The Last Days of Whitney Tilson's Kase Capital

March 20, 2018   Michelle Celarier

The hedge fund founder explains why his fund was "sucking the joy" out of his life -- and why he's turning its failure into a teachable moment.

   Illustration by Nicolas Ortega

Whitney Tilson's Facebook friends surely thought he was on top of the world last summer.

Photo after photo posted on the social media site tells the story of a rich, exciting life: There's Tilson watching whales off the coast of Iceland. Next, he's on the canals of Amsterdam with his wife and daughter. Just a few days later, he's checking out Lenin's tomb in Moscow. Last August he even climbed to the top of the famed Eiger mountain in the Swiss Bernese Alps, photographing every step of the arduous journey.

But to hear Tilson talk today, the reality was grim. After 18 years in the hedge fund business, his firm — Kase Capital Management — was losing money, and Tilson found himself dipping into his savings to keep it afloat.

"I had lost my passion for the game," Tilson confided in a two-hour, soul-searching interview about the events that led him to shut down his hedge fund last September. After gaining 184 percent, net — when the broader market was up only 3 percent — during the first 11 and a half years of his hedge fund's existence, Tilson's returns had been floundering. Since 2010, Tilson says, he trailed the Standard & Poor's 500 stock index, and in 2017 he had lost almost 9 percent on the year by the time he shut down his fund. "In an ironic twist, I always built my firm to survive the worst storm, but it was a nine-year bull market — complacency and sunshine — that took me out."

Tilson is one of several veteran hedge fund managers, including Eton Park Capital Management's Eric Mindich, Hutchin Hill Capital's Neil Chriss, Eclectica Asset Management's Hugh Hendry, and Blue Ridge Capital's John Griffin, who called it quits in 2017. Small hedge funds come and go with great regularity, but the inability of the industry's stars to profit as the stock market soared to new heights has raised questions about the viability of the model. Tilson was a much smaller player than the others — at his peak he managed only $200 million — but his experiences are a window into the headwinds that have faced these former masters of the universe.

What distinguishes Tilson from many of his peers is his willingness to talk about the long, excruciating road down. "It's hard, after seven years at sucking at something, to wake up and tap-dance to work. So, I found myself getting distracted. I wasn't physically getting out of shape; it was the opposite. I was going and climbing mountains. This one part of my life, I was miserable at; I was having no success. It's hard to have the self-discipline to focus all your attention like a laser, and all your spare time on a particular part of your life in which you're getting so much negative reinforcement."

Last year, as his fund's losses began to mount, Tilson says, "I didn't feel like I could look my investors in the eye and say, "˜Look, I'm losing you money, but I'm not doing anything else, 18 hours a day that I'm awake, the only thing I am doing is trying to turn performance around.' " The vacation photos notwithstanding, Tilson says he even felt guilty attending his daughter's soccer games. "My hedge fund was sucking all the joy out of my life."

Tilson's introspection is uncommon for those in the hedge fund business, where self-confidence and salesmanship are as important to success as any investing prowess. As Tilson readily admits, managers cannot afford to be frank while they are going through turmoil, lest they further hurt their business — and their investors. "The last thing you want to do is air your dirty laundry. That will further shake the confidence of your investors."

But there's another reason for Tilson's uncommon openness: His experiences, both positive and negative, have led him to create a whole new business, turning Kase Capital into Kase Learning (Kase stands for the first letters of the names of Tilson's wife and three daughters). From a small conference room at the New York Athletic Club, Tilson has started teaching the perils and profits of investing in general — and running a hedge fund specifically — to aspiring youngsters who don't come out of big seeding platforms like Julian Robertson's Tiger Management or a multibillion-dollar hedge fund.

"Unless you are the lucky 1 percent who has the chance of learning in an apprenticeship, how are you supposed to learn how to do this?" Tilson says. "Nobody teaches the next generation. There is not one business school on the planet that teaches anything really usable to starting up your own hedge fund.

"It's so rare to talk to a manager who is injected with truth serum, isn't it?" he asks as he details his long bumpy journey through hedge fund land. "But I don't give a crap anymore."

TILSON, age 51, still has an athletic endurance that means you'd never know he has been suffering from a kidney stone for days. After a weekend in San Francisco, where the pain got so bad he had to delay his flight, he's back in New York City. Dressed sharply in a navy blue suit, crisp white shirt, and hot pink tie, Tilson is pitching his new business to prospective students. He calls it a boot camp: "Lessons From the Trenches: Value Investing, Entrepreneurship & Life."

So far, he's held two four-day boot camps, each attended by about a dozen 30-something men (and one woman) in New York. Another session is planned for April, and a daylong seminar on short-selling slated for May already has almost 100 attendees and a roster of speakers including big names like Greenlight Capital founder David Einhorn and Muddy Waters Research's Carson Block. Tilson also plans to take his show on the road, with sessions in Italy and London in the works. His target students are mostly young men in their early to mid-30s who are either working at an investment firm and want to go out on their own or are already running a small hedge fund and hope to get bigger.

Tilson thinks he can help them. "What were the things I did right? What were the things I did wrong to screw it up and give it all back?" he asks the 15 men and one woman in the audience. "This is a business where when you hit it, [and] you have a great ten-year run, you should be making a lot of money," he encourages them.

Tilson's transformation from hedge fund manager to mentor might seem odd to those who don't know him. But a number of younger investors, like Sahm Adrangi of Kerrisdale Capital Management and Chris Irons of GeoInvesting, say Tilson is one of the first hedge fund elders who encouraged them in their early days.

"I'm a lot happier doing this," Tilson admits, leaning his lanky frame against the desk as he continues talking for more than an hour. He veers from discussions about investments called "value traps" to the perils of short-selling to what he calls life lessons, such as the desirability of driving a new car with the latest safety features. (He is convinced a new Volvo saved his wife's life when she ran into a tree in a late-night accident last Thanksgiving.)

"Whitney is a great storyteller," says Enrique Abeyta, a hedge fund founder of two former funds, Stadia Capital and 360 Global Capital, who is one of Tilson's guest speakers. "He gets very deep and very in-depth."

Tilson comes by it honestly. Both of his parents, who met in the Peace Corps and later took their small children to live in Tanzania and Nicaragua, were public school teachers, and the son seems to have inherited the teaching gene.

If anything, becoming a hedge fund manager was out of character. After Tilson graduated at the top of his class from Harvard Business School in 1994, his first gig was a nonprofit called the Initiative for a Competitive Inner City. Five years of nonprofit work didn't add up to much, but his wife's job as a corporate lawyer allowed him to pay off his student debt, and the couple even had $10,000 to spare. Before then, Tilson says, "I never had any interest in investing. I had never owned a stock, my parents had never owned a stock."

But, hey, it was the late 1990s, dot-com mania was on the rise, and Jeremy Siegel's Stocks for the Long Run was a best seller. On the advice of his Harvard classmate Bill Ackman, who'd already started a hedge fund, Tilson began reading Warren Buffett's writings and quickly became a convert to the notion of value investing. "It just made sense to me. My mom can squeeze a dollar until it screams. . . . I grew up driving secondhand cars and wearing secondhand clothes. Not surprisingly, the idea of buying stocks at a discount, waiting until you can buy a dollar bill for 50 cents inherently appealed to me.

"In hindsight, I had no idea what I was doing," Tilson admits. But in the bull market of the late 1990s, it didn't matter. Investing his small nest egg, Tilson saw everything he bought go up. "After a couple of years of that, I thought I was God's gift to investing. I was your prototypical bull market genius."

The next step in those days was to start his own hedge fund. "I was having dinner with my wife and her parents, and I remember telling them: 'It's just hit me. I'm going to start my own hedge fund.'" Six weeks later, after lawyers at Schulte Roth & Zabel (where Tilson's wife worked at the time) gave him a discount to do the paperwork, Tilson was in business. With money from his parents and his in-laws, he started with $1.1 million on day one and began operating Tilson Capital Partners from a corner of his bedroom on New York's Upper East Side. Since his personal investment account had been "ripping for the previous two or three years," he says, it wasn't hard to get other friends and family, including Harvard classmates, to sign on. Tilson bought shares of AOL, which went up six times, and thought he was conservative for buying Microsoft Corp., though it was trading at 150 times earnings. Buffett's Berkshire Hathaway was his biggest position — one he held until the very end. The future looked golden. "I started out with a plus-30 or plus-40 year," he recalls wistfully.

Tilson also built up a media presence, first writing a column for the Motley Fool, where he predicted the end of the internet bubble, and later being interviewed on 60 Minutes, where he appeared in an Emmy-winning program about the 2008 financial crisis. ("That should have been a career maker," Tilson wryly observes.) The bursting of the internet bubble, and the market downturn that ensued, was a boost to the fortunes of hedge funds, which took off in 2003 and soon became a trillion-dollar industry that was attracting pensions funds and other institutional investors. Many hedge fund managers adhered to value investing, which also had a comeback. Tilson launched a newsletter and an investment conference, the Value Investing Congress, which ran for ten years. But after surviving the bloodbath of 2008 by savvy shorting, like so many other hedge fund managers he had trouble finding his footing.

In retrospect, not only was he spreading himself too thin, Tilson tells his students during a session on how to build a hedge fund, "I kept costs too low. I never really invested in the business. . . . Money was coming in, the phone was ringing, the email box was filling, but I never had a well-organized, well-executed business plan. I could easily have raised $500 million, and if I had wanted to stretch a little bit, raise a little bit more volume, I could have gotten to a billion." He says that kind of money would have helped him build a stronger infrastructure, including hiring analysts to build out an investment team. "It was an enormous lost opportunity."

After running Tilson Capital Partners on his own for five years, Tilson hooked up with Glenn Tongue, a former DLJ banker who is now his partner in Kase Learning, to rename the fund T2 Partners in 2004. By 2010, at their peak, the men finally decided to hire a third-party marketer. But then, "Literally, the month we hired them and signed the contract, our returns went to shit," says Tilson. In 2011, his worst year, T2 Partners fell 25 percent, and it was impossible to raise money. The two split up but remained good friends.

"Most successful hedge funds don't have the structure we had, which was co—portfolio managers," says Tongue. "We didn't argue much at all. We just didn't generate returns."

IN 2012, TILSON restarted the fund as Kase Capital. It was a bare-bones, one-man operation run out of shared space in Carnegie Hall Tower in midtown Manhattan. Although he stopped the bleeding, Tilson says, he never beat the market again. "At every point in this long bull market, I had felt like it was ahead of the fundamentals. It turned out I was absolutely wrong the entire time," he admits. "I was too dogmatic. I failed to appreciate some of the incredible stocks I should have been able to figure out."

It was Tilson's passion for short-selling that ultimately did him in, he says. "If you're a value investor, that means you're a contrarian. You like betting against the crowd." He adds that shorting "bad people and bad companies made me feel good, like it was very righteous. That appealed to the crusader in me."

Tilson gained fame for his short on Lumber Liquidators, again getting the attention of 60 Minutes, which did a devastating expose on some of company's products. The stock fell about 75 percent in 2015.

But shorting can also be lethal, especially when most stocks are going straight up. After a small gain of 3.8 percent in 2016 — a year when the S&P 500 rose 12 percent — Tilson wasn't happy. But at least he wasn't losing money for his investors, who by then had diminished to mostly friends and family. Then things got worse, and by the middle of 2017, he was down more than 6 percent, his portfolio getting creamed by the many shorts in his book.

Short-selling was "enormous fun," Tilson says, "but it cost me financially. It was a significant contributor to my underperformance that ultimately put me out of business. I was in a vicious cycle. I felt like I had lost my mojo. Money was coming out of my fund, which was consistently underperforming."

Tilson's first step to stanch the bleeding was to cover all his single-name shorts, which he did in June. Among them was Exact Sciences Corp., which Tilson says appeared on its way to bankruptcy, but "rose from the ashes" after the U.S. Preventive Services Task Force gave its colorectal cancer screening test the go-ahead. "It had gone from 5 to 23 when I covered," he said. "It was a bad short." (Tilson had pitched it at Robin Hood conferences in 2014 and 2016.)

But covering his shorts did not turn the portfolio around, and by mid-September, Kase Capital was still losing money. Finally, Tilson decided to pull the plug after sharing his problems at a September 18 meeting of the Manhattan chapter of Young Presidents' Organization, a global group of young CEOs who serve as a support group for one another. "These are people I've been meeting with every month for many, many years. We help each other think things through," he explains.

Tilson wasn't planning on shutting his fund when he went to that meeting, but the words came spilling out. "I said, "˜We're wrapping up the third quarter, it's another miserable quarter of trailing the market, it's another quarterly letter that I have to write to my investors confessing to the poor performance and trying to explain it, and I'm completely miserable. I don't know. I've tried everything to turn things around. I've covered my short book. I bought some Google and Facebook, which I don't feel great about, buying those stocks ten years later than I should have. It feels like a capitulation buy. I'm doing things I don't like. Even the stocks that work, like Hertz — it fell from 50 to 10, and I bought it, and it went to 25 within six weeks — it's my biggest win of this year, but I knew I took hideous risks to do it. So I don't even feel good about the things I'm making money on. I'm taking terrible risks.' "

Those at the meeting, Tilson recalls, asked him bluntly: "Is it time to pull the plug? Do you have a viable business here? Even if you had a huge fourth quarter that turned things around and ended up in positive territory for the year, even if you had a big year next year, hedge funds are in the doghouse right now. You have had seven years of underperformance. So one good quarter, even one good year — it isn't like you're going to be able to go out and start raising money. Right?"

Kase Capital was down to $50 million, and the 1 percent management fee on the funds didn't even cover expenses. "So now, just to keep the doors open," they reminded him, "you're going to have to start writing a check."

Tilson knew they were right. "I was below my high-water mark, so I wasn't earning any promote. Every year my assets were shrinking. One of the key tipping points for me was recognizing that to keep the fund open, I was going to have to accelerate my cash burn." At the same time, he was paying for three teenagers in private school, two of them in college. "It wasn't impossible to turn things around, but it was increasingly, realistically a real long shot."

The next day Tilson called his broker and sold almost all his stocks, even Berkshire Hathaway, the one he had held since the beginning. The fund closed 12 days later, on September 30, and he returned 95 percent of investors' capital on October 15. He's still trying to unload one private holding and, ironically, close out a short on Lehman Brothers Holdings, a position that dates from the financial crisis.

Hearing such stories can be a bit overwhelming for Tilson's new students. "Whitney has been super honest and transparent about his own personal ups and downs and the pitfalls that come with being in the business," says Ronald Chan of Lakeside Financial in Seattle, who adds that the program is "a great crash course for aspiring managers to go into this business with eyes wide open."

He adds, "Given the headwinds in raising hedge fund capital, especially from institutions, I wonder if a hedge fund is the business model that most people should be trying." For now, Chan says, he's sticking with offering clients separately managed accounts instead.

Tilson agrees that the hedge fund model might not be suitable for everyone, and says he plans to add managed accounts and other investment products to round out his courses. But if you can do a hedge fund, he still believes, it's the best way to go.

"It's sort of funny. When I look back on my 18 years, I have nothing but happy memories," Tilson says. "It was tough times, but I think it was worth it in the end."

His greatest fear about shutting down his fund, Tilson says, was that "I would actually have to go get a job and work for somebody. When you've been an entrepreneur for 30 years, the idea of actually having a boss, and having somebody else decide which hours of the day I have to work, when I can go on vacation or not, was an unappealing prospect."

Tilson's new venture might not be as lucrative as a hedge fund, but he's still the boss. And at $6,500 for a four-day course, if Kase Learning could bring in, say, 20 students once a month, the business would gross more than $1.5 million a year.

So far, with only word-of-mouth marketing, Tilson appears to have found a new purpose in life — and an underserved market. After deciding to give teaching a try late last year, Tilson says, last November he sent an email to the 4,500 people on his investors' email list, saying, "I'm looking for 12 people, and I'm going to do it the first week of December." He ended up getting 50 applicants from all over the world and picked 12 of them for the first session. "We had an incredible week together," he recalls. "It made me realize, holy cow! There is an awful lot that I have to teach."

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