by Antoine Gara, Forbes Staff
Dec 13, 2018
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| Heard Capital founder, William Heard |
Dec 13, 2018 For the $3 trillion hedge fund industry, this year is
all but assured to be one of the worst on record. Big funds are shuttering on
an almost weekly basis, and limited partners are tiring of investors who lagged
the bull market but then failed to capitalize on recent bouts of volatility
like the October selloff. For William Heard, a 36-year old Chicago-based
manager, however, the current carnage is an opportunity many years in the
making.
Over the past eight years, Heard, a native of
Milwaukee, Wisconsin, has taken a quiet approach to breaking into the industry.
Instead of seeking the spotlight at the start, Heard spent his time trying to
learn from others, gaining counsel from some of Wall Street’s smartest
investors, including billionaire Robert Smith of Vista Equity Partners and John
Canning of Madison Dearborn Partners, and then slowly proving himself. This
patient, unassuming approach is seen in Heard’s investing style. Often his best
results come from simply listening closely to company management teams describe
their business and strategy over time.
Heard Capital, his over-$50-million-in-assets firm,
has posted 8%-plus net annualized returns in its flagship Heard Opportunity
long/short fund since its inception in mid-2011, more than tripling its
woefully performing hedge fund benchmarks.
This year is a standout. Coming out
of the carnage of October and November, Heard, who began taking risk off the
table when markets were soaring at midyear, is up 10%, roughly matching his
annual average returns of the past three years. By contrast, year-to-date,
Goldman Sachs’s prime brokerages services unit estimates U.S. long/short funds
are down 6%.
Heard’s entrance into the world of hedge funds began
in his hometown of Milwaukee, where he took an interest in investing early on
and earned a scholarship to Marquette University to study finance. He began
reading classics like Peter Bernstein’s Against the Gods and catapulted his career
by winning a summer internship at Merrill Lynch. His interest wasn’t casual.
Wanting more investing education in his studies, by the time he graduated Heard
had built an applied investment management program at Marquette, which became
the first undergraduate business program to partner with the esteemed CFA
Institute.
That initiative would serve him well when he launched
his investing career just as Wall Street was set to enter the crisis. After
graduation in 2005, he took a job as a special situations analyst with
Milwaukee-based Stark Investments, one of the early large hedge funds in
America. The role gave him a window into equity, credit and option markets and
sectors like telecoms, technology and industrials. Already sketching out a plan
to one day start his own fund, Heard began seeking advice.
He made a connection
with Madison Dearborn’s Canning at an industry conference, who found his plans
credible and offered support. “He’s done a great job against many speed bumps
and a lot of slammed doors,” says Canning, who adds since his first meeting
with Heard, “He knew what he wanted to do and he knew what his approach was
going to be.”
When the crisis struck in 2008, Heard left Stark ahead
of heavy layoffs, began taking steps to build his firm and applied to business
school as a backup. By mid-2009, he took his savings and left Milwaukee for
Chicago, enrolled in business school, and with the help of Canning, began
making connections with local investors like Jim Dugan, electronic trading
pioneer Blair Hull, and the Staffords. Heard also reached out to Vista Equity
Partners’ Robert Smith, who agreed to meet and says they formed an instant
bond. “Over the years, we've made sure to talk every few months, and I have
enjoyed helping him think through how to build his business,” says Smith.
By 2010, Heard felt he’d done enough legwork planning
a firm and honing his investing strategy, so he created Heard Capital. After
gaining momentum in fundraising, Heard dropped out of business school and, in
2011, began investing with around $10 million in assets, including from the
likes of Smith and Canning.
Heard’s strategy is to lean on attributes like his own
conviction. He runs a concentrated portfolio of 15 to 25 long investments in
six sectors—telecoms, media, technology and software, financial services,
energy, and industrial—where he owns knowledge. And he's a methodical
researcher, willing to ingest volumes of information and sift through the pros
and cons of an idea and avoid confirmation bias. To this end, he's a student of
the ark of regulated industries like telecoms, media and energy in the United
States, and the current strategy of the companies he's interested in.
Heard
focuses on what he calls a “say-to-do ratio,” in which he analyzes the business
factors that are in a management team’s control, how they communicate those
challenges or opportunities, and the credibility of their plan of action. When
Heard finds there is a disconnect between his analysis and the street, he
pounces.
At the end of 2014, Heard began combing the financial
sector for firms that would benefit from the eventual end of the credit cycle
and started researching firms like Equifax, TransUnion and Fair Isaac
Corporation. While the first two were simply credit score managers, Heard
decided Fair Isaac was misunderstood. The 2014 launch of its subscription-based
decision management suite and its early 2015 acquisition of Tonbeller
Compliance gave Heard the conviction Fair Isaac was transforming into a
software company for the financial sector. Though this shift hit profit
margins, Heard decided Fair Isaac's disciplined share buybacks—nearly 50% of
its market capitalization in a decade—and its willingness to now invest in the
business signaled a confident outlook from management. Trading in the $70s to
start 2015, the year Head invested, Fair Isaac now changes hands for $190 a share.
“What I found with Fair Isaac was, not only was the
valuation misunderstood in the marketplace but what they did as a business was
misunderstood,” says Heard. He believes that when a good management team is
pouring money into something they don’t have to, it indicates they’ve found a
greater return on capital than stock buybacks. He calls Fair Isaac's transition
from repurchases to investments "an uncanny signal.”
History is also a good anchor. Since his launch, Heard
owned Time Warner, the media giant that controls HBO, Turner and Warner Bros.,
believing its programming would thrive even as consumers switched from cable
bundles to streaming video. From a start in the $30s, Heard’s bet was an early
winner. Forced to sell Time Warner for risk purposes amid a selloff to end
2015, Heard re-tested his analysis and rebuilt the position in January 2016 in
the $60s. That year Time Warner shares shot up as it disclosed the
profitability of HBO, reaffirming both Heard’s belief and eventually enticing
buyers.
In October, AT&T announced an $85 billion takeover of Time Warner
at $110 a share. Heard studied up on antitrust case law and decided regulators
would allow the combination. AT&T closed the deal this past June.
“Uncertainty is always present,” says Heard. “It’s really about having a
framework. I try to build a mosaic of facts and then figure out what’s the
highest-probability outcome based on those facts.”
Finding the right balance between conviction and
overconfidence is also critical. Since 2014, Heard has owned a large position
in TransDigm, an aerospace parts giant he invested in to capitalize on rising
air traffic. Because of its stellar performance, the position became a top
holding for Heard by 2017. Then TransDigm was attacked by short-sellers and investigated
by a congressmen for its billing practices to the Department of Defense. In
response, Heard put on a low-cost hedge and began retesting his investment
thesis, deeply researching criticisms of the company. Ultimately, he decided to
stick to his guns. From a basis below $200 a share, TransDigm now trades above
$350 and has returned nearly $100 a share in dividends to Heard.
That’s not to say he won’t admit mistakes. For
instance, Criteo, a controversial digital advertising technology company that
was criticized by shorts, was Heard's worst performer of 2017. But it could
have been worse. After re-testing his thesis when scrutiny boiled over, Heard
admitted to limited partners, “We were simply on the wrong side of the
debate," and exited the position with an about 15% loss, but at prices
nearly 50% above Criteo’s current trading value.
“William has remarkable conviction and wisdom without
arrogance,” says Vista Equity’s Robert Smith. “He doesn’t have a prescriptive
thought process,” Smith adds, pointing out Heard has, “a different lens on the
world than others—and certainly other hedge fund managers.”
Canning, of Madison Dearborn, was impressed enough
with Heard’s work that he introduced the young investor to Northwestern
University’s endowment. Though the university didn’t invest, their
recommendations motivated Heard to spend everything he could to build systems
and a team that would comfort institutional money. Heard has reinvested just
about every dollar of fees back into his firm, hiring two partners and working
with firms like Monahan & Roth and Heidrick & Struggles to build a
foundation. “He has built himself a team that is way beyond his fee income,”
says Canning, who adds, “He's going to start landing some of these big
institutions, and I think he's ready.”
This year, Heard Capital’s assets have grown beyond
$50 million due to market appreciation and commitments from new investors like
the Robert McCormick Foundation and the Nielsen Foundation. In addition to his
long-short strategy, Heard runs a concentrated long-only strategy and one
tailored to specific investor needs.
Having used the market as his measuring stick, Heard
recently moved into his own offices in a tower overlooking Chicago’s financial
district and is now ready to grow. “For me investing combines both the desire
to build something based on meritocracy and the ability to communicate what I
believe is a different approach.” He adds, “Investing rewards you for knowing
yourself. It rewards you for being bold, and for taking a deep breath and
pausing.”
And what about spending years trying to build a hedge
fund at a time when many are starting to write the industry off? Heard replies,
“I was afforded a unique opportunity and got support early on from people I
admire. I didn’t want to wonder 'what if' because I didn’t take my shot.”
