Raj Rajaratnam's travels

Tue Aug 26, 2008


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Raj Rajaratnam has steered his ship through rough seas before. But the departure of a senior partner, the closure of a big fund and losses at his two main funds are leading him into uncharted waters as he opens Asian macro and private equity funds. Can he admiral an entire fleet?


Raj Rajaratnam sails into uncharted waters with Asian macro and private equity funds

By Julie Dalla-Costa

Galleon Group's Raj Rajaratnam is no stranger to rough seas. The technology captain steered his hedge fund firm through the last market crash, the departure of one of his shipmates and a number of lawsuits, including one settled with the Securities and Exchange Commission in 2005. Now Rajaratnam faces a new storm - the departure of another senior partner, the closure of a big fund and losses at his two main multimanager funds.

This time, the 51-year-old Sri Lanka native is trying to right the course by setting off for new lands - his native Asia. The stakes for his 11-year-old, $7 billion Galleon (named after the Spanish sailing ships that carried gold across the Atlantic) could hardly be higher. In an attempt to continue to attract institutional investors by diversifying the business, the onetime equity shop is diving into macro investing and has hired a big name to lead the effort. A macro team in Singapore began trading on August 1 and will launch a fund on October 1 with a capacity of $500 million. As part of the Asian push, Galleon also plans to start a late-stage private equity fund for the region next year.

Rajaratnam, who declined to be interviewed, got out of his prior troubles largely by adding new products, but never strayed too far from publicly traded equities until recently. "We know equity, and we are going to stick with equity," he told Absolute Return in 2003, when the firm had $3.1 billion in assets - a dramatic drop from the $5 billion it had in 2001. Rajaratnam held to that promise, and by January 2007, firm assets had reached $6 billion.

Rajaratnam did right the ship, navigating a steady course to where Galleon is today, through a multitude of sector portfolios in such hot areas as energy, financials and healthcare. It also started Asia and quant funds and grew by assiduously courting institutional investors, particularly sovereign wealth and pension funds. But its once-stated objective of providing a 20%-to-25% return seems to have gone by the wayside at the same time. Since January 2003, the firm's now-$1.9 billion flagship - a composite of the numerous U.S. funds it runs - has a 12% annualized return through July. The two-year-old pan-Asia flagship has fared a little better, with an annualized return of 14.6% despite double-digit losses this year.

Rajaratnam has some loyal followers and, despite current performance woes, has avoided the big redemptions of many of his peers. "He runs a big operation, which he built up from nothing," says one individual who has invested in several Galleon funds. "I think Raj is a great guy." The hedge fund pro's moves into macro and Asia are likewise viewed by supporters as signs he hasn't lost his opportunistic touch at identifying trends and hiring the right people to execute the strategies to take advantage of them.

At the same time, the multitude of strategies - 18 in total - has proved confusing to some investors. They worry Rajaratnam may have too many demands on his attention. The naysayers point to current and past turnover as a sign the firm's glory days are over. "They've had some key traders who have been with the firm for a long time leave," says one investor. "There is a change in mentality there."

That view is supported by the fact that one of the top partners in the firm just left. Todd Deutsch, 34, departed on June 30 following double-digit losses in his Galleon Captains Fund last year. Launched in January 2001, the $550 million midcap equity portfolio was the firm's most aggressively traded and highly leveraged vehicle. Until its launch, Galleon's funds didn't use leverage at all. Even the new macro fund will take on only modest leverage, according to someone familiar with the firm.

Assuming more risk enabled Galleon Captains to post an average annualized gain of 18.3% through June, despite a 26.6% loss last year. But last year's loss makes reaching its high-water mark unlikely - and ensures that another big payday for Deutsch is far off. The fund had gained 6.7% by the end of June, but was shuttered at that time.

Although Deutsch and Rajaratnam reportedly argued about how much leverage to employ, Deutsch is said to have left the firm on fairly amicable terms. (Both are restricted from talking by a court gag order.) But the departure of another partner dredges up memories of a previous, more acrimonious, exit - that of Krishen Sud. The college chum of Rajaratnam's at Wharton Business School, who became an early partner in Galleon, left in 2001. Bickering between the two men over the hiring of Sam Navarro, the previous global head of healthcare investment banking at ING Barings, to co-manage the healthcare fund is said to have prompted Sud's departure. Sud took many investors with him, leading to a big drop in Galleon's assets. Someone close to Sud's new firm, Sivik Global Healthcare (previously Argus Partners), says a big chunk of the fund's $1.5 billion assets left Galleon for the new venture.

Soon after Sud left, Rajaratnam sued his former partner, alleging Sud had poached clients and employees. The suit was settled a few months later, but the affair made some investors uncomfortable. "We couldn't get straight the story behind Krishen leaving," says a former investor in the fund run by Sud.

Sud's departure occurred as Galleon sailed through troubled seas, its flotilla of funds taking on water following the tech crash and the subsequent fallout. Later, Galleon faced other lawsuits, making some investors doubly skittish. Most notably, in May 2005, Galleon agreed to pay the bulk of a $2.4 million fine to settle charges made by the SEC. The regulator claimed Galleon, Oaktree Capital Management and DB Investment Managers had engaged in illegal short selling. All three firms settled without admitting or denying the charges, but Galleon paid the biggest fine: $2.02 million. The SEC alleged Galleon made illegal gains of more than $1 million in defiance of anti-manipulation regulations by illegally covering short sales with securities purchased in follow-on offerings The trades were made on 17 offerings from 2000 to 2003. Galleon settled yet another lawsuit last year. A former female employee accused the firm of sexual discrimination and breach of contract over compensation.

Litigation isn't uncommon at hedge funds, but the number and variety of allegations against Galleon add fodder to the claims of some that Rajaratnam is a difficult and arrogant man. "One incident, and there's no cause for concern. But once you get a couple, you think, 'where there's smoke, there's fire,'" says a former investor. Following Sud's departure, "there were a lot of moving parts, teams changing, new initiatives and poor performance," says another former investor. The same comment holds true today. The issue is whether Rajaratnam will once again be able to transform his firm.

RAJARATNAM'S U.S. HEDGE fund career came almost by accident. Rajaratnam, whose father was a senior executive at Singer in Asia, was shipped off to boarding school in England and stayed there for his university education. He earned a degree in engineering from the University of Sussex, an MBA from the Wharton School and completed a training program at Chase Manhattan in New York. Rajaratnam intended to return to Sri Lanka, but a trip home coincided with a violent uprising by the separatist Tamil Tigers in 1983, so he decided to return to the United States.

Two years later, Rajaratnam joined Needham & Co., the tech investment boutique and asset management firm, and became president in 1991. When he left in 1997, he took along a hedge fund he had started in 1992 for clients who were executives at technology companies, renaming it Galleon Technology. At the time, it had $350 million.

Galleon Technology was considered the firm's flagship until 2005. But as Galleon began to institutionalize by branching out and creating sector funds, it opened a diversified fund in 2003 - Galleon Diversified - which other funds fed into. That fund began to amass the most assets and is now considered the flagship. In its June letter to investors, Galleon touted an annualized return of 23.1% since the initial sector fund's inception in 1992 while still at Needham. But the diversified fund's annualized return since inception is about 12% through July and is down 2% for the year, illustrating how returns have slid since Galleon branched out.

Galleon Diversified acts as a multimanager fund, investing in all the U.S. sector funds. Rajaratnam and his risk management committee, headed by Sebastiano Calabro - who joined from Rubicon Quantitative Fund Management last October - can then adjust the risk at the multimanager-fund level without reallocating money across the sector funds or pushing a manager to alter his position. "It's a unique process," says one institutional investor. "It's one of the things I like about them."

Others say they are confused by the multitude of sector funds. The firm has four different technology funds, with such names as Galleon Technology, Galleon Emerging Technology (formerly Galleon Communications), Galleon Buccaneers and Galleon Explorers. Galleon also has at least two healthcare portfolios, four consumer stock strategies that make up the Galleon Admirals fund and portfolios investing in energy/cyclicals and financial stocks. Those are just the U.S. sector funds. "The strategy was to have multiple portfolios in each of the major industry sectors, with each portfolio run by a separate portfolio manager," Rajaratnam explained in a July 18, 2007, letter to investors.

The two main multimanager funds clawed back some of their year-to-date losses in July - a month when many other hedge funds plummeted. (The Absolute Return U.S. Equity Index was down an estimated 2.2% that month.) But they remain in the red for the year. Many of the firm's U.S. sector funds also posted gains in July. The Galleon Healthcare Offshore fund gained 10% that month. But, like the healthcare fund, which still is off 6.7% for the year, a number of the sector funds are still down.

The Asian funds are hurting, too. Galleon also has four sub-funds focusing on Asia, with Galleon International - an overlaid multimanager fund with $1.1 billion in assets - down more than 11% this year.

EVER SINCE SUD'S departure, Rajaratnam and Gary Rosenbach, also a founding partner, have been the firm's only equity holders. Rosenbach, previously head trader, became co-chief executive in 2002. But Rajaratnam is still in charge, overseeing 120 employees, 15 of whom are portfolio managers. Most of the employees are in New York, though Galleon has offices in Taipei, Shanghai, Mumbai, Beijing and Silicon Valley, plus the new one in Singapore. The Asian offices employed local analysts only until March, when Galleon shipped its Asia equity long/short team out to Singapore from its New York headquarters.

This move makes it clear Rajaratnam sees much of the firm's future in Asia. Taco Sieburgh, director of research at hedge fund consultant Liability Solutions, thinks that makes sense. "I'm not too surprised about Galleon launching an Asia macro fund," he says. Rajaratnam "is probably concerned about the need to broaden the firm's income streams away from a reliance on equity long/short strategies, given the uncertain returns in that area."

A former employee agrees, saying he thinks the Asian macro fund was started "because equity markets are so tough." He notes Rajaratnam is not one to embark on new adventures without thinking them through. To wit, Galleon in June hired David Lau away from the Development Bank of Singapore to launch and manage the macro fund. A heavy hitter in the Asian financial markets, Lau is also a former Wharton classmate. The eight-year veteran of DBS was most recently that bank's joint head of global financial markets, focusing on the bank's treasury and markets business. In that role, he was instrumental in building DBS into one of the top specialists in Asian currencies. Rajaratnam told investors recently that 10 professionals are dedicated to the Asian macro effort.

Some investors believe the dearth of macro funds in Asia makes the region fertile ground for foreign firms with experience in the more developed markets of Europe and the United States. "I can think of only three firms that have macro funds focused just on Asia...there's no competition," says Richard Blake, senior portfolio manager for Commerzbank's alternative investment unit, Comas. Equity long/short strategies accounted for about 77% of the total number of Asia-Pacific funds at the end of the second quarter, according to AsiaHedge, a sister publication of Absolute Return.

Galleon's planned Asian late-stage private equity fund might be an easier shift of direction. Galleon already has a similar U.S. fund, based on the premise that pre-IPO equity investing isn't that different from investing in public equities. Like a public company, "a private company that is about to go public has a wealth of information available to help qualified investors before they choose to take a stake," says Marina Lewin, managing director and head of North America client management at the Bank of New York Mellon.

The Asia pre-IPO fund, which is slated to have a four-year lock, will be managed by Sanjay Santhanam. He ran the $1.1 billion pan-Asian Galleon International fund from New York until recently moving to Singapore.

Galleon launched a similar U.S. crossover fund in May of 2007 after research turned up some promising technologies being developed in Silicon Valley, according to someone close to the firm. Based in Menlo Park, Calif., the $300 million fund is run by tech vet Kris Chellam, who was most recently a senior vice president at San Jose technology firm Xilinx. Chellam previously served as vice president and chief financial officer at semiconductor maker Atmel and worked in financial management roles at microprocessor maker Intel.

Hiring a tech maven, rather than a private equity expert, is in keeping with the firm's view that the fund is an extension of its core technology expertise into pre-IPO companies, rather than a significant move into private equity, says an investor. About 50% of the fund, which has a three-year lock, is currently invested in private companies. The other half is in companies that have already gone public.

An Asia version of the fund seems a natural progression. "It makes more sense for them than an Asia macro fund," says one fund-of-funds manager. But he adds that he doesn't think many investors have an appetite for this kind of vehicle. "From most funds of funds' perspective, you probably have all the illiquids you can bear [at the moment]." (The U.S. fund is closed to investors and is not expected to open soon.)

With valuation such a big concern for investors in illiquid holdings these days, Galleon has told investors it has a valuation committee that consists of Galleon executives not on the six-person team managing the U.S. Crossover Fund and it uses an independent auditor. The portfolio is revalued internally each quarter, using a fair value assessment required by accounting standard FAS 157.

Finding investors with the stomach for such investments might be difficult. But Galleon thinks there is plenty of demand for pre-IPO equity capital among Asian companies. "There is significant need for late-stage growth capital/pre-IPO funding in Asia," Galleon said in a November 2007 marketing document for the fund. "Galleon had been proactively approached by, and has already provided funding to, a number of companies in areas of our research expertise looking for such capital." Galleon Asia Crossover Fund is expected to launch early next year. The firm hoped to benefit from a lack of competition. "Galleon is not aware of any specialized, pan-Asia-focused competitors investing in late-stage private companies and public equities," the firm said in its 2007 presentation.

Since then, however, one huge rival has popped up: the Blackstone Group, which is jumping into private investments in Asia via a new hedge fund. The $98 billion private equity giant, which has billions of dollars of hedge fund assets, set an October 1 launch for an Asia-Pacific event-driven hedge fund with more than $500 million, a portion of which will be invested in private companies. The fund, managed by Aaron Nieman, who formerly ran SAC Capital Advisors' Canvas Capital Management, will invest across the capital structure but focus predominantly on equities.

Reduced investor appetite for Asia-focused funds may slow things down, at least for the immediate future. The AsiaHedge Asia ex-Japan Index (USD) was down an estimated 14.5% through July. And with IPOs scarce in both the United States and Asia, the time horizon for any realized profits is far distant.

Will the slowdown give Rajaratnam time to take stock? In addition to running the overall business and managing the tech fund, he oversees the Diversified Fund, the International Fund, the U.S. Crossover Fund - and the new ones being launched in Asia. Invariably, that provokes complaints that he is overextended. "We hear him investing or helping funds all over the world, [and] he seems to be getting spread a little thin," says one investor. On a positive note, this investor also points to Rajaratnam's efforts to set up a foundation called Galleon Tsunami Relief to build housing for fishing communities in his native Sri Lanka. Rajaratnam was in the country with his wife, Asha, and their three children the day the tsunami hit in December 2004. They had headed inland the day before the 20-foot waves washed over the coastline and were unharmed. The hedge fund manager donated $5 million to the cause in January 2005.

With all the efforts he is involved in, Rajaratnam has since put processes in place to allow him to focus on his passion - the former flagship technology fund (Absolute Return Award winner, 2006). It is down 5% for the year, but it has an annualized return since inception of 19.8%. All discussions with Rajaratnam about the other funds and the business typically are left until after the U.S. equity markets close. That gives a small window of opportunity before Asian markets open. With all the changes under way at Galleon, the question might not be how well Rajaratnam can captain a ship through rough waters - but how well he can admiral a fleet across uncharted seas.


FACT FILE: GALLEON
Founded: 1997 (1992 within Needham & Co.)
Majority owner: Raj Rajaratnam
Assets under management: $7 billion
Flagship fund: Galleon Diversified
Performance: 12% annualized since inception in January 2003 (23.3% from July 1992)
Offices: New York, Silicon Valley, Singapore, Mumbai, Shanghai,
Beijing, Taipei




GALLEON PERFORMANCE THROUGH JULY 08

Launch date

Fund name

YTD perf. (through July 31)

Ann. since inception (through July 31)

AUM

Jan-06

Galleon International

-11.3%

14.6%

$1.1b

Aug-97

Galleon Healthcare Offshore

-6.7%

13.6%

$300m

Jul-95

Galleon Technology

-4.9%

19.8%

$1.1b

Jul-00

Galleon Emerging Technology*

-2.5%

10.0%

$350m

Jul-92

Galleon Diversified**

-2.0%

23.3%

$1.9b

Jan-03

Galleon Diversified

-2.0%

12.0%

$1.9b

Aug-01

Galleon Admirals

-0.4%

18.1%

$210m

Jun-99

Galleon Explorers Offshore

1.4%

16.0%

$150m

Jun-03

Galleon Buccaneers Offshore

2.9%

19.0%

$1.2b

Jan-01

Galleon Captains Offshore***

6.7%

18.3%

$550m


*formerly Galleon Communications
**pre-2003 includes prof forma and predecessor funds' returns
***returns through closure on June 30




HOW THE GALLEON DIVERSIFIED FUND HAS EVOLVED



Source: Galleon

ISSN: 2151-1845 / CDC10004H