Memba them?

Jeff Banfield, Original Gangster of Arbitrage

OPM 5 min read

Jeff Banfield is primarily known as an arbitrageur. After working for many years as a prop trader at banks, he started Banfield Capital Management in 1997. In February 2001, Banfield was allegedly involved in some insider trading shenanigan (or it might have been a kerfuffle, I'm not a regulation expert) and in December 2001, he left the firm. Banfield eventually reached a settlement with the OSC in 2004. In my view, anyone operating prior to 2005 in Canada accused of insider trading is a victim of selective prosecution. Every track record from that era should have a Mark McGwire / Sammy Sosa style asterisk saying “may have been enhanced through insider trading”.

On a separate and unrelated note, Jeff’s record at Banfield Capital was a cumulative return of 350%, compounding at 34%. (The S&P 500 was compounding at 7% over the same period.) Interestingly, Banfield Capital Management was bought out by Jeff's partners, chiefly Danny Guy and eventually morphed into Salida Capital. Salida Capital totally blew up, though that's not necessarily a reflection of Banfield. (Salida's strategies mostly were highly directional and speculative, as opposed to arbitrage).

Following "retirement" from his firm, Banfield was mostly managing his own capital. He was an active investor in Canadian hedge funds, including backing small, emerging hedge funds. I think he was an investor in funds managed by Salida, Leeward and Sevenoaks, among others, though I can’t be sure. In fact, I think for a while he was working out of the offices of Leeward. All three firms are now extinct, maybe that’s a reverse Tiger Cub effect.

Banfield had a research firm called JMO Research that focused on hedge funds. JMO conducted quantitative analysis of hedge funds. I have reviewed some of the reports and find the methodology to be dubious - for example, focusing on 24 months worth of history. Many people analyze hedge funds with short histories - it's utterly meaningless. Banfield made some noise as an activist for more investor-friendly terms from hedge funds. He gave a speech called Heads they win, tails you lose, where he railed against 2/20 compensation. He also said most hedge funds don't deliver on the promise of higher than market returns with less than market risk. I have to agree, most hedge funds are crap.

It looks like he is attempting to take matters into his own hands because he has launched his own hedge fund, Caravel Capital in 2016, along with partner Glen Gibbons. Gibbons also has an interesting background. He worked at a Toronto arb fund manager called K2. Apparently, he made $10-$15m, bought a place in Hawaii or the Bahamas and retired at 29. Then he came back to start Radiant Investment Management along with partner Norm Kumar. Radiant I'm told started with $30m from Bay St. luminaries like CI Financial honcho Bill Holland and GMP Capital co-founder Gene McBurney. Radiant seems to have stopped in 2013. Gibbons then moved to co-found HGC Investment Management (which is still operating). HGC's arbitrage fund has had great numbers during Gibbons' tenure there.

As of early 2018, Caravel has about $30m in AUM, a fifth of which is the principals' money. The firm is based in the Bahamas, so it is regulated under the laws of that country. Neither the firm, nor the founders are registered with the Ontario Securities Commission (and of course, if their activities are confined to the Bahamas, they don't have to be). The fund is available to accredited investors investing a minimum of $500k (presumably, the Bahamian definition of an accredited investor). I could totally post a photo of Banfield’s place in The Bahamas, but I am not doing that this time. You think just because a guy moves to The Bahamas, I can’t track him down? You underestimate me. Understanding a person’s lifestyle is crucial to trusting them as a money manager.

Caravel describes its strategy as follows:

“Caravel Capital Funds pursues investment opportunities that are risk-averse and market neutral. The strategies include Merger Arbitrage, Capital Structural Arbitrage, Convertible Arbitrage, and Relative Value Arbitrage. ”

I have not reviewed the terms of the fund in any detail, but notice that the 20% performance fee is paid quarterly. This could mean that if the fund is up big in the first quarter of a year, and down big for the remainder of the year, clients would find themselves paying performance fees in a year in which they lost money. That seems to me pretty "heads they win, tails you lose".

The fund has delivered strong results since inception in September 2016 up 74% since September 2016 (vs 49% for the S&P 500 return) - including a single month return of 13.96% in November 2017. This year, it’s up around 4%. But as I said, short-term performance - good or bad - is irrelevant.

I have read their communications to investors - you can tell a lot from carefully scrutinizing fund letters. Here's what I found:

-In one letter, they say they target returns to be around 1.5% to 2% per month. In another, they mention a goal of generating an annual return of 15-20%. If your monthly returns are 1.5% to 2%, that annualizes to 20-27%, so there's a bit of inconsistency there. Regardless, anything above 15% is pretty ambitious using arbitrage and market-neutral strategies AFTER 20% performance fees, taken on a QUARTERLY basis.

-On the huge November 2017 - up 13.96%: Most of the gain was the result of playing a role in the financing of a company, both a debt refinance and an equity raise. Sounds like they were able to get shares cheap which doubled within 3 months, generating a 15% gross return to the fund (implying that the initial weight of the shares was 15%)

-In Feb 2018, they claim to have "Forecasted the current volatility by not forgetting to keep a watchful eye on bond markets, currency markets, and irrationally exuberant investors".

-I notice they have both arbitrage positions and what they call "catalyst" positions. They have "alpha shorts" and what they describe as "deep value" positions. They also had a long thesis on Cobalt (as of early 2018).

I like arbitrage a lot - what's not to like about almost free money? I recall Banfield had a mantra: "what we make, we keep"...he has always been obsessed with mitigating systemic risk and trying to be market neutral. Unfortunately, Caravel seems to combine an arbitrage core with the usual Toronto Hedge Fund 1.0 crappola. You'll notice big weights, macro forecasting, thematic investing, shorting, value. That's a lot of different strategies, on top of keeping a "watchful eye on bond markets, currency markets and irrationally exuberant investors".

In my view, terms like "catalysts" are delusions - the notion that you have somehow identified some event that the entire market is ignoring. As for being long cobalt, that's straight out of the Salida / Leeward playbook. Whether it's molybdenum, uranium, coal or whatever, I could name you a dozen managers who blew their brains out on ideas of the sort, I can't name you anyone who got in and out of such themes on any reliable basis. I'm not saying cobalt is not a smart idea - I have no view on that. I'm not saying Caravel can't pick out winning themes. But I am definitely saying that you betting on such skill being enduring is a bad bet. (Since I wrote these words in April 2018, the cobalt theme appears to have petered out, though I am hardly a cobalt expert)

Here’s a gem from the fund docs: “The Investment Manager may at any time adopt new strategies or deviate from the foregoing guidelines as market conditions dictate” As if the strategy is not vague enough, to begin with. I wouldn’t buy this fund with Danny Guy’s money.

I'm aware of one Canadian arbitrage firm with a much longer track record of adding value. I might write about them eventually. But in general, arbitrageurs will be competed away to irrelevance and I want to find good managers I can stick with for decades.

Finally, I clarify that I mean Original Gangster as that term is commonly understood, in the sense of early pioneer - not as in a crimelord, or anything like that.

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