Thomas M. O'Neill is a lifelong Bostonian. Following undergraduate and graduate studies at Harvard, he joined the Putnam Companies in 1977, where he spent 13 years, including six as Chief Investment Officer. In 1990, he became a general partner of Hellman, Jordan, a Boston-based investment management firm to help develop their newly-launched hedge fund. In 1993, his career shifted from the investment to the management side when he became President of Aeltus, the investment management division of Aetna, before becoming in 1995 the President, CEO and Chief Investment Officer of Fleet Investment Advisors. At Fleet, Tom restructured and developed a large investment organization and later oversaw the merger with BancBoston's investment management arm which created an organization with over $100 billion under management and more than 200 investment professionals. In 1998, while maintaining his role at Fleet, Tom launched Navigator Management Company with his two partners, Peter Murphy van der Velde and Thomas D. O'Malley, Jr. Earlier this year, he relinquished his position at Fleet in order to focus entirely on Navigator. In the two years since inception, the Navigator funds have grown to $400 million and achieved a cumulative return of 87% with an impressively low volatility. Tom O'Neill spoke to HFN publisher, Antoine Bernheim, in mid-October 2000.
Profile of Thomas M. O'Neill
Born: June 14, 1951 in Boston
Education: Harvard University, BA and MBA
Family: Wife, Nancy and Three Children, Alison, Lindsey
and Thomas Jr.
Last vacation: Nantucket Island
Last book read: Devil Take the Hindmost by Edward Chancellor
Hobbies: Sports and travel
Q. Could you describe your investment philosophy?
A. I have managed a large investment organization with different styles of investing and I do believe that every individual has inherent in themselves a certain investment style that is most natural to them and feels most comfortable. In running this hedge fund, I am applying a fundamental discipline, a technical trading discipline overlay and a tremendous amount of attention toward managing risk and preserving capital. My investment philosophy has a value and growth at a reasonable price orientation, rooted in my experience at the Putnam Companies where I learned to analyze companies by looking at cash flows, earnings and franchise values that can make an investment rewarding. In addition, I look for significant insider ownership by management. I also believe that it is important to have very strong disciplines, some of which are technical in nature in terms of how to manage risk within your portfolio. I constantly reassess the risk and reward profile of each investment idea, in addition to looking at the overall porfolio and the different sectors to which it is exposed.
Q. Could you describe your research process?
A. We go through both a top-down and a bottom-up process where the macro and the micro feed on each other. We have a network of research people established over more than twenty years whom we think do the best research. We want to know what they say about a company, not so much whether they are recommending the stock, although we also know that some analysts' recommendations have the power to move a stock. We share our best thinking with people on Wall Street as well as people on the buy side. We maintain our own files. We use First Call to a significant extent. We are not trying to reinvent the wheel in having a massive research staff duplicate what Wall Street does and what many of the good fundamental analysts do. We attend conference calls and meet with companies. We also believe that successful people beget success and we watch successful people as they change companies.
Q. Could you describe your approach to hedging?
A. We do a lot of hedging both at the individual position level with stock options and at the portfolio level with indices and futures. If we like an idea, we may buy a core position in a stock and overlay it with an at-the-money, in-the-strike-month option. We want to minimize the premium and create a built-in hedge, with our risk being limited if the position goes against us while we get automatically more fully invested if it goes in our favor. We may also buy a position and overlay it with some puts just underneath where we bought the stock, also in the strike month and we also do some straddles when there is a critical event such as an FDA decision for a pharmaceutical company. For the overall portfolio, we use S&P futures, NASDAQ futures, and some of the indices in the technology area. We have very strict trading disciplines that overlay these futures positions.
Q. How do you control risk?
A. We keep a very conservative risk reward profile with respect to exposing our capital and we use our option positions to create a self-limiting mechanism. We focus on gross exposure rather than net exposure as we have seen unlikely bed fellows such as energy and financials which can move in the same direction on the same day while historically they have moved in opposite directions. We do follow certain rules on individual positions. For instance, if we are buying a stock with good fundamentals because we think it is bottoming out and it goes to a new 52 week low, we will sell half the position. If it goes down another 10%, we will sell it all and we will do the same thing on the short side. In each case, if we continue to believe in the fundamentals, we will just wait for a more opportune time to re-enter the trade. At times, we will use puts and calls if the position is more difficult to move.
Q. What is the mix between trading and investing?
A. A third of our portfolio is short-term trading where we are looking to make 5% to 20% over a day to a month; a third is intermediate, three to six months where we are looking to make 20% to 50%; a third is long term where our objective is to make at least 50%. Even in the part of the portfolio that is trading oriented, what we do is based on a fundamental opinion.
Q. Could you describe the typical structure of your portfolio?
A. We have averaged long exposure of 35% to 70% and 10% to 35% short exposure over our two year history. We typically operate with 40 to 50 names, many of which are enhanced by option positions. With the increased volatility in the market, the majority of our exposure has shifted to option positions. For instance, long call option premiums may represent 5% to 7% of our equity and give us a notional long exposure of 50%+ of our equity. If the options move well into the money, we either sell them outright or roll them into a higher strike price to limit our downside risk.
Q. Could you describe the criteria that may cause you to buy a stock or sell it short?
A. Over a year ago, we thought the insurance group was extremely depressed in price. The cycle had been very negative while the companies had good cash flows and sound balance sheets. Our belief was that there were very attractive names and franchises that would be of interest to both investors in the market and strategic investors. That thinking led us to look at Everest Re Group which was selling in the low 20s, around 7 times earnings and below tangible book. The management has significant ownership and the company was buying stock actively in the marketplace. Through our sources in the insurance industry, we were able to determine that the cycle was turning. Our view was that the stock could be a $50 to $70 stock over a twelve to twenty four month period. On the short side, we are looking for companies that are very overvalued relative to their actual franchise and capability to generate predictable earnings. You have to overlay very strong trading disciplines because the market can tell you that you are quite wrong over a short period of time if momentum investors become enamored with your short. For instance, we shorted Lucent Technology and Agilent, both spin-offs of large companies, on the belief that while they were solid companies and franchises, they were not comprised of only cutting-edge technology operations and, therefore they were not deserving of extremely high valuations. Also, we thought that the predictability of these businesses was far less than what the Street was looking for. After we began to short them, we switched to puts because we wanted to limit the potential for us to be subject to a short squeeze.
Q. Could you describe how your organization functions?
A. There are three partners and, in addition, we have two analysts, two traders, a Chief Financial Officer and support staff. Murphy van der Velde manages the trading which is very important to us. He has run the trading department for a $100 billion organization and also ran index funds. He has a very strong futures background both in a large organization setting and with a hedge fund orientation. He executes the orders, pays attention to what is happening in the market and oversees our risk exposure and option positions. Tom O'Malley has a strong background in energy and healthcare and has developed a good network of analysts as an institutional salesman for ten years. We have meetings early in the morning where we talk about the market and different sectors. When it comes to investment decisions and putting ideas in the portfolio, the buck stops with myself as managing partner, but we have a constant flow of communications in bringing up ideas as both Tom O'Malley and I do research.
Q. What are your goals for the future?
A. We want to achieve 15% to 20% returns net to our investors and we believe we can run $1 billion to $2 billion with our style. We are about to close to new clients as we reach $500 million and future asset growth will come only from existing clients and capital appreciation. We want to be important to our clients and we want them to be important to us. I also want to keep this organization with a very limited amount of moving parts, keep our process streamlined and maintain our discipline.