John Henry: Part 1

April 23, 2007

Henry’s real ‘life extension’ challenge I

A buy signal? On a perilous—but well-trod—path

The conclusion of this two-part article will be published tomorrow.

Search the phrase ‘“Red Sox” +immortal’ and Google helpfully pops up 182,000 references, more than a few pointing the general direction of the late slugger Ted Williams, today safely nestled in an Arizona cryogenic facility. Now, Red Sox principal owner, and investment manager—in that order, these days—John W. Henry has his own interests in the life extension business as the largest shareholder in Sirtris Pharmaceuticals, according to a recent Boston Globe article.

But on the life extension front, Henry’s real concern should be with John W. Henry & Co, his famously volatile commodity trading advisor, now confronting the biggest gut-check in its gut-check checkered 25-year history. Hedge Fund Alert reported Apr. 11 that Merrill Lynch Alternative Investments had ordered its financial advisors to stop putting their clients into JWH products.

It’s not like John Bogle decided that conventional index investing is a silly idea. But it’s close. Merrill Lynch has been a key contributor to JWH’s asset base since the 1980s. Its recent call almost certainly reflected two-years-and-counting of brutal performance, possibly compounded by this year’s round of senior management changes, apparently triggered by efforts to address those performance concerns. [JWH general counsel and spokesman David Kozak did not respond to an email message (Apr. 13), or a telephone call (Apr. 20) by pixel time].

It’s never a good time for an asset manager to get cut off by Merrill, and this moment was spectacularly inopportune. Perhaps for Merrill and its customers, because JWH’s current decline—near 40 percent in its flagship Strategic Allocation program—is in the neighborhood of an historically reliable buy signal.

But definitely for JWH, where some familiar storm flags—performance issues, management turnover, the owner’s flash toys, all early chapters in Due Diligence for Dummies—are flapping loudly. Together.

Two years of losses, and counting
The great amorphous Red Sox Nation celebrated the World Series win in 2004, which ended an 86-year drought and the legendary ‘Curse of the Bambino.’ But the curse didn’t leave; it simply infected the team’s current ownership.

Seven of JWH’s eight active programs are already down double-digits for 2007, through Mar. 31, with the one-time flagship Financial & Metals dropping almost 20 per cent. Over three years, the portfolios are all in the red, by as much as almost 18 percent, annualized. The Strategic Allocation program, which has in recent years accounted for the bulk of JWH’s assets, is down almost 12 percent, after losing 13 percent in 2006 and almost 25 percent in 2005.

The declines are one thing. Their duration is extraordinary. SAP’s decline, through Mar. 31, has run 27 months and is now just a whisker under 40 percent. F&M is off more than 40 percent over more than three years.

Intriguingly, if only coincidentally, stock in The New York Times Co is also off by around 40 percent since Dec. 2004. The Times has 20 percent of the Henry-controlled New England Sport Ventures, which owns the Red Sox and 80 percent of the New England Sports Network regional cable television channel.

Inevitably, the performance has taken its toll on JWH’s assets under management, which have dropped to roughly $1.3 billion at Mar. 31, down from $1.7 billion at Dec. 31 2006, and less than half of the $2.8 billion it managed in Dec. 2005.

Of course, market conditions have been far from ideal for JWH’s relatively long-term trend-following style. As Ken Webster, recently promoted to president, put it in the firm’s 2006 Year in Review newsletter, in Jan. 2007:

...an unfortunate coupling of historically low volatility and trendless markets plagued by strong and sharp reversals…were fueled by the uncertainty surrounding the economic health of the majority of the world’s industrialized nations. This uncertainty led to a year of negative performance in the JWH programs. Market conviction and direction were replaced by doubt and ambiguity in 2006 as markets overreacted to any and all possible economic precursors. We look forward to a return to trending market cycles in 2007...

The proximate cause, according to Mark Rzepczynski, Webster’s recently-departed immediate predecessor explaining the miserable 2005, and the eternal test of long-term trend-followers:

…the extent and number of trends were below what we have encountered historically. Additionally, the markets that did have strong moves were coupled with significant reversals along the trend path. This reduced our profit potential as we adjusted to changing risk or hit stop-loss levels…In between the rough first quarter and the last month of the year, monthly returns showed a relatively good pattern of small gains, but those cumulative gains were not enough to offset the extreme reversal months.

Those conditions have also affected JWH’s competitors, but to a much more limited extent. FME Large, the flagship of Baltimore-based Campbell and Co, was down 6.3 percent through Mar. 31, or just over half SAP’s year-to-date loss. But the program was profitable in both 2005 and 2006, when it made 11 percent and 5.5 percent respectively.

JWH cut the leverage in SAP in Jan. 2007, reducing “existing positions by 25 percent and limiting by 25 percent new positions as they are established…for the foreseeable future,” according to its latest disclosure document. It’s not the first time the company has tweaked its leverage, but the decision wasn’t unanimous and had consequences.

Shuffling the deck chairs
Rzepczynski, who joined the company in 1998 and became president in 2001, left on Jan.12: “It was an amicable separation in terms of the decision by the company to pursue the development of lower leveraged programs and strategies going forward,” said JWH general counsel David Kozak, according to the UK-based HFM Week. In other words, Rzepczynski lost a fight over the firm’s future direction.

Others shown the door at much the same time as Rzepczynski included long-time marketing executive Ted Parkhill; Bill Dinon, head of sales; and Andrew Willard, director of technology. Webster, with JWH since 1995, added the president’s title to his chief operating officer role, while head trader Matt Driscoll was named chief investment officer, a title formerly on Rzepczynski’s business card.

Most recently, long-time Henry aide Mark Mitchell cut his ties with the investment operation, where he was vice chairman, for a role with New England Sport Ventures.

Like those stomach-churning drawdowns, management turnover is nothing new at JWH. Before Rzepczynski’s record tenure ended in January, past holders of the president title included Verne Sedlacek, now president and chief executive officer of Commonfund; Bruce Nemirow, now a principal of Capital Growth Partners, a third-party marketing company; and Ken Tropin, who, after a distinctly less than amicable split with Henry, went on to found Graham Capital Mgt Inc in 1994. That firm’s assets passed JWH’s several years ago.

Between Nemirow and Sedlacek, Peter Karpen, a former chairman of the Futures Industry Association; and David Bailin, now head of alternative investments at US Trust, held similar responsibilities, without the title of president.

It would seem a stretch to compare Henry—usually described as polite, softly spoken, press-shy, modest and similar terms—with the once impatient, headline-demanding, bombastic and eternally meddlesome New York Yankees owner George Steinbrenner. After all, in his hey-day, Steinbrenner never broke down in public when he lost a general manager, as Henry famously did when the Red Sox briefly parted ways with Theo Epstein in 2005.

But even Henry concedes, euphemistically, an inner Steinbrenner, never seen in public: according to a profile published in Institutional Investor in 1996:

“For his part, Henry readily admits that he demands a lot of his employees. ‘We’re driven to excel,’ he says, ‘and that’s necessarily going to occasionally create differences of opinion.’”

Since Tropin—the last person to hold the chief executive title—left some 15 years ago, and despite the lengthening list of distractions, nobody’s been under any illusion which differing opinion will out.

Tomorrow: The distractions; Falling behind the crowd; A buy signal?