Michael Rome started his investment career in 1982 as a research liaison with Goldman Sachs & Co. In 1989, he joined Mark Asset Management as a Senior Vice-President and in 1991, he moved to Lazard Fr¿res, New York, where he became a partner in the asset management division with responsibility for U.S. equities. Lazard Fr¿res is one of few old line investment banking houses to have developed early on a strategic money management operation which has grown today into a global organization with $70 billion in assets under management. While Lazard has also been active for many years in private alternative investments, the firm's hedge fund operation has only recently come to light. In 1993, Michael Rome began to manage a Global long/short equity hedge fund, Guernsey Global Opportunities, now restructured as a Bermuda fund, Lazard Global Opportunities, Ltd. Over the past eight years, the Fund has compounded at a 22.4% annual rate of return and the assets managed in this strategy now exceed $350 million. Another Fund focused on European long/short equities, Lazard European Opportunities Ltd., was started in August 1998 under the management of William von Mueffling and produced two triple digit return years before closing to new investors, with assets now in excess of $900 million. The firm recently made a commitment to expand its alternative investment operations under Michael Rome's leadership and use its research and portfolio management resources to expand its business: a short-term emerging markets currency strategy, Lazard Emerging Income, started six years ago with various levels of leverage, currently has $600 million in assets under management; Lazard European Technology Opportunities Ltd. , run by Ben Guest in London, began in November 2000 and has currently $40 million in assets under management; and recently, Lazard hired a team from J.P. Morgan to start a fund of funds. Michael Rome spoke to HFN publisher, Antoine Bernheim, in early April 2001.
Profile of Michael Rome
Born: August 14, 1958
Education: BA, University of Rochester, 1980; MBA, Cornell University
Family: married, 2 children
Last vacation: Skiing with family in Beaver Creek
Last book read: The Tipping Point by Malcolm Gladwell
Hobbies: Antique maps, golf, skiing
Favorite quote: "Remember that time is money," Benjamin Franklin
How he best describes himself: "Focused and inquisitive"
Q. Where do alternative investments fit into Lazard Asset Management?
A. When I entered the business in 1982, interest rates were 14% and P/Es were 10. In 1999, when I stopped running the US business, interest rates were 5% and P/Es were 35. We know that stocks cannot compound at 25% annually as they did for five years and, in 1999, I became convinced that our institutional clients were going to invest in alternative or hedge fund products. Further, we believe that hedge funds are not going to be a carve out process for our clients but are going to be integrated in their portfolio, so that, for instance, long/short U.S. equities will be part of their U.S. equities as opposed to a separate hedge fund allocation. I wanted Lazard Asset Management to diversify its business plan so that over the next ten to fifteen years, we have non-traditional assets in our mix and I also decided that I wanted to spend 100% of my time in the alternatives business. We are building a global alternatives platform which includes both public and private investments. On the private side, we have ventures, private equity and real estate. On the public side, we now have four hedge fund strategies where we are building our assets.
Q. Could you describe how hedge fund products will continue to be developed at Lazard?
A. This is an exercise about finding shortages of capital in the world where return on capital is likely to increase and matching that up with a talented team that can capture that opportunity in a risk-controlled way. For example, the high yield markets are back to the Drexel days of 800 to 900 points over treasuries as people are worried about increased default rates and global recession. It seems that the rates of returns in high yield might be more attractive now than they have been in the past five to ten years. Japan after a twelve year bear market has plenty of capital but no return on capital. The Yen has been devaluing against the dollar and having gross exposure in Japan through a long/short strategy might make a lot of sense, while having net exposure might not since we don't know when they are going to fix their problems. So, our hedge fund offerings will be developed based on the investment opportunities, our clients' interest for products that can help them diversify their portfolios, and if we find a team, internally or not, that can execute at the top level and put their own money to risk. This effort is not about being average. We want a fund strategy that can be a leader.
Q. Could you describe how you have integrated the research and execution resources of Lazard into the alternative investments group?
A. We have 130 investment professionals and 100 are doing equity work and 30 fixed income work. Since 1995, analysts have been organized in global industry teams, which means that we have five or six people in each global industry following all the stocks that trade in that industry with a capitalization in excess of $1 billion. They screen for value, they do accounting validation and they do fundamental research. They write in a common Notes database which we all see and, in the long/short strategies, we try to identify the most attractive ideas which meet our target rate of return. Because we follow all stocks in each industry, our analysts find companies that have problems and we can use these ideas for shorts as opposed to discard them as we used to. The analysts are compensated based on the return that our clients receive. Our hedge fund team members have their own capital at risk and $60 million of the $350 million in the global opportunities strategy is from the management team.
Q. Could you describe your investment philosophy in managing money in your global long/short equity Fund?
A. It is a global portfolio which tends to be around fifty percent in the U.S., a third in Europe and the balance in Asia, primarily Japan, although I am indifferent as to where the gross exposure comes from. There are three types of risk we want to accept because we have opinions on them: stock-specific risk, industry risk and sector risk. We want to squeeze out all of the other risk factors that we view as macro or top-down factors, such as currency, country, region, style, size and interest rate sensitivity. We do that by shorting individual stocks in the same industry and hopefully country. We have a strategic interest in certain industries which we think can compound at high rates of return such as healthcare, finance, consumer, technology, telecom, industrials and special situations. We have little interest in commodities, cyclicals, transportation, usually energy, any industry where the individual constituents of that industry or the industry itself has not been able to compound at high rates of return at any point in its history. In those industries, we tend to be either neutral, net short or uninvolved.
Q. Could you describe the criteria that may cause you to buy a stock or sell it short?
A. We are a value shop and we are trying to buy great businesses that are mispriced, with high marginal cash flow generation, good management teams and large and increasing market share in a well-defended business. If we can find companies that can compound at 12% to 15% a year and buy them 10% cheap, we can get 15% plus returns on our long portfolio. On the short side, I am interested in shorting stocks after they have said they have a problem, and we are looking for companies with bad business plans, accounting or management.
Q. Could you describe the typical structure of your investment portfolio?
A. The portfolio is highly diversified and today we have approximately 140 positions, with size of 1% to 3% on the long side and 1% to 2% on the short side. A neutral stance for us would be 120% long and 80% short. I feel most comfortable with a net exposure in the 40% to 60% range. Net exposure in the U.S. has ranged between 25% and 75% and we have been as high as 12% in emerging markets (it is currently net 2%). In eight years, we have never been net short.
Q. How do you control risk?
A. While we don't have a hard and fast rule, if a stock is down 15% when the goal is to be up 20%, we clearly have made a mistake and we tend to sell it and move on. Some stocks have more volatility and may need a little more room than others but we try to liquidate mistakes early and let the good investments compound. The same goes for the short side. Because we have such a diversified portfolio, no one stock should have a material impact on our aggregate return at any given point in time and we tend not to respond to very short-term movements of stocks. We currently have no futures, very little options and no illiquid securities. Our holding periods tend to be much longer than most long/short strategies. On the long side, we have more than two year holding periods on a lot of names and we rarely trade around positions. Even on the short side, positions may be held for six to nine months. We enter slowly and we usually exit all at one time. From a top-down perspective, we monitor five factors that would cause us not to want to invest: a spike in short-term rates, an economic event like a recession, a collapse in a currency, a political event and war. Last September, with the problems in the Balkans and the Middle East peace process turning into rock throwing, we reduced our exposure to a low of 6.9%.
Q. What are your goals for the future?
A. We want to provide consistent absolute returns without losing money for our clients. We want to grow each of our hedge fund strategies to the extent the size will allow us to reach our targeted rate of return. We want to be able to help our clients integrate these investments into their portfolios so that they understand how to use them and provide as much disclosure and transparency as possible. The goal is to move Lazard Asset Management toward a more balanced portfolio of products.