: large investments, built up quickly.
The Ardea investment reflects a strategy that SAC employs more than most peers. Looking at six years of regulatory filings, the Journal found nearly 5,300 instances in which SAC built an investment of $5 million or more in a company during a quarter, either by at least quadrupling the number of shares it already held or by establishing a new position.
No other hedge fund in a group of 20 that, like SAC, invest primarily in stocks made as many of these kinds of bets.
SAC’s portfolios undergo constant, sweeping churn: From one quarter to the next, new positions and shares added to existing ones made up an average of 56% of the value of SAC’s stockholdings. SAC’s share turnover during 2012’s final quarter ranked fourth-highest among the top 50 hedge funds tracked by FactSet Research Systems Inc. FDS -2.82%
This piling in and out of stocks dovetails with current and former employees’ descriptions of a short-term, rapid-fire approach to investing. Managers of SAC’s portfolios are urged to funnel their best trading ideas—usually involving an expectation of a coming price move—to founder Steven A. Cohen for trading in a multibillion-dollar account known as “The Big Book.” Employees detail these “high-conviction” ideas to Mr. Cohen in regular calls, and successful ideas can add millions of dollars to a fund manager’s bonus.
To get a sense of SAC’s most timely bets, the Journal measured how often the investments were followed by single-day stock jumps of 15% or more in the following quarter, along with a stock gain for the quarter of at least 10%. It found 186 such instances over the six-year period, following news such as stellar earnings reports, takeover offers or drug-trial announcements.
SAC isn’t alone in making big bets before market-moving events. In fact, SAC’s rate of success by this measure was in the middle of its peer group. But its success rate exceeded those of its peers that came closest to SAC in the number of large, abrupt bets on stocks.
For SAC, the Journal analysis turned up plenty of failures, too. Using the same test of a one-day 15% stock move in the following quarter, the Journal found even more quick drops than quick gains during the six years, which included a 2008 financial-crisis stretch when stocks were brutally pummeled.
SAC declined requests to comment on specific investments identified by the Journal or to provide details of its trading, beyond the quarter-end holdings it must report to federal regulators.
“Our model is based on over 100 portfolio teams delivering a diversity of investment ideas resulting in our portfolios having thousands of different investments,” an SAC spokesman said in a statement. “With so many investments, it is unsurprising that some will vary in size during a quarter. Most of the other firms the Journal examined had far fewer investments than we did.”
The spokesman, Jonathan Gasthalter, also called the Journal’s examination “flawed because it plucks data in a vacuum.”
Indeed, it isn’t possible to determine either SAC’s exact trades or their profitability because of the limited nature of public filings. SAC makes and unwinds many stock trades within quarters. Investment firms don’t have to report the dates of trades. And they don’t have to report short sales, which are bets that a stock will fall.
Regulators can see more, however. Between 2002 and 2011, dozens of well-timed SAC trades that didn’t show up in its quarterly filings were flagged as suspicious by securities regulators, according to referral letters one regulator sent to the Securities and Exchange Commission. (SAC in 2011 noted that the referrals weren’t allegations and said it was confident in its practices.) Much of SAC’s trading documented in the two civil settlements announced a week ago by the SEC also doesn’t show up in the quarterly filings.
The larger of the two cases involved an indicted former SAC portfolio manager whose advice the hedge fund’s “owner”—meaning Mr. Cohen—relied on to make drug-stock trades, the authorities allege in civil and criminal complaints against the ex-manager. The authorities haven’t charged Mr. Cohen, nor have they alleged that he knew of any inside information when he made these trades. The former portfolio manager has denied the allegations and pleaded not guilty.
SAC agreed to pay a total of $616 million without admitting or denying the allegations. SAC President Tom Conheeney told investors Monday that the decision to settle was a difficult one that SAC made after considering the toll protracted litigation could have had on the firm.
Despite the settlements, federal authorities continue to investigate Mr. Cohen and his firm. The SAC spokesman has said that Mr. Cohen has acted appropriately and that SAC will continue cooperating with the investigations.
The Journal closely examined seven SAC trades. There was no indication any of these involved any impropriety.
In 2007, SAC positioned itself for a potential surge in the stock of Equinix Inc., EQIX -0.03% a data-center operator. Two SAC units, which hadn’t reported owning any Equinix shares in the previous quarter, bought 858,100 shares that summer, which SAC’s filings show were valued at $76.1 million on Sept. 30, 2007.
A month later, on Oct. 30, Equinix released financial results and projections that beat expectations. Instead of a four-cents-a-share quarterly loss predicted by some analysts, it reported profit of 12 cents a share. At the end of the next day’s trading, Equinix shares were worth 32% more than when SAC reported its position.
Only SAC would know whether the firm still held the shares at that point.
By the end of the quarter in which the stock jumped, SAC’s reports show it had sold most of its shares.
Sometimes, SAC’s traders made big, abrupt bets more than once in the same stock.
One such company is Whole Foods Markets Inc., WFM -0.03% the upscale supermarket chain. In the second quarter of 2009, three SAC units bought a total of nearly 2.6 million shares of Whole Foods, which on June 30 were valued at $49.1 million. The investment was more than five times as large, by market value, as any SAC previously reported in Whole Foods, which had seen its stock slump as recession-weary consumers switched to lower-priced stores.
The company made cost cuts and other adjustments, which on Aug. 4 produced signs of success as Whole Foods reported revenue that beat expectations. By the end of the next day, the shares were worth 51% more than when SAC reported its position. Again, it isn’t known whether SAC still held its Whole Foods shares and profited from the stock’s surge.
In any case, by the end of this third quarter, SAC was mostly out of the stock.
In 2010, SAC made another play on Whole Foods. During that year’s third quarter, two SAC units increased their combined holdings by 27-fold from the prior quarter, to $78.6 million.
Whole Foods was trying to spur business by offering products costing less than the high-price ones that had earned it the nickname “Whole Paycheck.”
After the stock market closed on Nov. 3, Whole Foods reported a 58% rise in quarterly profit, and its chief executive said it had “some serious momentum.” The next day’s market action left the stock 27% higher than on Sept. 30, when SAC reported its position.
In the fourth quarter, the SAC units sold about 600,000 Whole Foods shares, then whittled down their remaining 1.5 million shares gradually over the next several months as the stock continued to drift upward, filings show.
In contrast to good earnings reports, merger news can pop up at any time, and deals are generally negotiated in secret, making such news much harder to anticipate.
Two years ago, SAC made a big bet on telecommunications firm Global Crossing Ltd., one of dozens of timely pre-takeover bets in the period examined.
SAC hadn’t reported owning the stock in three years, but at the end of the first quarter of 2011, it said it held nearly 500,000 shares valued at $6.8 million.
During that first quarter, according to a chronology Global Crossing later filed with the SEC, the company secretly rekindled stalled discussions with a competitor, Level 3 Communications Inc. LVLT -1.08%
Although executives of both companies had at times expressed willingness to merge with a competitor, a review of six months of published references to the companies found no sign of any market speculation about an imminent deal involving either company.
On April 11, 2011—a week and a half after the quarter in which SAC invested—Level 3 announced it would acquire Global Crossing. By the end of that day, Global Crossing shares were worth 79% more than when SAC reported its investment on March 31.
Global Crossing’s price continued to rise through the end of the second quarter, by which time SAC reported it was largely out of the stock.
The health-care industry has held Wall Street’s keen interest in the past decade, thanks to a spate of mergers and to stock volatility that creates the potential for trading profits. The industry has been a focus for SAC as well. Many of the successful trades the Journal examined involved health-care stocks.
They included an investment in Barr Pharmaceuticals Inc., a maker of generic drugs.
During 2008’s second quarter, three SAC units increased their holdings in Barr to a total of $137 million from $2.5 million. No other institutional investor reported buying as many Barr shares as that during the period
Two of the SAC units bolstered their bullish bet by buying call options. Such options give their buyer the right to purchase a stock at a set price by a certain date—a bet that the stock will rise above that price in the interval. The units bought calls on 153,000 Barr shares.
It turned out that during that second quarter, Barr was in confidential deal discussions with Israel’s Teva Pharmaceutical Industries TEVA +0.52% Ltd. The talks began in mid-April 2008, according to federal disclosures Barr made after the deal became public.
At a conference in Palm Beach, Fla., at the end of that April, Teva’s chief executive privately floated a preliminary bid to Barr’s chief. Teva then sweetened its offer as the confidential talks progressed over several weeks. On June 27, in an indication that word of the talks had begun to leak, an executive of another drug company called a Barr official to ask if Barr was negotiating with a competitor.
On July 16, an Israeli newspaper reported Teva’s bid for Barr—news that sent Barr shares soaring the next day and left them worth 27% more than on June 30, when SAC reported its position. Two days after the newspaper report, Teva confirmed it would acquire Barr.
By Sept. 30, two of the three SAC units had largely exited the stock. The third bought more. Barr shares ceased trading in December when the Teva deal closed.
Some of SAC’s bets have been losers. In the fourth quarter of 2007, an SAC unit went from having no shares in Human Genome Sciences Inc. to owning 1.85 million shares valued at $19.3 million on Dec. 31, 2007.
On Jan. 23, 2008, the Rockville, Md., company said it would switch some patients in clinical trials of a hepatitis C drug to a lower dose because of pulmonary side effects recorded at a higher dose. The stock plummeted. At the end of that trading day, it was worth 46% less than when SAC reported its position.
By March 31, the SAC unit had sold all its shares. If it still owned them when the side-effect news came out, it incurred a substantial loss.
Ardea Biosciences, the company SAC plunged into shortly before AstraZeneca agreed to take it over, was a stock that SAC had never before reported owning in Ardea’s 12 years as a public company. Then on March 31, 2012, an SAC unit reported owning nearly $27 million of Ardea shares.
Ardea was making progress on a gout treatment and had been in contact with a number of larger pharmaceutical companies about a potential deal for nearly two years, according to a subsequent regulatory filing. Despite these discussions, securities analysts say there was nothing public early last year to indicate that a deal was imminent.
Behind the scenes, however, AstraZeneca executives had privately offered to buy Ardea during a health-care conference in New York on Feb. 15, 2012. By the end of March, AstraZeneca had sweetened this still-confidential bid and was conducting on-site due diligence at Ardea’s San Diego headquarters, Ardea’s later filings with the SEC show.
The deal—sending Ardea shares soaring—was announced in late April. SAC’s filings show that by the end of June, it had sold all its Ardea shares.
Read More: WSJ
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