The Downfall of John Taylor
From aiCIO magazine's December issue: Generations of hedge funds rose and fell; FX Concepts endured. Then, the unshakeable disintegrated. So how did John Taylor’s steady reign end in ruin? Leanna Orr reports.HT: Abnormal Returns
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The Champagne was flowing at the 21 Club in New York City. It had been a good year. FX Concepts employees, gathered at the 2006 holiday dinner party, quieted down as the firm’s founder, chairman, and CEO took to the front of the room for his address. He held up a brick. Did anyone know what it meant, John Taylor asked. Then he filled them in: On top of the performance and trading bonuses, which promised to be bountiful, FX Concepts was sending all 60 or so staff members and their partners to the BRIC country of their choosing—first class all the way.
Seven years later, the fund cannot afford to clean the two massive, custom fish tanks in its Park Avenue office. According to Chapter 11 bankruptcy filings, International Foreign Exchange Concepts owes $3,742.10 to New York Aquarium Service. There is talk of repossessing the fish.
The average life span of a hedge fund is about five years. FX Concepts lasted 32. Not all of those years were good, either: The fund teetered on the brink of insolvency in 2001, then rebounded to become one of the industry’s most powerful revenue engines. With such a strong foundation and so much institutional experience, how could things end this way? The fund is more than $35 million in the red to its creditors, and $35 million short of where it started—at zero.
“It’s hard for me to believe, but in 1980, ’81, when we started, we didn’t even have a computer,” says Taylor in “FX Concepts: Looking Back and Moving Forward,” a video released by the fund this August. “In 1981, inflation was really very high in the United States. There was a lot of feeling that things were out of control. I had the feeling that foreign exchange wasn’t very well understood by most of the people in the world. I found a couple of people who agreed with me… and we became a quantitative shop that tried to measure psychology, political change, trends in the market. For us, going into this business and trying to tell people where we thought currencies and interest rates were going to go was really very different. There was no one doing this kind of business when we started.”
After a few years of building out its technology and research process, FX Concepts took flight. It had about 70 clients in 1985; two years later, Taylor and his team were providing currency research to 250 investors. “We were doing very well,” he says. It became the first firm to manage foreign exchange risk for pension funds, and in doing so, it helped create an entirely new asset class: currency.
This burgeoning sector spawned another hedge fund titan. Ray Dalio, who founded Bridgewater Associates out of his two-bedroom Manhattan apartment in 1975, made his living advising corporations on how to manage currency and interest-rate risk. Both Dalio and Taylor’s firms built their reputations on research first, and the assets to manage followed. Bridgewater, of course, is now the world’s largest hedge fund; FX Concepts is the largest in recent memory to go bust. But according to industry players from those early years, it was by no means obvious which of the two hotshot currency shops would end up on top.
Rusty Olson, the legendary longtime former head of Eastman Kodak’s pension fund, backed both. In 1987, the fund awarded FX Concepts the mandate to manage the currency exposure linked to its international equity portfolio—one of the first currency overlay mandates ever granted. Three years later, Bridgewater launched its first hedge fund portfolio with its own overlay mandate from Kodak.
“Bridgewater was pretty much in the same boat as FX Concepts—they played the same game,” says Arun Muralidhar, a longtime currency specialist and the founder of Mcube Investment Technologies. “Both firms were cutting edge with good research.” In 1995, as head of research for the World Bank and a member of its investment committee, Muralidhar hired FX Concepts as an overlay manager. “I liked them because they were boutique-y, and they were aggressive. There were a lot of bright guys working there.” Later on, Muralidhar would be one of them: He served as a managing director during FX Concepts’ best years. But while Taylor and his team devoted themselves to dominating the currency market, Dalio and company were already thinking bigger. Bridgewater’s Pure Alpha strategy launched in 1991, giving the firm free reign to invest in almost any asset class. FX Concepts stuck to its namesake until the very end.
Remaining dedicated to its core strategy wasn’t necessarily the fund’s death knell, however. Plenty of currency-focused firms continue as going concerns today, including Insight Pareto, Adrian Lee & Partners, and AG Bisset. And FX Concepts hit its peak success as hedge funds in nearly every other sector were bottoming out. In 2008, the firm’s flagship strategy, the Global Currency Program, returned 11.5% to investors, net of fees. In comparison, Credit Suisse’s broad index of 496 hedge funds dropped by 19.1%. Extreme volatility in currency prices, as were brought on by the global financial crisis, only gave FX Concepts’ quant traders more room to play. This massive outperformance crowned nearly a decade of stellar returns: 26.1% in 2001, 29% in 2003, 18.6% in 2006, and 12% in 2007, according to fund data. Total assets under management hit an all-time high of $14 billion in 2008, and John Taylor took home an estimated $250 million of that. Almost no hedge fund manager out-earned Taylor that year. But the end of the financial crisis also brought an end to FX Concept’s good years.
“John used to say, ‘We’re an impressive company because nobody in this company drives a BMW or a Mercedes.’ Up until the time that the money really started coming in, it was the nicest place to work,” says one former employee. But dramatic wins, as prudent asset owners and managers know, also pose a danger to long-term success. As Alberta Investment Management Company CIO Leo de Bever puts it, “You can’t start believing your own bullshit.” Lady Luck has flattered many an ego. FX Concepts’ exceptional longevity and string of good years indicates it was riding on more than mere chance. But markets change, and strategies that worked in the past almost by definition cannot continue to do so forever. According to accounts from many former employees, the social and governance structure at FX Concepts rendered it both more vulnerable to believing its own bullshit and less able to evolve with changing market circumstances....MUCH MORE
