Hedge funds in Texas
The Lone Star State attracts plenty of financial whizzkids
DALLAS
Miss Ellie’s stat arb strategy was the talk of the ranch FOR a state more closely associated with cattle and cowboys, Texas is home to a surprisingly big herd of hedge funds. They manage around $40 billion, making Texas the fifth-largest US state for hedge-fund assets (after New York, Connecticut, Massachusetts and California), according to the Blue Heron Group, a research firm. Some of the industry’s biggest names, like Lee Ainslie of Maverick Capital and Eddie Lampert of ESL Investments, have ties to the state or Texan investors.
Many Texans like to trace the industry’s vibrancy to the state’s risk-taking traditions. A century ago “wildcatters” put everything they had on the line to drill oil wells, hoping to discover a gusher. Some made millions; others lost everything.
More important than the idea that there is something entrepreneurial in the water is the state’s tremendous wealth, much of which comes from oil and gas. Around 10% of Americans worth over $30m are in Texas, according to WealthX, which tracks rich investors. The Bass brothers in Fort Worth were among the first to invest in hedge funds—in the 1970s, after they inherited some of the family fortune—and to bring talented managers down to run arbitrage strategies. Texans today also prefer investing in trusted local managers.
Being close to the oil and gas industries also gives managers an investment edge. Take Centaurus Advisors, a $5 billion energy hedge fund run by John Arnold, once a natural-gas trader at Enron. Or BP Capital Management, founded by T. Boone Pickens, an oilman. There are dozens of energy-focused private-equity firms.
These are not the only draws for hedge funds. The costs of living and of operating a business are cheap. Corporate taxes are low and there is no state income tax, which is why Texas has also become so popular as a headquarters for big companies. Managers have to pay a maximum rate of only 0.7% on their fund’s management fee. That’s much less than the 9% their peers in New York state have to pay on both their management and performance fees, says Vicki Martin-Odette of Haynes and Boone, a law firm. This may be why Mr Ainslie’s Maverick keeps its official headquarters and back-office operations in Dallas but its main executive team in New York.
Texans also like to point to the sage of Omaha, Warren Buffett, as proof that isolation can be a big benefit. “You’re not caught up in the groupthink as much,” says Clint Carlson of Carlson Capital, a $6.7 billion Dallas-based fund. “You’re not constantly bombarded with other people’s opinions.” Investors say this independent streak helps Texans pick stocks to short because they’re not afraid to go against the grain. Mark Hart of Corriente Advisors and Kyle Bass of Hayman Capital (no relation to the Bass brothers) both bet against the housing bubble early and won big, for example. Contrarian thinking colours political attitudes, too. Mr Bass has a painting on the wall of a conference room of a zero dollar bill with Lenin’s face in the centre, with the “United Socialist States of America” emblazoned on it.
Luring capital to launch a fund can be hard (although new plans by Maverick to provide seed capital for start-ups may be a boon to Texan managers). There may be lots of local money but international investors don’t make a habit of stopping in Dallas or Houston. Besides Maverick, whose traders are almost all in New York, the biggest Texan fund is Carlson Capital, which also has offices in New York and London (see table). If Texan funds that have a strong record, like Kleinheinz Capital, were based in New York, they would already be much larger.
Unusually for Texans, hedge-fund managers don’t appear to crave hugeness. Teton Capital Partners, a $362m long-short equity fund that has posted annualised returns of 21% a year since 2001, is in effect closed to outside investors because its founder, Quincy Lee, apparently doesn’t want to get bigger. Bradbury Dyer, who founded Paragon Associates, Dallas’s second hedge fund, in 1972, feels the same way: “I believe there are inefficiencies the larger you get.” That suits some investors fine. “We’re attracted to the smaller managers and you run into the smaller managers locally,” says John Boone of Belmont Global Advisors, a family office in Dallas.
A few optimists expect a gradual hedge-fund migration from New York and Connecticut to Texas as states hike tax rates. There are more immediate incentives to set up shop. In June Rick Perry, the state’s governor, signed a bill into law that allows Teachers Retirement System of Texas (TRS), a $109 billion pension fund, to double its allocation to hedge funds, to 10%. TRS’s chief investment officer, Britt Harris, is a former boss of Bridgewater, the largest US hedge fund, and a big fan of Texan funds: “I’d rather have people who are important in my investment network closer to me.” Statements like that may tempt Yankee funds to saddle up and head south.