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Most hedge funds like to retain an aura of anonymity. My old firm went without a nameplate outside its front entrance; clients would squint up at the building and down at the address in their calendar, wondering if they had the right place before being ushered in by doorman Arthur. Other firms put up a single landing page as their website, void of any information that may allow outsiders to discern their activities. 

So it’s no wonder that hedge fund firms have been slow to list on public markets. The merits of issuing a currency to attract and retain talent and facilitate a transfer of ownership run counter to the ingrained culture of privacy. Going public might offer hedge fund founders a payday, but it also requires them to participate in quarterly earnings calls and answer analysts’ questions – a potentially unedifying experience when those analysts work for competitors. 

Back in 2007, two firms bucked the trend. They had been formed 12 years earlier and between them had accumulated over $50 billion of assets under management. Founders were mulling succession plans and concluded that a liquid market in their stock would smooth the process while rewarding them for the franchise they’d created.

The first of the two firms – London-based GLG Partners – didn’t survive long in the public domain. It listed on the New York Stock Exchange in mid-2007 via combination with a SPAC. Initially valued at $3.4 billion, it was bought by Man Group three years later at a valuation half that.

The second – Och-Ziff Capital Management Group, later rebranded Sculptor Capital Management – finally called time this week. It came to the market at a price of $320 per share and was purchased this week at a price of $11.15. Along the way, the firm suffered many blows, some landed by the market, most self-inflicted. The process didn’t even surface a succession plan: One candidate ended up in jail and another fell out with the founder in a high-profile feud.

But, as a public company, Sculptor opened the veil on the inner workings of a hedge fund. The sixty 10-Qs and 10-Ks it filed with the Securities and Exchange Commission along the way tell a story of how money is made and lost in the industry, how the spoils are shared and how challenges are managed. If you want to understand the business of hedge fund management, Sculptor is a good case to study. 

Most people in the investment industry have an awareness of the Tiger Cubs – a large cohort of firms set up by former employees of Julian Robertson’s Tiger Management. But Tiger wasn’t the only place that nurtured a disproportionate share of investment talent. At Goldman Sachs, Robert Rubin’s risk arbitrage desk turned into a training ground for successful investors. As M&A activity accelerated during the late 1970s and throughout the 1980s, Rubin understood the strategic importance of detached, rational analysis and the ability to craft decisive merger arbitrage trades based on it, so he recruited people with that same calm, analytic detachment. 

“Arbitrage became known as the area where the very brightest people worked together,” Charles Ellis writes in his history of Goldman. “It developed into a power node of creativity and profitability within the firm.” Rubin later went into government but his employees fanned out to found hedge funds including Perry Capital, Farallon, Axon, Eton Park, ESL … and Och-Ziff.

Daniel Och had been at Goldman for 11 years before he decided to branch out on his own. In 1994, he secured backing from the Ziff media family to set up a new fund. April 1994 was a difficult time to launch – the bond market was in crisis – but Och got off to a good start; he was up 3.35% in his first month of trading. 

Och’s fund employed a multi-strategy approach, encompassing merger arbitrage, convertible arbitrage, equity restructuring, credit and distressed credit investments, private equity and real estate. “We base our investment decisions on detailed, research-based, bottom-up analysis, and our investment philosophy focuses on opportunities for long-term value,” the firm told investors. 

Over the 13 years up to his IPO, Och’s OZ Master Fund would go on to do a net annualised return of 16.6%, higher than the return of the S&P 500 market index on a lower volatility – the kind of risk/return profile investors love. When the market went up, the fund would do OK and when the market went down, it wouldn’t fall by as much. “Quite simply our performance in down months for the S&P 500 is what I think best differentiates Och-Ziff and our investment approach,” Och told investors later.

Asset growth followed. Och agreed with the Ziff family that he wouldn’t raise outside funds for five years. When the restriction was lifted, he used his track record to win new clients. By the time of the IPO, Och was running a $19 billion fund.

But a single fund, even if it is diversified by strategy, doesn’t constitute a business. A business (at least an IPO-able one) needs to be durable and that requires more people, more offices, more clients, more funds – in short, more diversification. Och-Ziff established a European operation in 1998 and an Asian operation in 2000, launching dedicated regional funds shortly afterwards. These funds accounted for around a third of firm assets under management in September 2007, with the OZ Master Fund accounting for two thirds. In total, the firm had 700 investing clients and 350 employees, including 135 investment professionals. 

The question though was whether Daniel Och was sharing sufficient economics with these other parts of the group. It’s a question we put to him – as analysts working for a competitor – when he came into our unmarked office to pitch us the IPO. In particular, Michael Cohen, Och’s protégé, dispatched to London to run the European fund, was being offered only 6.7% of the firm’s equity in the transaction despite managing 20% of its assets. His performance was as good as Och’s, too: up an annualised 16.3% a year since launching at the beginning of 1999. 

Och blustered about franchise and team and future opportunity while Cohen stared out the window, but it didn’t matter. What none of us anticipated is that Cohen would end up destroying more shareholder value at Och-Ziff than he created.

A few months before meeting with us in London, Cohen had flown out to Vienna to meet with the son of Colonel Muammar Gaddafi of Libya. Introduced by an intermediary, he was keen to secure an investment in the firm’s funds from the Libyan Investment Authority. “They [the Libyan Investment Authority] have 77 billion, half in cash and no idea who to give it to… I haven’t been this excited in a while,” he emailed Och.

At the time, Libya was open for business. Sanctions had been lifted in 2003 and would not be reimposed until 2011. But the way Libya did business in this window was…different to anything Cohen may have been used to. He ended up securing a $300 million investment but it involved an off-the-books “fee” payable to the intermediary which got funnelled back to Gaddafi’s son and other government officials. 

It took a few years for any of this to come out. In the meantime, Cohen splashed “fees” around on other deals. He made an investment in his intermediary’s Libyan real estate company before moving on to Chad, Niger, Guinea and the Democratic Republic of the Congo, in all cases paying off high-ranking government officials for access to various investment opportunities. In most instances, bribes were paid with investors’ money rather than Och-Ziff’s own capital. 

By 2011, the authorities were on to him. In its 2013 10-K, published in early 2014, the company admitted that it had “received subpoenas from the Securities and Exchange Commission and requests for information from the U.S. Department of Justice in connection with an investigation involving the FCPA [Foreign Corrupt Practices Act] and related laws… At this time, the Company is unable to determine how the investigation will be resolved and what impact, if any, it will have.”

The impact turned out to be quite severe. In 2016, the firm settled with the authorities, agreeing to pay a fine of $412 million, at the time the fourth biggest FCPA enforcement ever. Daniel Och wasn’t alleged to have been aware of the actions, but he agreed personally to pay a fine of $2.2 million for a record-keeping violation. Cohen, meanwhile, was found not to have been entirely honest with investigators during their inquiry. He was charged with making false statements about the date of a loan he made to one of his intermediaries and, at the end of 2019, he was sentenced by a Brooklyn federal judge to three months in prison. (He was released a week early at the outset of the pandemic.)

Och committed to tighten up his firm’s compliance processes, but clients were rightly appalled. Starting in 2014, the firm’s flagship fund started to see redemptions. Before revealing that an investigation was underway, the firm had $32 billion of assets invested in its multi-strategy funds. In 2015, $4.7 billion flowed out; in 2016, $9.0 billion flowed out; in 2017, $9.2 billion flowed out. It didn’t help that performance was weak, too: +5.5% in 2014, -0.4% in 2015 and +3.8% in 2016.

Fortunately, Och had another protégé.

In 2006, Daniel Och hired Jimmy Levin into the firm in New York. He’d already known Levin, having helped him secure his first job from college three years earlier. Levin joined as a credit analyst. By 2010 he had become head of US structured credit and was very excited about the prospects for the asset class. Residential and commercial mortgage backed securities had fallen out of favour following the financial crisis and Levin spotted an opportunity. 

In 2012, backed by his team of 14 people, Levin allocated $7.5 billion on a trade linked to these securities. It paid off, scoring gains of nearly $2 billion, or about 25% before fees – “likely making it one of the top trades on Wall Street” that year, according to the Wall Street Journal. 

The following year, Levin was made global head of credit and sought to build up the credit side of the business. “We certainly weren’t known as a credit shop when I first met with clients,” he said. “Those early meetings weren’t the easiest in the world.”

But the pivot saved the firm, with credit strategies providing a ballast when assets started to flow out. The firm launched an institutional credit platform to invest in performing credit and it also issued a succession of closed-end credit opportunistic funds that kept capital locked in. As the flagship multi-strategy fund withered, credit picked up the slack. Having accounted for 85% of firm assets in 2012, the multi-strategy funds – chiefly Daniel Och’s original OZ Master Fund – shrank to account for less than 30% of assets by 2019. 

The problem for outside shareholders is that these new strategies, in particular institutional credit, were less profitable than the traditional core multi-strategy business. Not that multi-strategy hadn’t suffered price compression following the financial crisis. In 2010, the firm had to revise its high water mark condition, bringing it into line with industry norms. Previously, the fund had one year to recoup any losses made and if it didn’t do that, performance fees would begin to accrue again off a new lower base; after 2010, the fund would have to recapture all losses before charging a performance fee. In 2016, the firm also cut management fees on the fund by 25 basis points. 

Firm revenue fell from a peak of $1.63 billion in 2013 to below $500 million in 2018. Management fees, which historically made up just over half of total revenues (the rest being incentive fees) fell from 1.50% of average assets to 0.80%. 

Nevertheless, Levin, recognising he was running a growing share of the firm’s assets, pushed for a greater share of the economics. In 2013, he received nearly $119 million in stock awards, based on the fair value of the shares at the time they were granted. In 2017, he was promoted to co-chief investment officer and awarded shares worth as much as $280 million in a plan designed “to incentivize Mr. Levin for the services, contributions and leadership he provides and to ensure the future continuity of the company.”

The underlying motive was to get Levin ready to take over from Och as CEO the following year. But, over Christmas weekend 2017, Och changed his mind. Supposedly, Levin was pushing for too great a share of the firm’s economics at Och’s expense. Levin retreated to his chief investment officer role in the knowledge that he’d be leaving too much money on the table if he were to quit the firm, and an external candidate was brought in as CEO. 

Levin did eventually take over as CEO in April 2021, but not before a major reallocation of shares took place between the old guard and the new. In December 2018, the firm announced that around 17% of its outstanding shares would be transferred from retired personnel – including Och – to current employees in return for some of the current team taking a cut in their annual pay.¹

The plan “underscores our collective focus on aligning incentives across the organisation in order to achieve outstanding results for our shareholders and global clients,” said Daniel Och (at the same time as he redeemed two-thirds of his investment in the firm’s funds). 

But Och remained a major shareholder, controlling 15% of the company alongside other founders, and didn’t like what he was seeing. In August 2022, he filed a lawsuit against the company, complaining that Levin had received “a series of escalating compensation awards” culminating in a 2021 payout of $146 million, “exceeding the pay of the CEOs of nearly every other public company in the United States, including Apple, JPMorgan Chase, and Goldman Sachs.”

The IPO may have created the means for a transfer of leadership but it never created the spirit; it just meant that the normal travails of hedge fund succession got played out in public. And it got pretty ugly. 

In November, Och agreed to back down as part of a deal in which the firm agreed to put itself up for sale. That sale was finally announced this week. Rithm Capital, an asset manager focused on the real estate and financial services industries, is buying Sculptor for $639 million in cash, reflecting a price per share of $11.15. Levin will remain its head, but he will report to the CEO of Rithm.

When a closely held firm goes public, it brings in an entirely new class of stakeholders, whose interests aren’t necessarily aligned with either employees’ or customers’. Sculptor even introduced a fourth class of stakeholders by issuing debt. Prior to its IPO, the firm borrowed $750 million to make distributions to its executive managing directors. After paying back that loan, it took out another which contained a covenant linked to the firm’s overall fee-paying assets under management (drop below $20 billion and the firm would have been in breach). 

Managing all these interests is hard, and it is clear that Sculptor failed. In its 15 years since IPO, Sculptor’s multi-strategy fund returned only an annualised 5% per annum to investors, a steep drop from returns prior to the IPO. Across all its strategies, investing clients accumulated $16.8 billion of returns, net of fees. Against this, the firm itself captured revenue of $12 billion, which was shared $4.3 billion to employees, $2.2 billion to admin expenses, $1 billion to the tax authorities and a bit to debtholders via interest expenses, leaving $4.4 billion for outside shareholders.

In 2022, its last full year as a public company, Sculptor squeezed out just $56 million for outside shareholders after paying employees $218 million and losing money across all main strategies. There’s a saying about hedge funds, that they are a “compensation scheme masquerading as an asset class”. Sculptor’s public filings don’t disprove that.

From its perspective, by adding Sculptor to its existing businesses, Rithm wants to recreate a mini-Blackstone. “If you look at what Blackstone has, and obviously, they have their mortgage REIT and they have their private capital business. I think any of us in the asset management business would aspire to have a reasonable capital structure that looks something like that,”  said Rithm’s CEO on the call announcing the transaction. “So, we’re not going to get to $1 trillion in assets, but I look forward to getting to some percentage of that.”²

With Sculptor wiped from public markets, it is unlikely another hedge fund will aim to fill the gap. It was a useful experiment, but not one anyone wants to repeat.