PAUL TUDOR JONES:‘ADAPT OR DIE’

By Katherine Burton

In the first year that Jim Pallotta joined Tudor Investment Corp., the $9.4 billion hedge fund firm founded by Paul Tudor Jones, he learned how his boss managed to rack up one of the best performance records of any hedge fund manager. Pallotta, 46, says he was talking to Jones one day in 1994 at around 6 p.m., when Jones told him he had made a large bet that the U.S. dollar would rise against the yen. “It’s my favorite position,” Pallotta remembers him saying.

When Pallotta woke up the next day, he looked on the Bloomberg Professional service and saw that the dollar had gotten crushed. He called Jones, expecting the worst. Instead,Jones told him he had woken up in the middle of the night, seen something that changed his mind and reversed his wager so he would make money if the dollar tumbled. “He made a killing,” Pallotta says.

Jones, a blue-eyed, Memphis, Tennessee–born trader who looks younger than his 49 years, has posted an annualized return of about 26% since opening his flagship Tudor BVI Fund in 1986, investors say. Few managers of hedge funds—loosely regulated investment pools marketed to institutions and wealthy individuals—can boast as strong or as steady a performance.

Now, Jones is set to expand his business into Asia, with plans to open a trading office in China. And he’s looking to add other seasoned fund managers in the U.S. and Europe to the 45 who trade such things as commodities, U.S. and European equities, global bonds and the yen.

“You adapt, evolve, compete or die,” says Jones, who hunts pheasant, fishes for trout and bass and owns property in the Florida Keys; along Maryland’s Chesapeake Bay; in Pawling, New York; and in Zimbabwe. By following that rule, Tudor has managed to increase its assets more than 30,000-fold since Jones opened his first fund, with $300,000, two decades ago. The one-man trading office he started in Manhattan now has about 300 employees, with headquarters in Greenwich, Connecticut, and offices in Boston, Washington, London and Epsom, England. Tudor, the world’s seventh-largest hedge fund group, has 35 equity partners.

As Tudor grows, so does the need to generate profit to keep the organization running and the traders happy. In 1985, Tudor’s first full year of trading, Jones returned 136%, followed by 99% in 1986 and 200% in 1987. As funds get larger, the ability to make such outsized returns diminishes, because with bigger investments, it’s more difficult to get in and out of positions. Since 1995, when Tudor BVI became a multistrategy fund—expanding beyond futures contracts to include such investments as stocks and private equity—the fund’s returns have averaged about 18% a year, investors say.

Jones says China is the next place to look for profits. “China is set to overtake the U.S. in GDP supremacy in our lifetime,” Jones says, pointing out that Chinese GDP growth has an effect on everything from commodities prices, because China is a huge manufacturer, to U.S. interest rates, because the country buys U.S. bonds.

Some money managers, including billionaire investor George Soros, aren’t as confident about making money in China, even while the country’s economy grew 7–9% in each of the past three years. “China is in an incipient asset bubble, and it’s very difficult to find vehicles for investing,” Soros, 73, founder of the $8.3 billion Quantum Endowment Fund, said in a televised interview with Bloomberg News in January.

Jones says Tudor has already turned a profit in China, where it has made private equity investments since 1993. Some of the investments have been through or with Cathay Investment Fund Ltd., a private equity pool run by an affiliate of Greenwich, Connecticut–based hedge fund firm Paloma Partners LLC. In the 1990s, Cathay and Tudor invested in China Yuchai International Ltd., one of China’s largest diesel engine makers, and held stakes in a food company and a drugmaker. Tudor President Mark Dalton, who joined the firm in 1988, declined to name the companies or comment on performance numbers.

In 1994, Tudor opened a Shanghai office run by Kyle Shaw. That lasted until Shaw left for Hong Kong in 1997 to open his own fund. Through Shaw, Tudor successfully invested in a Shenzhen-based construction products company in 1997, says Dalton, who declined to provide additional details. “For the last 10 years, we’ve gone through a crawl, walk and run process [in China], and now it’s time to act,” Jones says.

Chief Operating Officer John MacFarlane, 49; Dalton, 53; and Jones are each planning trips to Asia over the next few months, including stops in Taipei, Singapore, Beijing and Shanghai to find an executive who can lead their expansion there, Dalton says.

Jones, who wears two braided African bracelets on his wrist next to a Rolex, says he feels more pressure to perform well now than when he started the fund, because he has almost three dozen partners whose net worth and annual pay are tied to the performance of the funds. Partners and employees are the largest investors in Tudor investment pools, he says. That isn’t unusual for large funds that have been in existence for a long time. “It is really easy in this company to beat yourself up if you are doing poorly, because we have so many people taking risks successfully,” he says.

During Tudor BVI’s 18-year history, Jones has more than doubled the average annual return of the Standard & Poor’s 500 Index. His track record is similar to that of Bruce Kovner, who runs Caxton Associates LLC, which controlled $12 billion in assets at the end of 2003, making it the largest hedge fund management firm in the world.

Kovner has returned about 25% a year since 1986 in his so-called macro funds, which try to chase macroeconomic trends in interest rates, international trade and production by betting on stocks, bonds, currencies and commodities. James Simons has produced returns of about 35% a year since 1988 in his $5.2 billion Medallion Fund. He trades futures contracts, agreements to buy or sell assets at a set date and price, which Jones traded exclusively when he first started.

Within a decade of opening Tudor, Jones decided he needed to surround himself with other traders who had complementary skills to share the burden of managing his clients’ money. That approach differed from the management style of Julian Robertson and Soros, the hedge fund giants of the 1980s and ’90s, who tended to give their employees less responsibility for investment decisions.

Dwight Anderson, 37, spent five years at Robertson’s Tiger Management LLC before joining Tudor. “At Tiger, nothing material went into the portfolio unless it went through Julian,” Anderson says. His next job was at Tudor, where he managed the Ospraie commodities fund from July 1999 through 2003. “At Tudor, you are pulling the trigger,” he says. Anderson left Tudor because he wanted to run Ospraie as a stand-alone fund. Tudor remains his largest investor.

Even Soros, who left day-to-day management of his flagship Quantum fund in 1989, weighed in regularly with his investment views. By the late ’90s, Soros and Robertson, 71, ran the largest hedge fund management firms in the world, with more than $20 billion in assets each. By 2000, both men had lost billions of dollars from bad bets and client defections. Soros scaled back the risk level in his trades for several years; today, he’s again near the top of the hedge fund heap. Robertson closed Tiger.

Giving traders autonomy and responsibility may be the key to Tudor’s longevity, says David Smith, a Tudor client. “The people who have survived have branched out into new investment areas,” says Smith, chief investment director of multimanager funds at GAM Ltd., a unit of UBS AG that farms out $17.5 billion to hedge funds. “To adapt to the new world order, you need new skills.” Tudor, for example, was one of the first macro managers to develop an expertise in trading stocks, Smith says.

Smith adds that hedge fund managers sometimes get too greedy and lose discipline and creativity, which is one reason that GAM generally doesn’t stay with a fund manager. “Managers often become distracted by the financial reward, and they lose their ambition,” he says. Tudor has been a GAM manager since 1994. “They’ve never relaxed,” Smith says. “They’ve had a great strength in Europe, and now they have to push into Asia.”

Tudor opened its first European office, in London, in 1992, and it now has two offices in the London area, with about 80 employees. They include a seven-person stock investment team, a leveraged buyout group and traders who specialize in macro trading, bets on emerging markets and trades in the debt of troubled companies.

Jones says he didn’t always expect to be a trader. After he graduated from high school in Memphis in 1972, he went to the University of Virginia, where his father had earned a law degree. He says he considered being a journalist. His father ran a financial and legal trade newspaper, and Paul, who was editor of his high school paper, used to write articles under the byline Eagle Jones. He says he was drawn to managing hedge funds because he’s always loved games and odds. Back in college, he says, he routinely played poker. These days, he’s more likely to play Monopoly with his four kids, he says.

When he read an article during college about Richard Dennis—who started with $400 and became a millionaire by making bets at the Chicago Board of Trade on moves of commodities like soybeans, corn and sugar—he says his future was fixed. “‘That’s my dream job,’” Jones says he thought at the time. “He was standing in an arena physically and mentally competing with hundreds of other bright and talented people in an ultimate test of wits.”

After graduating with a bachelor’s degree in economics in 1976, Jones asked his uncle, Billy Dunavant, a cotton merchandiser, to help him get a job as a trader. He says his uncle sent him to Eli Tullis, a cotton trader in New Orleans, who gave Jones a job on the floor of the New York Cotton Exchange.

From there, Jones became a commodities broker at E.F. Hutton & Co., trading futures on the cotton exchange for clients. In 1984, he decided it was time to start his own company. “I wanted the camaraderie of working with folks, and my appetite was such, wherever there was opportunity I was going to go,” he says.

Jones has mellowed since his early days in New York. In the 1980s, he made appearances with Bianca Jagger and Christina Onassis, had a chauffeured car and flew invitees to his 3,000-acre preserve on Chesapeake Bay. He described himself in an interview in the Wall Street Journal in May 1988 as “a cowboy in the purest sense.” In the late ’80s, he let a camera crew follow him around for a documentary called Trader. Now, he and his wife, Sonia, 37, an Australian former model he married in 1989, try to avoid publicity.

Jones says the biggest battle in his current trading life is against being too conservative. “You get so you really want to avoid drawdowns because they are so painful,” he says, using trader’s jargon for losses. While some fund managers aren’t easily thrown off a position once they take it—even if it’s losing money—Jones, who says he spends about 90% of his time trading, sees no point in suffering if a bet moves against him. “All day long, I try to find a happy place,” he says. If he starts losing money, he says, he gets out.

About half of Jones’s trading depends on technical analysis, using historical price charts to predict market moves, he says. He’s even endowed a professorship at the University of Virginia to teach students about technical analysis concepts.

Jones’s toughest time in recent years was in 1999, when he had trouble trading both stock indexes and currencies. “Personally, I contributed squat,” he says. “I was completely, totally wrong—and early—that the Nasdaq would break.” Even though Jones barely made any money for Tudor BVI that year, other Tudor traders did. In Boston, Pallotta’s portion of the fund returned 98%.

“We have 45 portfolio managers, and at any one time, a handful will have markets that present good opportunities, while other portfolio managers are inactive or playing good defense,” says COO MacFarlane, who joined Tudor in 1998. The approach lets Tudor traders practice patience, Jones says. “If you don’t see anything, you don’t trade,” he says. “You take risk only when you see an opportunity.”

Managers are given plenty of leeway. The nine-person management committee meets each quarter to discuss which portion of the assets of the $3.8 billion Tudor BVI Fund each manager will trade. Over the past few years,

– about 60% of the assets have gone to Jones and other macro traders;

– an additional 30% is dedicated to global equities, and the balance to other strategies, such as the trading of stocks of merging or distressed companies.

– The trader then is left alone. Each manager has a maximum loss level;

– the risk management department monitors positions to ensure traders stay within limits.

– If losses exceed the limits, the top executives will meet with the trader to discuss what actions should be taken, Jones says.

MacFarlane, who’s responsible for risk management, says he recalls only three times in five years when traders exceeded their limits, causing management to tell them to sell their positions.

Tudor pays well, basing compensation on the revenue they generate and the expenses they incur, says Dalton, Tudor’s president. Initially, traders get about 15% of their profits, which is generous compared with other hedge funds. “That’s designed to grow over time until it’s competitive with having one’s own firm,” Dalton says.

“They don’t scrimp on compensation,” says Ivo Felder, head of hedge fund investments at RMF Investment Management, a unit of Man Group Plc, a Tudor investor. “On the trading side, that’s very important, because that’s what generates returns.”

Jones’s decision to give other traders the opportunity to manage their own funds came as assets grew to about $775 million in 1991, almost triple what they were three years earlier.

“You learn early in life that 50% of everything you do is wrong,” Jones says. “It’s great to have other people’s opinions for you to rely on.”

In 1992, Jones and Dalton decided they needed to expand by opening a London office to trade in European markets. They also started looking for a U.S. stock picker, and as they asked around, the name Jim Pallotta kept coming up, Dalton says. Pallotta had been managing stocks for almost a decade at Essex Investment Management Co. in Boston, a firm that manages money for individuals and institutions. Pallotta says he met Jones for what was supposed to be a half-hour breakfast.

Two and a half hours later, it was clear they shared the same trading philosophies. “You don’t lose money,” says Pallotta, who grew up in the north end of Boston, where his father worked three jobs. “You just shrink the book when you don’t know what’s going on.”

Now Pallotta manages the $6 billion Raptor Fund, the largest fund in the Tudor universe. Raptor, which was started in August 1993, has posted an average annual return of about 21% since then. About 90% of that money is from outside clients, with the rest contributed by Tudor BVI and other Tudor funds.

A year after Pallotta joined, Tudor hired Tom Bannatyne, 42, from London-based brokerage firm S.G. Warburg Plc, where he was director of European equities, to trade European stocks. Since then, Tudor has added a private equity group in Boston and, last spring, a London-based buyout team, which purchases controlling interests in companies, often using borrowed money. Now Tudor runs two private equity funds and a European buyout fund in addition to Raptor, Tudor BVI and a futures fund. It also invests in about a half dozen outside hedge funds, Dalton says.

Even though Tudor funds are generally closed to new investors—and usually return capital to clients every few years — Jones says he’s still looking for experienced traders with strong track records. Areas in which he might expand include mortgage-backed securities, federal agency bonds and corporate bonds, including distressed, high-yield, and investment-grade issues, MacFarlane says.

It’s not easy to get hired by Tudor, Jones says. Traders must

– have a proven track record of gaining at least 20% a year

– and generally have returns that don’t vary much from year to year.

– And they must be focused on managing risk, he says.

– “What we are looking for is traders who are capable of recognizing when they are 100% wrong and reducing their risk,” he says.

And the person has to be a team player. “We have a very collegial culture,” MacFarlane says. “There is no room for territorialism or not sharing. Many times, that’s caused us to pass on hiring a moneymaking portfolio manager.”

All of the traders share information, whether they work in the commodities, bond, currency or equity markets, Pallotta says. Recently, he says, he sent a message to all of the traders saying his group surveys had found slowdowns in the trucking and packaging industries that were much greater than expected.

Jones contributes to environmental causes such as protecting the Everglades in Florida and raptors in Zimbabwe. His biggest commitment outside his business and family is the Robin Hood Foundation, a charity he started in 1988 with the goal of eradicating poverty in New York. The nonprofit is unusual because the 25-member board pays all of the foundation’s expenses, so 100% of the money raised goes directly to charities Robin Hood chooses. If one of the hundred or so organizations it funds doesn’t meet its goals or mission, the dollars stop flowing.

“I was a child of the ’80s,” Jones says. “It was a period of excess and very egocentric.” Jones says something about the stock market crash of Oct. 19, 1987, changed American culture and made the “me generation” less selfish.

For Jones, the crash was perhaps his greatest moneymaking moment: His fund returned 62% that month. Jones says he had been expecting stocks to plummet since the middle of 1986 and saw patterns in stock indexes very similar to price movements in 1929. After the market dived 5% in heavy trading the previous Friday, Jones says, he expected the worst.

So he bet against stocks and bought more bonds than he ever had, wagering that the Federal Reserve would take action that would send bond prices higher. It was also that day that he dreamed up the idea of Robin Hood. “I thought we’d be in a depression,” he says. Jones says that’s one time he was thankful for being wrong.

KATHERINE BURTON covers hedge funds at Bloomberg News in New York.kburton@bloomberg.net