0. Daniel S. Och, full year results for 2013 

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Understanding Hedge Funds terms

Absolute returns 

Unlike long only funds, hedge funds use absolute returns instead of relative returns.  In reality the only index to beat is cash, and the relevant view is from the beginning of your Investing life until the end.

Alternative investment managers

By investing in alternative investment managers, you can benefit from potentially greater asset inflows as more investors become comfortable with the idea od directing their capital into their funds.  The funds do not share in Client losses, winning fees go straight to bonuses and shareholders. 

Aum

Assets under management (AUM) comes from inward capital cash flows, as well as retained investment returns. There are trillions of dollars of global money looking for a RELIABLE return higher than government bonds but with LESS risk than long only equity. It takes a certain amount of back office to run a fund. You have regulatory costs, staff, research and computers. On a small firm the 2% won’t cover it, which is where the performance fees came in. But when the fund gets really big, the 2% will cover the costs for additional offices to bring in more Clients.

Benjamin Graham

Early Hedge Fund operator. It involved a partnership structure, a percentage-of-profits compensation arrangement for Ben Graham as general partner, a number of limited partners and a variety of long and short positions.

Carried interests
Partners are taxed on their share of partnership income only when a partnership-level realization event occurs, regardless of how long it takes for such an event to transpire or how many years go by before realized funds are distributed.  It happens when the income comes in short term and is deferred or carried until it is long term for tax purposes. - Carry

Distributable earnings
Measure profit minus adjusted income taxes. Och-Ziff reckons this distributable-earnings figure is a more accurate gauge of its performance than Earnings per share.  Market watch

40 Act

The “40 Act,” as investment professionals often refer to it, are Hedged mutual funds which comply with the Investment Company Act of 1940. 40 Act funds, can be owned by small investors and must have daily mutual fund redemption, whereas real Hedge Funds are not regulated, not liquid and require Millionaire investors.

Fee based
The fee based part of the dividend is more predictable than the performance fees. A Hedge Fund may have fees that barely cover expenses in years with low incentive fees, and receive relatively gigantic payouts during periods when the performance fees apply.

Hedge fund
An expression believed to have been first applied in 1949 to a fund managed by Alfred Winslow Jones. His private investment fund combined both long and short equity positions to “hedge” the portfolio’s exposure to movements in the market.  Hedge funds are largely unregulated and therefore are free of the restrictions that keep most mutual funds from pursuing untraditional investment strategies like selling short and investing in complex derivatives.

Hedge fund managers 
Have their own money on the line usually seeking absolute returns.  The 20% of profits is particularly beneficial since that income generally receives favorable capital gains tax rates.  Being allowed to own the management company sidesteps those charges and the stringent income and net worth requirements attached to hedge fund investing. 

Investment banks 

The core activities of investment banks are subject to regulation and monitoring by central banks and other government institutions - but it has been common practice for investment banks to conduct many of their transactions in ways that don’t show up on their conventional balance sheet accounting and so are not visible to regulators or unsophisticated investors.

Leverage
Unlike many hedge funds, Och-Ziff uses very limited leverage, the practice of borrowing multiples of the firm's assets under management to enhance returns.  Management gets 20% of the profits on other peoples money when it goes up, none of the losses when it goes down. 

Loophole

The loophole is that the limited partnership is being taxed as a partnership.  The lawmakers say it is compensation for work and should be taxed as such.  If it should be abolished  the profits for the asset managers will be significantly curtailed by increased taxes.

Och-Ziff Capital Management Group LLC - Prospectus 

Private equity
Multi-million-dollar blocks of “private” capital from a limited number of wealthy investors or institutions, as opposed to the “public” money from unlimited numbers of investors holding exchange-traded, SEC-regulated securities.  Investors in private equity funds contractually limit their ability to withdraw their capital. 

Revenue

OZM revenue is primarily derived from its management fees and incentive income.  Management fees equal between 1.5-2.5% annually of the assets under management, and are set and charged at the beginning of each quarter, based upon the amount of assets under management.  Performance fees, also known as incentive income, generally equal 20%, of the net returns earned by the funds, and form the majority of the firm’s revenues. This poses a problem in bad markets, as the funds have high-water marks that prevent the manager from receiving performance fees unless the fund is above its previous greatest value.

Risk

Risk is not the relative risk of beating some made-up average on retirement day. Risk is not having enough to make partial withdrawals for thirty plus years. It is always a blend of how much to keep earning and how much to spend.

Sales
One of the things that you might notice. Instead of offering a product and trying to sell it like a mutual fund salesmen.  Instead he acts as Investment Counsel which earns higher fees.  Emphasis is on finding out what the client needs and providing it on a three year agreement with 2% and 20% fees.  Then getting them to bring him more problems to solve, so that they re-up with more funds later on.  Instead of offering one strategy to all, they try to mold a strategy to meet the pension fund or Investment banks clients needs.

Two and Twenty
Investment Counsel use to get 2% annually of assets under management, Hedge funds enjoy the “two and 20" fee structure, in which asset managers are paid 2% of assets and 20% of profits.

Tranche
The French word for “slice." A piece, portion or slice of a deal.

Volatility of expected return

 This is what Wall Street calls this risk.  Volatility is not risk when it is anticipated.

What is a Hedge Fund?

Justice Department Probes on Possible Violation of Antibribery Laws

At the center of the probe is a group of middlemen, known as "fixers," operating in the Middle East, London and elsewhere. The fixers established connections between investment firms and individuals with ties to leaders in developing markets.

The investigation is looking at fixers' roles in arranging deals between financial firms and Libyan officials. The fixers acted as placement agents. In some cases, the sovereign-wealth-fund fixers collected a "finder's fee."

Fees paid to placement agents can be legal or can be considered bribes, depending on the size of the fees and the nature of the agents' relationship with the parties to the transaction.

Among the deals being scrutinized is a $120 million hotel project in which Och-Ziff had a stake—a joint venture involving U.K.-based InterContinental Hotels Group as well as a Libyan developer and the Libyan Investment Authority to build a luxury hotel in Tripoli.

Wall Street Journal

Exit strategy

When I learned that China was being overlooked by Wall Street, I wanted a piece of the action.  This was late 1990s.  So first I built positions in all of the China funds on the NYSE.  I learned Mark Mobius was the man to watch, he taught me to let the manager do whatever he wants without limits.  

This led me to a global fund which out performed the S&P enough to pay for my Porsche.  During one of his seminars, this one was in New Zealand, he let slip that he was getting much higher returns on private capital.

In the US only the rich are allowed to get richer using private capital.  It is still that way, three million dollars will not get you in.  Which is why I became interested in a private capital management company that I owned in my Insider portfolio?  

While we cannot Invest in the companies investment properties directly, we can own the management company and earn fees from those very same funds.  They tell me the same thing.  Not to restrict them to any ideas or countries and let them do their own thing too bring us higher risk-risk-adjusted absolute returns.   

Och-Ziff makes investments on a global basis with headquarters in New York City and offices in London, Hong Kong, Mumbai, Och-Ziff Consulting (Beijing) Company Limited, and Dubai.  So with one investment we get a global reach, diversification and a team investing along side of us.

With a pipeline we have solid assets in the ground paying out cash.  But  a management company is a service company.  Our returns come from assets under management (Aum).  

As long as Aum increases we should see greater growth, currently $40.6 billion in assets under management.  When those assets begin to shrink we should not hesitate to bail out.

Och-Ziff history

Dan Och working for Goldman Sac (11 years), took the Ziff Bros (Car and Driver) clients off and started a hedge fund (1994).   They are now one of the oldest and largest Wall Street Hedge Funds.  They always had to worry that the Brothers would take off and the whole thing would fall apart.  About 13 years in, the Partners had a lot of equity in the firm and wanted to go try their own ideas in other countries.

They sold their economic interest to public investors at twice todays prices.  In a sense they cashed-in.  The funds that they received they put into the current and new Oz funds that they had ideas to run.  As investors in the funds they made out as fund owners.  Carry from the other investors funds, went up to OZm which covered the back-end costs and distributed profits to shareholders which as you can see from insider acquisitions included the partners and employees, as well as public shareholders.  

When Rockefeller created a standard oil company he did not want any of the parts making profits.  They all joined the octopus, upstream, midstream and downstream.  All of profits went to the top and everyone with Standard oil shares got the same dividend.  So here the partners took the money from the public offering and ran separate funds.  All of the management fees go to the top which they share with public shareholders who put up the capital to get them free.  The funds that they run bring in more capital, fees from this capital also goes to the top.

If you read the history of Hedge funds that I posted earlier you can see how it evolved from a long/short theory, to managing A. W. Jones’s own funds.  Later he was managing money managers in house, then it evolved into managing other funds.  His deal became a fund of funds.  One big fund made up of smaller funds, managing the risk between them based on the suspected view of the future.   

We see the same thing here.  The original partners took their money out and were given B-shares that had voting rights but no economic rights.  They took their own funds, invested in their own funds under the Ozm umbrella.  The funds have to have a billion dollars under management to cover cost of running a fund and its offices, regulatory responsibilities, etc.  The management company decides where the new cash flows from incoming funds go.

$40.6 billion AUM

The estimated unaudited amount of assets under management is approximately $40.6 billion, which reflects a net increase of approximately $1.4 billion last month.

Fund		December 2013 Performance Estimate (1)(2)					December  2013 Year-to-Date Performance Estimate (2)(3)
OZ Master Fund				+1.55%					+13.90%
OZ Europe Master Fund				+0.65%					+12.41%
OZ Asia Master Fund				+1.63%					+13.64%

Buy owner-managers who want their stock to go up for solid reasons. The firm went public in 2007, and these insiders have a five-year lockup. That means they can’t sell until late 2012. I would expect the partners to cash out some of their stake at that time. They have every incentive to the get the stock price up before then. 

Moreover, they eat their own cooking. Of the $30 billion in assets under management, about 9% is money the partners and employees invested themselves. They have every incentive to do well in their funds because a good chunk of it is their own money. Plus, the partners take no salary or bonus. They get paid the way shareholders get paid through distributions. 

The distributions reflect the performance of the year prior. The big dividend is always the last dividend, declared at the end of the year and paid in February. It’s also a simple business. Gather assets, get paid. Invest well, get paid. There is little mystery here. It generates a lot of cash and has little need to reinvest that cash in the business.

Commentary on prospectus summery.

• 0zm

Hedge Funds went public to go closed-end, to give themselves a pool of “permanent capital.” The money investors paid the partners for the shares was used by the Partners to invest in Oz’s Hedge funds, to monetize equity interest. This they could take out later like any Investor in the Funds.

You understand now how the partners are compensated with restrictions. They might give you a $hundred million, but it is spread out across four years, and you can’t go anywhere. That new guy probably had to sell half, just to pay his taxes on the distribution.

The stock originally crashed because the Summer of 2007 was not the best time to go public. The collapse of the Bear Stearns hedge funds and worries about higher taxes depressed valuations in the whole alternative investment sector. 

July 2007: New-York based Och-Ziff Capital Management Group announced it was planning an IPO on NYSE that could raise around $2 billion, saying it planned to use the IPO proceeds to expand abroad in search of new strategies and investors. As the group planned to sell shares to the public as a partnership, it would not be subject to federal income tax, and also will not have to provide the same level of disclosure as most other publicly traded companies.

The media reflected that the IPO would allow investors to profit from its investment advisory fees and incentive compensation rather than its funds. Moreover, these public offerings can also benefit investors by offering them yet a different way of getting a piece of the “hedge fund action.” Investors who wish to share in some of the gains (as well as losses) of publicly offered hedge fund managers would be able to do so without the high minimums, fees, and long lock-up periods that would typically be required to invest in the manager’s hedge funds.

The hedge fund industry has continued to see increased asset flows in recent years, capital inflows have been concentrated largely into funds with more than $1 billion under management. As a benchmark a lot of them were being valued at 30% of AUM when they went public.

Prospectus Summary

This summary highlights selected information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our Class A shares. You should read this entire prospectus carefully, especially the risks of investing in our Class A shares discussed under “Risk Factors” beginning on page 27, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus before making an investment decision.

Overview

We are a leading international, institutional alternative asset management firm and one of the largest alternative asset managers in the world, with approximately $26.8 billion of assets under management for over 700 fund investors as of April 30, 2007. We have a strong track record spanning over 13 years, which places us among the longest standing alternative asset managers globally.

We were founded in 1994 by Daniel Och, together with the Ziffs, with the goal of building a world class investment management business. Prior to founding our company, Mr. Och spent over 11 years at Goldman, Sachs & Co. Mr. Och instilled the team-based culture he experienced at Goldman Sachs into our firm, and this approach has helped us become a leader in the alternative asset management industry. Today, we have over 300 personnel, with over 125 investment professionals, including 18 partners, located in our New York headquarters and offices in London, Hong Kong, Tokyo and Bangalore. We have been a leader in international expansion in our industry and expect to further expand by opening an office in Beijing later this year.

We seek to deliver consistent positive, risk-adjusted returns throughout market cycles, with a focus on risk management and capital preservation. Our diversified, multi-strategy approach combines global investment strategies, including 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. Our investment processes are designed to incorporate risk management into every investment decision: our portfolio managers meet with analysts daily to review the risks related to their positions and the inherent risks associated with these positions, and we have a risk management committee that conducts regular oversight of portfolio risk. Risk management has been a core foundation of our business since inception and remains a critical part of our investment process today.

We manage and operate our business with a global perspective, looking to take advantage of investment opportunities wherever they arise. We have been among the pioneers in building out a global alternative investment platform, enabling our teams in the United States, Europe and Asia to share ideas and analysis across geographic regions and investment strategies.

We believe our deeply embedded, team-based culture differentiates us from our competitors. We currently have 18 partners and 27 managing directors, all of whom derive virtually all of their income payments from participation in the profits of our entire business. Our compensation system helps minimize the potential for asymmetric risk profiles between fund investors and our partners and employees and fosters a strong culture of internal cooperation and sharing of ideas. Additionally, all of our professional employees have the opportunity to eventually become managing directors and partners, providing a compelling incentive and retention mechanism. We have historically experienced very little employee turnover, and believe that, as a result of this culture, we have been particularly successful in attracting and retaining some of the leading investment and business talent in the industry.

Assets Under Management (AUM) .Estimate as of January 1, 2014.

Founded in 1994 by Daniel S. Och, Och-Ziff Capital Management Group is one of the largest institutional alternative asset managers in the world, with approximately $40.6 billion in assets under management as of January 1, 2014.

OZ the business

What they did in 2008 honoring all withdrawals when others wouldn’t, is what gives OZM the edge now in attracting more money.

With the insiders carrying that much interest in the performance, I can easily see it taking out the next two highs.  The driving force is the increasing AUM.  Most of the new big money coming in is going to the biggest firms as can be heard from the conferences, and backed up online.  Aum goes up, profits go up, relative costs go down, and the evaluation of what those payouts are worth goes up.  

I just don’t want to left out of something I suspected many years ago.  I could hear it between the lines when Mark Mobius taught us, most clearly on that seminar he did in New Zealand a few years ago.  How his private clients has access to things that small investors could not play.

More clearly when congress attacked carried interest, which is the same advantage Kmr has,  carrying the gains forward free of ordinary tax. Pushing the capital gain ahead.

We know why it bottomed in 08, it was probably the Emerging Markets that pulled it up in 09.  In theory the way these LLC pay out all the profit every quarter you would think they could make Investors happy just going sideways.  But something gave Oz a shove in 2013.  Smaller funds may gain market share from the new loosening of restraints on advertising.  But it does not matter for the big players.  Big players have to use big funds to be prudent in an unprudent world.

As the Banks are being kicked out of the game by the Volker rule, Hedge funds, the big Hedge funds will pick up the slack.  Private clients going through Private banks and Pension funds.  Hedge funds that invest in hedge funds (Fund of funds).  China using Ozm as a porthole.

Trillions of dollars are coming this way and we stand to get a percent of that.  Congress threw in the towel on harassing carried interest because Law firms do it and they are all Lawyers.

Simple business, easy to understand, moat around it.  May not be around as long as pipelines, but is having its day now.

Pure play Hedge Fund

It’s truly one of the few pure plays on the Hedge fund businesses. Och-Ziff is structured as a partnership that pays out the lion’s share of its retained earnings to shareholders.

One key reason why I like Och-Ziff is their managers are all about taking on very low risk-adjusted return types of strategies. Here we are talking about pre-announced cash mega merger deals in which there is 2% to 3% arbitrage returned involving a three- or four-month holding period for buying shares now at a discount to the tender value and then cashing them in when due. 

The ability to make sense — and money — doing deals like this is one of the beauties of a hedge fund, and it’s something most individual investors just aren’t equipped to do.

Another reason to like Och-Ziff is due to the anticipation of more institutional money flowing into hedge funds from corporate and public pension funds seeking ways to address looming long-term liabilities. 

Undoubtedly, some of that money seeking high returns will flow to Och-Ziff, and according to CEO Dan Och, he is “very confident” that the company will be able to capture more than its share of the anticipated money flow into the industry.

Bryan Perry Editor, Cash Machine 

Hedge fund rankings

The largest AUM are at a Connecticut firm at about 3 times Oz.  J.P Morgan’s AUM are about double Oz.  Clearly Ozm is not being hampered by its size, and has plenty of room to grow.  

When it doubles its amounts under management (Aum) you would think it could double its income.  All things being equal (caters paribus). Double income, double payout, less important double payout, double market value.  Which just makes compounding more expensive.

A.W. Jones - The Original Hedge Fund

A.W. Jones - The Original Hedge Fund 

Measuring Market Risk

Jones was light-years ahead of both Wall Street practitioners and the academic community in developing an understanding of market risk as well as the relationship between individual stocks and the market. Before the academic community had codified the Capital Asset Pricing Model (CAPM) with its notion of Alpha and Beta, Jones had developed his own measure of market risk and how individual stocks related to the market. Even more astonishing is that he was actively managing the exposure of a risk-adjusted portfolio with this system.

Jones calculated a metric for each stock called Relative Velocity, which is closely related to the CAPM's Beta (the key difference being the omission of the risk-free rate in the calculation of Velocity). Relative Velocity was the tendency of a stock, based on historical performance, to move with the S&P 500 to a greater or lesser degree. Armed with this metric, the firm could then calculate to what extent its long book and short book were correlated with market moves. What follows below is an excerpt from the 1961 Basic Report to the Limited Partners of the firm, describing in detail the measurement and management of market risk.

From the 1961 Basic Report to the Limited Partners:

ON MEASUREMENT AND REPORTING 

This is our post-graduate course. It should be taken by all partners and must be taken by those who wish fully to understand our bi-monthly reports. 

In the main body of this communication we described our investment theories and explained at least the basis of our method. It now must be made clear that such a program cannot be put into operation without careful and continuous controls. We have developed methods which provide accurate measurement of the degree of risk being taken at all times as well as a system of allocation by which we determine whether our gains or losses are attributable to stock selection or to the trend of the market. Daily computations using this method enable us to see where we stand and permit us to plan any desirable changes with regard to market risk. In addition we have a moving record of our accomplishments in market or stock-selection judgment. 

Relative Velocity

Different stocks habitually move up and down at different rates of speed, and hedging $1,000 worth of a stodgy stock against $1,000 worth of a fast mover would give no true balance of risk. We must therefore compute the velocity of all our stocks, both long and short, by their past performance, compared with the past performance of a good measure of the market as a whole. For this we use Standard and Poor's 500 Stock Index, which we consider the most scientifically constructed of the several averages. We shall refer to it below merely as the Standard 500. 

We measure, for example, the size or amplitude of all the significant swings in the price of Sears Roebuck since 1948 against the corresponding swings in the Standard 500 and find that the average extent of these moves is 80 per cent of the average extent of the moves of the Standard 500. We say therefore that the Relative Velocity of Sears is 80. 

By the same measurement (which we have made and which we bring up to date at about two-year intervals for over 2,000 stocks ) we find that the velocity of the stock of General Dynamics is 1.96. Obviously, to buy and sell short, respectively, equal dollar amounts of Sears and General Dynamics would constitute no true hedge. Instead there would have to be more than twice as much of the stable Sears stock as of the volatile Dynamics to cause them to offset each other in market risk. 

To illustrate :

This would seem to be no hedge at all, but appearances change when we correct each dollar amount by the respective velocities of the two stocks:

It must be pointed out that relative velocity has nothing directly to do with the desirability of a stock. All a velocity measurement does for us is to measure one aspect of the risk we are taking when we buy it or sell it short. Either Sears or General Dynamics might be a good purchase or a good sale, depending on all the factors that go into stock selection. From here on all the amounts used in the various examples of aggregate stock holdings will be dollar amounts after correction for velocity.

Since the Standard 500 is composed mostly of the big "blue chips," which move slowly, a portfolio of stocks commonly used for investment by us will have an average velocity over 100. Thus a list of typical stocks worth $70,000 to $80,000 in cash, might come to $100,000 after correcting for velocity (cash times velocity in each individual stock.) 

Measurement of Results 

Let us now take the simplest of cases -- a fund of $100,000 equity or net worth, with $100,000 of long positions and $100,000 of short positions (each position computed in cash times velocity.) Such a fund, being fully hedged, has a market risk of zero and all net gains or losses will be attributable to good or bad stock selection, none to the action of the market. 

For six months we maintain this even balance between long and short (this could hardly happen in actual practice,) though we shall certainly make shifts during the period within both the long and short list, thus realizing profits and losses, and then replacing the long stocks sold and the short stocks covered. Every day from the newspaper stock tables we calculate our gains and losses, arriving at a net figure for the long list and a net figure for the short list. These two figures are kept cumulatively and include both unrealized and realized gains and losses. By the end of six months, the following has happened: This is fine as far as it goes. It tells us that we have made $7,000 by good stock selection (since we are fully hedged), but it doesn't tell us how to allocate the gain as between long and short selection—perhaps we should have made more on the long side, in the market rise, or perhaps lost less an the short side. So the following further calculations are necessary: 

1) Just to keep pace with the "market" rise of 5%, our long stocks, worth $100,000 should go up by $5,000. But in fact they went up by $9,000. The difference, attributable to good long stock selection, is $4,000. 

2) Also to match the rise in the market, our $100,000 worth of short stocks should have gone up, showing us a loss of $5,000. Actually they went up only $2,000, and the difference, due to good short stock selection, is $3000.

3) For a total gain, to account for the net gain shown above, of $7,000. 

With an Unhedged Balance 

When we are not fully hedged, but have a net-long (as is usually the case) or a net-short balance, the operation has an added complication. Suppose now, still with $100,000 of equity, we are optimistic about the stock market, so we buy stocks worth $130,000 and sell short stocks worth $70,000. We hold this balance (though we may shift individual stocks) for one week, during which time the following happenes:

Our problem now is to allocate fairly this net gain.

Reporting 

Our reports go to a good many persons besides yourselves, and because we do not wish to reveal to all who receive them the size of the fund, also in order to indicate more clearly to you the change in your own partnership share, the figures for gains and losses are not stated in dollar amounts but in percentages of our net worth at the beginning of the fiscal year. Therefore if the week's results illustrated above were for the first week of the year, the report for that week would read: 

Progress : Since June 1, our fund has gained 2.1% against a gain of 1.0% in the Standard 500. On long stocks we show a gain and on short stocks a loss of 0.4%

 

These figures are the result of calculations made every day and kept cumulatively for the entire fiscal year. They include both unrealized and realized gains and losses for the period from the beginning of the fiscal year, and are calculated after brokerage expense and transfer taxes on all transactions that have taken place. 

The reports take into account dividends received on long stock and dividends paid on short stack. They take into account also, at monthly intervals in our cumulative reckoning, the interest we pay to banks and brokers. 

However, the reports overstate the eventual return to you, since they cannot conveniently, and do not, take into account the 20 per cent of realized capital gains paid over to management at the end of the fiscal year. Also, as the year goes on, the reports become more and more unfair in the comparison with the Standard 500 since to the latter should be added a small percentage as dividend yield. 

We used to report regularly and we still do report occasionally the amount that we are making in the hedged part of the fund alone. In the example above, the hedged part of the fund is the entire minority, or short list, ($70,000) combined with an offsetting $70,000 of the long list. The entire long list being $130, 000, the hedged part of it is 7/13 of the whole. We now find how much we have made in the hedged part by the following calculation: 

We keep this figure cumulatively during the fiscal year, reporting it also as a percentage (in this case 0.9%) of our equity. By a somewhat complicated method we calculate from it what we make on the hedged part of the fund as a percentage of the money actually used in it. This is a gain obtained without risk due to the trend of the stock market, and not to be had by any other form of investment procedure. 

The Risk Figure 

In the Market Judgment section of the reports you see a number variously called the risk figure, market risk, or percentage of risk in the Standard 500. From the above it is easy to see how this is obtained. Remember that our list of long stocks aggregates $130,000 only after the cash value of each stock in it has been multiplied by its velocity, relative to the Standard 500. This relates our long stocks to the Standard 500, so that $130,000 long gives us a risk on the long side alone (our equity being $100,000) of $130,000 divided by $100,000, or 1.3. Instead of using a decimal fraction we use a percentage and say that our long side risk is 130. By the same reasoning, our short risk, also exactly related to the risk in the "market", or Standard 500, is 0.7, or 70 per cent. Our net-long risk is therefore 60 (130 minus 70), which means that our net-long risk in the stock market is equal to 60 per cent of the risk we would be taking if we had our whole equity exactly invested in the stocks of the Standard 500. 

Any minus figure will stand for a net-short balance, in which we gain from a decline in the stock market. At plus 40, say, we would be incurring about the market risk of a widow with half her money in somewhat stodgy, blue-chip common stocks and half in bonds. At plus 100 to 150 we would be taking the risks of a business man with most or all of his capital in more volatile stocks. 

Containing, as it does, the velocity measurements of all of our stocks relative to the Standard 500, the risk figure is a very precise measurement of just what we want to measure. It enables us to adjust our position in the market exactly to our outlook for its probable future trend.

A.W. Jones - The Original Hedge Fund 

In the style of A.W. Jones.

Heirs to A.W. Jones by Chris Mayer Aug 15, 2011.

Last week, in The Daily Reckoning column entitled, Hedge Yourself!, I shared a few highlights from the investment philosophy of Alfred Winslow Jones, the “father of hedged funds.” Today, I’ll share some insights about some very smart guys who manage money in

In 1994, Daniel Och and the Ziff brothers started Och-Ziff Capital Management (NYSE:OZM). They wanted to earn consistent returns with low risk. In a sense, they were heirs to the ideas and techniques of A.W. Jones. And they have done him proud. The success of the OZ Master Fund, the main fund of the company, is one of the best in the business.

Since inception in ’94, the OZ Master Fund returned 14.2%, versus 8.4% for the S&P 500. That’s huge outperformance. Even more impressive is how it did so with a lot less risk. This is the idea of being “hedged.” You can see it in the performance of the fund during down months.

In all but four of the years, the OZ Master Fund actually made money during down months! And even when the fund fell, it fell far less than the market. With performance like that, it is no wonder Och-Ziff today manages $30 billion in assets, mostly institutional money such as endowments, pension funds and the like.

In the world of money, Och-Ziff is known as an alternative asset manager, an option becoming increasingly popular post-crisis. Based on various surveys, institutions are likely to boost their allocations to alternative managers more than threefold from 2009. This is a good tail wind for Och- Ziff. So one catalyst for the stock is growing that $30 billion number.

But what I really like about Och-Ziff is the people and the structure of the company. Successful money manager Martin Sosnoff was once asked how he invested in management teams. What did he look for? He answered: “I am always looking to buy owner-managers who want their stock to go up for solid reasons.”

Och-Ziff has exactly that. Dan Och is CEO and head of the investment committee. Och and his partners own nearly an 80% economic interest in the same assets at OZM shareholders. The firm went public in 2007, and these insiders have a five-year lockup. That means they can’t sell until late 2012. I would expect the partners to cash out some of their stake at that time. They have every incentive to the get the stock price up before then.

Moreover, they eat their own cooking. Of the $30 billion in assets under management, about 9% is money the partners and employees invested themselves. They have every incentive to do well in their funds because a good chunk of it is their own money. Plus, the partners take no salary or bonus. They get paid the way shareholders get paid – through distributions.

Those distributions are fat. Och-Ziff pays out 80-90% of its earnings. In the past three years, distributions per share were $1.42, $0.19 and $0.88. The distributions reflect the performance of the year prior. They took a hit in the financial crisis in 2008, as you can see with the low distribution in 2009. But they have since recovered. For the last 12 months – which includes the first quarter of 2011 – the stock’s paid $1.01 per share, for a near-10% yield!

In 2011, Och-Ziff should earn around $1.50 per share. Take 85% of that and you get $1.28. On $11.25 per share, that’s an 11.3% yield this year. The big dividend is always the last dividend, declared at the end of the year and paid in February. In 2012, the stock could earn $1.80, which would pencil out to yield of 13.6%, based on the current share price.

Key risks? There are always at least a few. One is there is some discussion of raising taxes on publicly traded partnerships. If subject to full corporate taxes, Och-Ziff would suffer a 20-25% drop in net profits. However, this has been bandied about for a while, has gotten lots of press and is at least partially discounted already. Plus, such a rule would likely be phased in over a number of years, softening the blow. The other key risk is what we called “key man” risk in my banking days. If Dan Och got hit by a bus, that would have a big impact on the firm that bears his name.

Let’s see if Och-Ziff meets my CODE criteria:

Cheap? The stock market is a market of secondhand goods and it can help to think about why the shares are for sale at all. The insiders sold a piece of the business to the public at over $30 per share in an IPO in late 2007 (and invested 100% of the proceeds in Och-Ziff funds). Today, OZM is half that. Asset managers typically get valuations of 19 times management fees and 9 times incentive fees. The former fees are valued highly because they are very stable, and the latter less so because they are more volatile. Using the blended 14 times for Och-Ziff gives us a value of about $21 per share on $1.50 in earnings, which seems fair, if conservative. When you consider Och-Ziff has grown assets under management at a 19% clip since 2001, it looks cheaper still. Looked at another way, the stock trades for about 10 times 2011 earnings. A growth stock, yet you are not paying for growth. The high yield offered also protects the downside here.

Owners? Och-Ziff aces this test, which forms a key part of our thesis, as I discuss above.

Disclosures? One of the most transparent companies in the business. It’s also a simple business. Gather assets, get paid. Invest well, get paid. There is little mystery here.

Excellent financial condition? Och-Ziff has few assets of its own, mainly cash, tax assets and some investments. What it has is $30 billion under management, a great brand name in the business and a team of talented and vested insiders. There is little debt, especially compared to its huge cash flows. Och-Ziff is in excellent financial condition.

Asset management is one of the best businesses in the world. It generates a lot of cash and has little need to reinvest that cash in the business. (Hence those fat distributions.)

I like Och-Ziff. 

Secure dividends

  Somehow I don’t see Hedge fund dividends as secure as pipelines that feed utilities. 

Ozm compared to Kinder Morgan

With pipelines there are two ways we bring in cash. Spot tariffs on pipelines are higher than contracted rates, though they forsake the reliable cash generation that comes along with contract agreements. 

Kinder favors the long term contracts that fuel our steady dividends.  Ozm’s incentive distribution is more like selling in the spot market. Both companies have a blend. Kinder's Trans Canada pipe is about 80% contract, 20% spot (Contracts sold to committed shippers is 708,000 barrels per day (bpd), Trans Mountain total will be 890,000 bpd). 

Ozm contract fees covers more than cost, but incentive fees supply most of the distribution.  That means that Kinder can determine its dividends further out. Ozm has to wait until it is actually earned to know how much it will pay out. 

Somehow it seems like OZ is out of touch with what Investors want. He thinks if he shows a record of incentive payouts, that Investors will pay for the unearned, uncontracted, evaporatable income payments at greater multiples in the share price. He must think its like a credit card report that gives you more points for a longer payment history. 

Insider buying is a clue that both look undervalued from the inside.

Daniel Saul Och part 2

Daniel Saul Och part 1

Jon Parepoynt

Great article. I agree with the premise and believe OZM is under followed and under owned. I think it is far better to own the shares of the hedge fund managers than their products. In addition, many hedgies use their shares as additional compensation, meaning management has a very vested interest in keeping share prices high.

One interesting note is that during the financial crisis, other funds were hedging their redemptions while OZM embraced them. This higher transparency has led to a better reputation in the sector. 

Jon Parepoynt Seeking Alpha

Charts tell the story

This chart shows Total Return, the only thing that matters in an IRA.  Charts were going OK until they dropped that $0.75 dividend on us last February.

Ozm hit another new high and an s/a article came out today.  Ozm is the fifth largest hedge fund firm and one of the fastest growing with a compound annual growth rate of approximately 19% over the last 11 years.

This is the deal with management companies, assets under management, not how much they make in the markets each year.  The Hedge Fund they manage has returned more than double the S&P 500 while taking less than a third of the risk.  Like Kmr the LLC pays out nearly all its income to shareholders.  The dividend pays 7.7%.  Quarterly distributions are considered a return of capital, not interest or dividend income, which means a K-1s and tax advantages.

I only went with these guys because of my interest in the Investment Counsel business which I understand, and my belief that the management companies prayed upon Investors and Private Bankers.  Risk of dilution is high as OZM could sell new shares of stock and use shares to pay help.

These charts tell the story

This chart shows the current jump in P/E ratios that is causing the rise.

Investors are pissed off at them because they diluted the shares to pay off debt a few years ago.  This shows in a low P/E ratio.   Och-Ziff reckons this distributable-earnings figure is a more accurate gauge of its performance than Earnings per share.

Using a dividend discount valuation methodology off of Bloomberg (above) intrinsic value looks to be approximately $17.50 per share, or about 34% higher than the current price.