May 12, 2008

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Rebounds by Hedge-Fund Stars
Prove 'It's a Mulligan Industry'

Jeffrey Larson lost $1.5 billion for his hedge-fund investors in a few painful weeks last summer. He shuttered Sowood Capital Management LP in July, one of the more embarrassing meltdowns in recent memory.

So what are the 50-year-old Mr. Larson's summer plans this year? He is trying to raise money for a new fund, arguing that he has learned valuable lessons. And he is attracting some interest.

Wall Street likes to consider itself a strict meritocracy, but hedge-fund managers who fail in ugly ways often convince investors to hand them piles of cash so they can give it another go.

Says Ken Phillips, who runs RCG Capital Partners, a Boulder, Colo.-based firm that invests in hedge funds: "It's a mulligan industry," referring to the golf term for a second chance after a poorly played shot. "That's what makes America great."

Just over a week ago, Drake Asset Management announced that it was closing its $2.5 billion hedge fund after heavy losses. Executives say they already have more than $800 million committed to a new fund.

Some investors in Daniel Zwirn's D.B. Zwirn & Co. fund recently received subpoenas from the Securities and Exchange Commission regarding an investigation into the fund, which is closing. But some already have told Mr. Zwirn that they would be interested in giving him money for a new firm he is considering.

Meanwhile, trader Philippe Jabre, who received a record fine for market abuse from the United Kingdom's market regulator, launched his own fund last year after raising $3.5 billion. And John Meriwether, who oversaw the collapse of Long-Term Capital Management a decade ago, is dealing with fresh losses at his latest hedge fund.

Traders sometimes even get third chances. Take Brian Hunter. After leaving Deutsche Bank amid a dispute, his trades led to $6.6 billion of losses for hedge fund Amaranth Advisors. He now is advising a new fund.

Investors have a range of explanations for opening their wallets for failed managers. Sometimes, managers demonstrate that big losses made them smarter investors, or they offer to waive some of their hefty fees for those who got burned in previous funds. Some managers who had stumbled in the past, such as David Shaw of D.E. Shaw and William Ackman of Pershing Square, restarted their careers and generated big returns.

It can be helpful to have lost loads of money, rather than a smidgen of cash.

"It's crazy, but the guy who's down substantially often will have a lot more options versus someone smaller who hasn't lost much money," says Neal Berger, who runs Eagle's View Asset Management, LLC and invests with funds. "Some investors will say 'lightning doesn't strike twice in the same spot,' or, 'there must be something smart about him that someone gave him the opportunity to lose so much money in the first place."'

Those like Mr. Larson, who were felled by volatile markets rather than because of any improprieties, usually receive more interest from potential investors. "He was a smart guy who got caught in a severe market dislocation," notes RCG's Mr. Phillips, who says he would be interested in meeting with Mr. Larson to learn about his new fund.

Still, Mr. Phillips acknowledges that there may be more to the phenomenon than a hard-headed calculus about returns. "The hedge-fund industry tends to glamorize managers," he says, "and people get star-struck."

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com¹ and Craig Karmin at craig.karmin@wsj.com²