Ever hear of something called Farallon? It’s a safe bet that the answer is no, which is good, from the Farallon perspective, because you are not supposed to know that it exists. “Farallon” may sound like a brand of stain-resistant carpeting, but it is actually an operator of hedge funds and is located in San Francisco. It doesn’t have to disclose a darn thing to you, of course, but, as of early 2005, it was reported to have about $12.5 billion under management. That made Farallon among the very biggest hedge fund operators in the entire world, possibly the largest. Thirteen billion dollars is a lot of money when you can do whatever you want with it and not tell anybody about it, and use as much leverage as your conscience permits. As we’ve seen in previous chapters, hedge fund operators are the last absolute dictators in the world, answerable to no one. They’re sort of like ship captains, except they can’t perform marriages and are only too happy to push aside the women and kids and jump into the lifeboats when the weather gets a little rough.
Like most hedge funds, Farallon adheres to what might be described as the “reverse Willy Loman” school of nondisclosure: Attention must not be paid! This is not to say that the reputable people who run Farallon—I mean it; these guys have shoes so white you can use them as shaving mirrors—won’t insert that name into a carefully chosen media outlet when exceptional circumstances arise. On such occasions they submit themselves, like a child dragged to the bathroom for an enema, to a vaccination against negative-information bacteria. That distasteful chore was most recently performed in a Wall Street trade publication called Institutional Investor, in its issue of February 14, 2005. The date held no special significance, for you might say that every day is Valentine’s Day at Institutional Investor. II ’s content—smooth as a baby’s bottom, deferential as a midshipman—was reflected in its acronym: Aye aye!
“Day after day, month after month, for five long years, Thomas Steyer showed up at work wearing the same tie, a vibrant red plaid with navy, green and white stripes.” So began the humorous anecdote at the beginning of the 7,260-word article. * After pointing to the white shoes worn by Farallon CEO Steyer, ex–risk arbitrageur at Goldman Sachs, the rest of the article reads, as hedge fund manager profiles usually do, as if it had been written by Rodgers and Hammerstein. Farallon was a superbly managed hedge fund (“determination, willfulness and self-confidence are on full display”), a beautifully performing (according to “sources” with uncannily precise information) hedge fund. And, above all—walking in the storm, but keeping its head up high—it was an unfairly attacked hedge fund.
Here we have the exigent circumstances that necessitated the inoculation. It seems that the bane of boiler rooms and stock promoters had come to hedge funds. An outbreak of negative-information bacilli needed to be suppressed and prevented from spreading, so as not to infect the perceptions of the world at large.
In the past, Steyer sought privacy “as doggedly as he does undervalued assets,” but those days were no more. He could maintain his privacy in Argentina, Indonesia, and Russia, but not on the campus and in the computers of Yale University, which invests an undisclosed but large percentage of its $12.7 billion endowment with Farallon. There were people at Yale who just wouldn’t leave Farallon in peace. II observed that Steyer was being “demonized by a gaggle of former graduate students with time to burn and a proclivity for building Web sites.” They were portrayed as a kind of Baloney Blitzkrieg, with II heaping on the Yalies the kind of ridicule the anti-naked-shorting cranks deserved, but did not receive, from II or pretty much anyone else in the media.
The “gaggle” was doing nasty things and making statements that were sometimes “over the top” and “misleading.” It was so…hurtful. “The protests hurt on a personal level,” said II. Steyer was more than just a decent man. II pointed out that he was a “voluble Democrat” and a “key fundraiser for John Kerry’s presidential campaign” who maintained a sympathy for the oppressed that you would expect from such an individual. What you had here, in the view of II, was a bunch of damn fools bothering a good man.
Probably to avoid adding to the emotional wound already suffered by Steyer, II left out the worst part, something that would really get the blood boiling of anyone who cares deeply about the privacy of hedge fund managers and Democratic fund-raisers. The Farallon protesters had gotten their grimy hands on Farallon’s top-secret partnership documents and had the unmitigated gall to post them on the Internet!
Not to worry. The Steyer piece was as effective as a vaccination, even if it was pretty execrable as journalism. No further publicity of any kind about Farallon—not on the Yale campaign or anything else concerning this significant hedge fund operation—subsequently appeared in the media. This was, after all, a 7,260-word profile. While II was not a direct competitor of the New York Times, the Wall Street Journal, or the major business magazines, it was closely read by their staffs and the sources of their staffs, and no self-respecting reporter is going to suggest a feature story on a subject that had received such exhaustive “ink.” Not even Jonas Salk could have come up with a more effective magic bullet. When the Times profiled the manager of the Yale endowment in August 2005, the article didn’t even mention Farallon, much less the anti-Farallon campaign. Success!
Clinically efficacious as it was, anyone reading the II piece with an open mind might have been bothered by a few things.
For instance, why was this “gaggle” of people at Yale being so nosy? Was there no public purpose whatsoever for anyone at that prestigious presidential training ground, or outside it for that matter, wanting to know what was being done with Yale’s substantial endowment, particularly its hedge fund investments? Were these “former graduate students with time on their hands” just a bunch of trust-fund slackers adding “embarrassing hedge funds” to their idle-rich gambols? Or was there a serious, substantial, even public-spirited motivation at work here?
In fact, these supposedly wild-eyed kids, without necessarily knowing it, were working in the best interests of the people with the most at stake in the endowment. I refer, of course, to future generations of Yalies. The Yale endowment is more important than ever in funding the institution, providing more than twice the share of revenue provided by tuition and fees. So Yale students, and their parents, directly suffer if the Yale endowment stumbles, because they’ll have to make up the difference if Yale’s investments hit the skids. Farallon, neckties and all, white shoes and all, is prone to all the hedge fund vicissitudes that we’ve seen in this book. It may be the most terrific thing to hit New Haven since Oklahoma! went into rehearsals, but even more terrific hedge funds have stumbled in the past, dragging down their investors with it.
Here’s why the Yale-Farallon disclosure people were on the right track—showing the kind of aggressive curiosity that you might do well to emulate with your college, whether you are a student, a faculty member, an employee, an alumnus, or, above all, a parent who has to pay the tuition bill:
Last but not least:
The average endowment manager lagged the S&P 500 by two percentage points over ten years, according to a survey by the National Association of College and University Business Officers in early 2005. They beat the S&P over a five-year period, but still were not able to outpace inflation and provide for their institutions’ needs. “When inflation and yearly endowment spending rates are considered, the five-year average 3.8 percent investment return rate for institutions [participating in the survey] translates into a decline in endowment investment earning potential over time,” even when strong 2004 gains are taken into account, said NACUBO.
That last point, by the way, explains the first point—why endowment managers are desperately scratching for higher returns, usually without success, by putting ever-greater sums of money into hedge funds. Yet it’s been proven time and again by the efficient-market types that scrambling for higher-than-market returns is a losing battle, and that the market will beat you most of the time. Those are the house odds. They stink for active money managers.
So all these are good reasons for members of the Yale community to be curious about Yale’s dealings with Farallon and other hedge funds. However, it should be noted that none of these reasons was the initial motivating factor behind the “gaggle” of Yalies who dared to put Tom Steyer’s fund under a microscope. Contrary to II ’s portrayal of them as hysterical dilettantes and cynical union activists, these were actually serious, committed graduate students—mainly current students, by the way, not the former ones, with its sixties outside-agitator imagery, alleged in the II piece.
One of the principal student activists running the Farallon campaign at Yale was Andrea Johnson. She was a fairly typical student at the two-year graduate course of study at the Yale School of Forestry—serious, socially aware, a Colorado native, and a bit beyond the college-kid range at twenty-eight years old. Andrea never read the II story because Wall Street trade organs devoted to favorable-bacilli inoculation are not among her ordinary reading matter. She is interested in stuff like community-based environmental initiatives, not money-manager back rubs. In fact, until this whole Farallon business arose, she had never even heard of hedge funds. Like most nonfinancial types, she is not interested in such stuff until it comes breathing down her neck—as it did in this case.
What got people like Andrea interested in Farallon was a quintessential New West tale, kind of the thing you’d read about in John Nichols’s New Mexico novels, only messier. The mindset in the rural West today is very much like the Old West in one respect: You mind your own business, but if someone messes with you or your neighbors, you don’t back down. As a Coloradoan, Andrea didn’t much like the idea that her school was involved in a scheme that didn’t exactly reek of good-neighborliness. In 2002, word crept out in the Colorado media and Yale student press that the university had been involved in a bit of a mess in her home state. It was the kind of mess that used to get people reaching for their Winchesters, back in the more straightforward days of western history.
In the 1990s, Yale, in partnership with Farallon, wanted to take water from a patch of land called the Baca Ranch in the San Luis Valley of southern Colorado, and sell all that precious moisture to the Denver suburbs. Yale’s involvement in the thing was not revealed at the time.
Now, anyone who has ever seen a George Stevens movie can tell you that water is a bit of a troublesome issue out west. Apparently the people at Yale, and Farallon, didn’t watch many George Stevens movies. Not surprisingly, the idea of outsiders coming in and pumping out water tended to cause resentment among environmentalists and, of course, residents of the San Luis Valley. They fought it and the plan died, unmourned, in 2001.
Nice little mess, wouldn’t you say? Dumb too. Even if the Baca Ranch plan was as innocent as a newborn lamb, as its defenders said it was, it certainly sounded stupid, which was almost as bad.
I’ll mercifully fast-forward to early 2004. By now, the Baca Ranch water-pumping idiocy had died down. There was a transaction with the Nature Conservatory that defused the whole thing, more or less. But there was another element that became evident fairly quickly to the Yalies pursuing this issue, which included forestry students like Andrea, other activists, and union organizers seeking to needle Yale. They realized that not just the whole Baca Ranch episode was conducted behind closed doors, but that pretty much every aspect of the Yale endowment, particularly its dealings with hedge funds such as Farallon, was shrouded in secrecy. After all, Yale’s dealings with Farallon over the Baca Ranch had emerged only after the deal was deep-sixed.
So in early 2004, these noninvesting, financially agnostic Yale environmental and community-activist types became investor advocates—and good ones, very much worthy of being subjected to attack by informational antibodies. As they researched the Yale-Farallon links from an environmental standpoint, they got peeved at stuff that is familiar to anyone who has read this far in this book, but came as quite a surprise to people unfamiliar with hedge-fund-land. (Students at Yale’s School of Management, who might have provided some technical expertise, steered clear of all this, as best as I can tell.)
What bugged them the most was the lack of transparency of the whole thing. The students felt that they were groping around in the dark. Andrea later recalled, “If we kept attacking Yale investment by investment by investment, it’s not really—it’s putting out fires. And the larger issue is that we don’t know where Yale’s money is. We know even less than in the past. Twenty years ago we could kind of find out where a fair portion of Yale’s money was because it was in public equities that you could track on the stock market, because they have to report if they have more than so much of a public holding.” But by 2005, she said, students could identify only a small percentage of the endowment—2 percent—invested directly under Yale’s name in domestic public equities. Instead, they have “a ton in absolute returns.” That is, hedge funds. But precisely how that ton is distributed is something they have never been able to pin down.
As you’ll recall, hedge funds are a land of Superinvestors and would-be Superinvestors, who take particular joy in their ability not to disclose anything to anybody. College endowments aren’t much better. The students found that Yale administrators didn’t like to discuss the endowment in any detail, particularly when it came to hedge funds, and also that Yale’s disclosures were opaque. Andrea and the student researchers were unable to get the university to disclose the identity of the hedge funds in which Yale invested, or how much was in Farallon. It didn’t help the cause of transparency that David Swensen, the manager of the endowment, was viewed as something of a Superinvestor himself, with his 16 percent annual return, realized since coming on board in 1983, definitely putting him in the first ranks of endowment managers.
Swensen’s superstar status is reflected in occasional media puff pieces, and in his pay. If the student researchers had wanted to be really intrusive, they could have pulled Yale’s IRS Form 990 off a public database and plastered his salary on the Internet. In 2003—the most recent year available—Swensen was paid a little more than $1 million in salary and benefits. While not very much by the insane standards of Wall Street, that made Swensen the highest paid employee of Yale, earning considerably more than the $695,000 in pay and benefits earned by Yale’s president, Richard C. Levin.
As you can see, Yale does disclose stuff—if the feds require it, as they do with salary data for tax-exempt nonprofits. But, like most university endowments, it doesn’t disclose what it doesn’t have to disclose. Yale does not disclose its actual investments to the people who pay its bills, but rather puts out an annual report that is a study in obfuscation. In the 2004 report, for instance, the university’s hedge fund investments are not separately broken out, but instead appear under the quixotic name of “Absolute Return” investments—the term that understandably befuddled Andrea. Those are indeed hedge funds, but without the name actually being used. To make the whole thing even foggier, the endowment uses two benchmarks for that asset class—a passive one, consisting of one-year Treasuries, and an active one, consisting of, sure enough, hedge funds. In 2004, 26 percent of the endowment was in these absolute-return investments, which would put Yale’s investment in hedge funds just north of $3 billion. The words hedge fund do not show up in the endowment’s annual report.
So the students et al. had ample, rational reason to feel a bit frustrated, and to go on the offensive, as college students tend to do when thwarted by authority. What Andrea describes as researchers at the Yale student union, presumably with the help of moles in the Yale administration, got out those Farallon partnership documents, and put out their own Web site, www.unfarallon.com. Encouraged by the Yalies, students at other colleges with Farallon investments, such as Stanford University, began to push for more transparency in their own endowments as well. In March 2004, the Yale student activists committed a public relations boner of their own, by organizing a silly sixties-style demonstration. “Chanting ‘What do we want? Disclosure!’ and ‘Farallon has got to go,’ over 60 concerned students, community members and alumni marched on the Yale Investment Office Wednesday afternoon.” So reported the Yale Daily News on March 4, 2004.
Yale viewed the student activism with a kind of paternal contempt, ignoring the protests. They didn’t have to change a thing or disclose a thing, and they didn’t. When I called them about this, spokespeople for the university and Farallon sought to spin the Yale student activists as the cat’s paws of steely-eyed union activists unsuccessfully seeking to represent university employees. Their activities were winding down, I was told, and were no longer worth mentioning.
I had no better luck than the students in trying to extract information out of the university and Farallon. A Yale spokesperson, the one assigned to dealing with pesky press inquiries on the endowment, would not even acknowledge that “absolute returns” meant hedge funds, in very much the way the British government would not acknowledge the existence of MI6. Farallon’s spokesperson had nothing to say on the subject either, which is a bit more understandable.
The student activists believe that Yale might have as much as $2 billion invested just in Farallon—if so, the lion’s share of its absolute returns in just one fund. A bit of an overconcentration—if so. But the Yale Form 990 for 2003 lists only $500 million in Farallon partnerships. However, that does not seem to be a complete list, and, as I said, I can roast their tootsies over an open flame and Yale’s not coughing up that secret. Neither Steyer nor Swensen would be interviewed for this book on the campaign for more transparency at Yale.
That is not an unreasonable position, by the way. Hedge funds have a right to privacy, and college endowments have only the sparsest disclosure obligations. They can pretty well disclose what they wish—and students, faculty members, parents, alumni, and steely-eyed union activists have as much right to push and prod and embarrass them to turn on the lights.
A little bit of good, old-fashioned southwestern sunshine would have prevented Yale from getting involved in a mess called Baca Ranch. And a few rays of light might not do Yale, and other college and university endowments, any harm at all—not as long as only their consciences, if any, prevent white-shoe money managers from turning their portfolios into replicas of Long-Term Capital Management, or worse.