When Californian utility Pacific Gas & Electric filed for bankruptcy protection in January, a once-prominent Wall Street hedge fund was feeling the pain.
BlueMountain Capital, founded in 2003 by two former Harvard Law School students during the halcyon days for the hedge fund industry, reckoned the market was too gloomy on the company that provided gas and electricity to 16m Californians.
After first buying PG&E shares in August 2018, BlueMountain increased its bet last November even as California was again ravaged by deadly wildfires that the utility would eventually shoulder the blame for.
“I still remember the head of distressed [investments] saying they [PG&E] are not going to file for bankruptcy,” said a former BlueMountain portfolio manager. “Six days later, there it was.”
Nine months on, and the firm has shut its flagship Multi-Strategy $2.5bn Credit Alternatives fund after it haemorrhaged half its assets in three years. In October, it completed the sale of the rest of the business to bond insurer Assured Guaranty for $160m.
It was a humbling moment for a hedge fund that shot to fame in 2012 after making substantial profits from JPMorgan Chase’s London whale trading debacle. BlueMountain’s traders went on to assist the US bank in liquidating the calamitous credit derivative positions that chief executive Jamie Dimon was hauled before Congress to explain.
Months later, and riding high on its new-found cachet, BlueMountain poached Jes Staley, now chief executive of UK bank Barclays, from a top job at JPMorgan. Investors followed, pouring money into BlueMountain.
Assets under management
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But according to six former employees as well as investors, the London whale triumph also marked the beginning of troubles that ultimately culminated in a series of botched bets, including stakes in oil shipping companies.
The money managed by the group ballooned to $18bn in 2013 from $12bn the year before, prompting the fund to stray from the corporate bond and derivative trades that were the bread and butter of co-founders Andrew Feldstein and Stephen Siderow and had built its reputation before the financial crisis. Its assets would eventually peak at $23bn in 2016.
“Boatloads of capital have overwhelmed a lot of opportunities that hedge funds used to have,” Chris Walvoord, global head of hedge fund research at Aon, said of the dangers funds face from rapid expansion.
Between 2012 and 2018, BlueMountain launched five new strategies, including a systematic equity fund and private capital one. The firm started allocating a portion of the flagship fund to so-called pod traders, where capital is allocated to employees to run their own strategies, according to people familiar with the firm.
Nathaniel Dalton, the chief executive of asset manager Affiliated Managers Group, which bought a stake in BlueMountain in 2007, lamented in May that the firm had moved from its core strengths in credit and volatility trading as AMG disclosed a $415m writedown in the value of its stake.
“There was a lack of direction,” said one former portfolio manager who worked there after the London whale trades. “The firm became very large and they were trying to chase whatever the hot hedge fund thing was.”
Mr Feldstein’s background was rooted in fixed income, having cut his teeth as a credit trader at JPMorgan in the late 1990s. Former colleagues say he preferred to keep a low profile while Mr Siderow, a former McKinsey consultant, was recognised as the face of the business and was more of a point of contact for investors.
Mr Feldstein and Mr Siderow declined to comment.
Even as the variety of investment strategies at BlueMountain grew, the fund kept a foothold in credit with a push into collateralised loan obligations (CLOs) — securities backed by pools of business loans often tied to private equity buyouts. They comprised more than half the group’s assets under management this year, according to a presentation from Assured Guaranty.
But it was the mis-step on PG&E that investors and former BlueMountain employees characterise as the straw that broke the camel’s back for the flagship Credit Alternatives fund that was already struggling to generate returns.
Share price
In a letter sent to investors last December, and seen by the Financial Times, PG&E was described as a “high conviction investment” and the likelihood of a near-term bankruptcy put at less than 10 per cent.
Three former senior BlueMountain employees said the intense pressure on portfolio managers to deploy capital as quickly as possible contributed to the decision to make a bet on PG&E.
“It was symptomatic of having to take big shots to make things work, as opposed to running on the merits of an idea,” said one of three portfolio managers.
A spokesperson for BlueMountain denied this was the case, and that the value of the PG&E investment never exceeded 3.5 per cent of the flagship fund’s net asset value. BlueMountain also had exposure to PG&E in other funds, the spokesperson added.
As it outlined its conviction to investors last December, BlueMountain said the shares could be worth $60 because the market was overestimating the utility’s wild fire liabilities. BlueMountain’s opening $200m bet on PG&E had been at an average share price of close to $46. Last November, it added another 3.7m shares at an average share price of about $24, regulatory filings show.
Late last month PG&E shares slumped to a record low of below $4 after the company cut off power to almost 3m Californians in an attempt to avoid the risk of more wild fires. Analysts at Citigroup have warned that the stock may become worthless.
The fate of PG&E’s investors is now in the hands of the US courts, where shareholders and bondholders have pitched competing plans for a restructuring.
Assured Guaranty, which plans to inject $500m from its investment portfolios into BlueMountain’s strategies, is shifting the firm’s focus back to its roots in corporate bonds and credit derivatives.
Mr Siderow will leave the firm at the end of the year, while Mr Feldstein is staying on.
Meanwhile, investors — from pension funds to sovereign wealth funds — seeking juicier returns will be hoping to find the hedge fund industry’s next hot property.
“They built a monster that was so complicated they couldn’t manage it any more,” said a former analyst at the firm.
