TIMBERRRR! Even the mightiest oak in the forest must fall sooner or later, and so it was with FX Concepts back near the end of 2013. Boasting over $14 billion under management in 2008, it had become the largest forex hedge fund on the planet, and its founder and major owner, John R. Taylor, the reputed currency guru of our era, had topped the list of fund managers by pulling down an estimated $250 million in annual compensation. But forex is high risk, and Taylor and his cronies would soon respect those words and take a mighty fall. Even the best have bad days is the lesson.
After 26 years, Taylor’s forex juggernaut had reached the pinnacle of success, but in six short years, all would come crumbling down. Losses would become the new normal. Clients would withdraw billions and switch allegiances. Management fees would dry up, forcing employee terminations from the top to bottom. On October 17, 2013, the beleaguered crew at FX Concepts finally threw in the towel and sought protection in the bankruptcy courts via Chapter 11. Liquidation proceedings are still ongoing, but liabilities continue to exceed assets by roughly $77 million.
The average life of a hedge fund is generally accepted as five years, but Taylor had truly beaten the odds, lasting some 32 years at the helm of his enterprise. As a final insult, his $25 million co-op on 5th Avenue overlooking Central Park is now on the chopping block, having been funded by a mortgage from his firm. In situations like these, one wonders where all the money went. One would have thought that he could have paid cash from previous bonuses, but reinvested equity distributions and ownership positions have a funny way of disappearing when the ship goes down.
At 71, John Taylor could easily call it quits, but when you spend your entire career chasing after returns in chaotic financial markets, the peaceful times of retirement living appear as pure anathema. In early 2014, John vowed to return, “”The market is my home, not administration; I am back. The newsletter business will be the primary business asset and livelihood of John R. Taylor as it was years ago.” And so it was no surprise when John announced this week the launching of FX Concept News, a New York-based research and advisory firm. There are already 200 buy-side clients that have plopped down deposits of nearly $12.5 million, an impressive start by any measure.
How did John Taylor and FX Concepts get started in the first place?
John Taylor earned his foreign exchange stripes in the seventies, first with Chemical Bank and then with Citibank, helping multinationals manage their currency risk. But, as John was quick to learn, helping clients hedge their forex risk was never a win-win situation. If the client had a good year, he would question why he had to pay large fees to hedge his risk. If he had a bad year, he was angrier still at having to pay any fees at all. Surely, there must be a better way to make money in the forex arena.
While reminiscing in a corporate video made at a much later date, Taylor noted that, “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.”
Taylor and his associates began development in earnest, creating computer models for both research and automated trading. He and his team became pioneers in the analysis of cyclicality of foreign exchange and interest rate markets. Unbeknownst to them, they were joining the burgeoning wave of the quantitative revolution, where sophisticated math and computer algorithms would glean billions from the financial markets. With a focus on foreign exchange, FX Concepts was up and running at a feverous clip. By 1987, over 250 investors received their research, and it had established a permanent beachhead in the pension fund industry, carving out currency as a new asset class.
There were prosperous years and growing pains in the firm’s first two decades, but the avalanche of success was yet to come. In John’s own words again, “We went on a fantastic streak from 2001 to 2008, and then, since that time, the currency world has been undergoing some changes. The governments now are very, very much involved with managing the currency rates.” 2009 would mark the zenith of Taylor’s rise to stardom. Suddenly, the carefully crafted computer-driven investment models did not perform as expected, and 90% of the trading activities of the firm depended heavily on this systematic approach. A reversal of fortunes for FX Concepts was imminent.
What caused the losses to come and the eventual Chapter 11 filing?
In 2009, FX Concepts lost 17.9% in its flagship fund. Models were revised, and a gain of 12.5% was realized in 2010, but this turn of events was the exception, rather than the new rule for years to come. Another round of double-digit losses in 2011 increased the momentum of client withdrawals. Funds under management dropped to below $3 billion, but when the San Francisco Employee Retirement System in early September 2013 sent notice that it, too, was leaving with two-thirds of the remaining funds, the death knell for FX Concepts had sounded.
In some respects, the inevitable had been delayed due to the firm’s pension fund base. According to one former employee, “Having so many public pension clients probably bought FX Concepts a lot of time. It takes them, like, three quarterly meetings to decide to pull their assets.” Was this “time” used wisely? Many disgruntled employees think otherwise and have registered their complaints in public forums. Time will only tell if lawsuits will follow, but negligence is not the reason most often cited for the firm’s demise. The following opinions have been the reasons given by most industry pundits:
- Taylor did not change rapidly enough to changing market conditions, but, as one writer put it, “He built a stellar reputation and cutting-edge business on his market calls, yet couldn’t execute an exit strategy.”
- Central bankers had flattened interest rates around the globe and intervened in currency markets behind the scenes, thereby making most assumptions in economic models invalid. Long-term trends were non-existent. FX Concepts, along with several other forex hedge funds, lost heavily on the Euro, which everyone had presumed would go to parity with the U.S. Dollar, based on fundamental economic data. When the Fed delayed “tapering”, millions more were lost by speculators;
- Trading is essentially a zero-sum game. You win one year, but your positions can cause the opposite to occur the next. Hubris can easily pump up the ego when success comes your way, or as one fund manager chided, “You can’t start believing your own bullshit.” Lady Luck is fickle. What goes around, comes around;
- Insiders complained of “mission drift” and a reluctance to use leverage to advantage to multiply gains, claiming that Taylor had surrounded himself with yes-men that refused to challenge the status quo. Taylor had handpicked his cohorts, made millionaires of them all, but such practices tend to create an atmosphere of self-interest, rather than one where checks and balances can self-correct serious errors in judgment.
Robert Savage, a newcomer to the firm, a believer in Taylor, and one that had his research company bought out with equity, lost heavily, but could only guess at what went wrong, “Maybe the lesson is that you can’t just be in one market. Maybe they should have branched out and used their knowledge from FX to exploit inefficiencies. They did try famously to get into fixed income, and spent a lot of money and time trying to make it work. Maybe it was wrong time, wrong place; or maybe they were the wrong people for that market. But it’s not like these people changed—John Taylor didn’t grow fangs. The business changed enormously.”
What are the takeaways from this industry failure of mammoth proportions?
Fund managers, as a rule, do not have lengthy track records of success. Do not make the mistake of not having an exit strategy. The longer that you stay with one manager, the higher your odds will be for a failure along the way. You also do not want to put all your eggs in one manager’s basket. Diversification does offer a layer of risk protection, and simple comparisons year-over-year can highlight if any issues are developing that should be attended to immediately. Markets do change, and managers often trust their own judgment, rather than seek independent confirmation of their decision-making process. At the end of the day, if you delegate fund management, you must participate.
Will John Taylor rise like the phoenix from the ashes with his new venture? Leanna Orr, a reporter for aiCIO magazine, concluded in “The Downfall of John Taylor” that, “It’s unclear what will happen to John Taylor. At about 70 years old, with a young family, bankrupt company, and looming debts, he’s living out the downside of founding a hedge fund: skin in the game. But most staff members lost big as well, and few have tears to shed for the man they hold responsible. More so than their own financial stake, former employees lament the loss of the institution and the community that grew around it. In their view, Taylor and his deputies may have built FX Concepts, but it wasn’t theirs to destroy.”
Do you have funds under management with someone else? Maybe it is time to get more involved and to ask a few more penetrating questions of your fund manager. After all, it is your money and your livelihood at stake. Stay skeptical! Question everything!