By Irwin Speizer
Photographs by Dorothy Hong
When the call came from the investment office of Texas billionaire Edward Bass, Pamela Lawrence (right) was at once excited and concerned. Lawrence was scouting for investors to launch her new distressed-debt hedge fund, and the Bass organization, which was looking to seed just such a fund, could single-handedly put her in business.
There was one problem. The Edward P. Bass Group is based in Fort Worth, and Lawrence had no desire to move out of the Northeast, where she maintained strong business and personal connections. If Bass was looking for someone to relocate, Lawrence would have to pass on a rare opportunity.
"One of my first questions on the phone was, 'do you expect this fund to be managed out of Fort Worth?'" Lawrence recalls. Fortunately for Lawrence, the Bass organization had no Texas imperative. Lawrence flew to Fort Worth and gave her spiel for a distressed-debt hedge fund based in the New York area. It was an unusual proposal: A former school teacher from New York who had started out in the investment world as an office assistant was now courting one of the wealthiest families in Texas to be an investor in a new hedge fund that she would run. But Lawrence had proven herself through a series of high-profile jobs as an expert in distressed debt, and she came to Bass with a recommendation from Marc Lasry, the pioneering distressed debt specialist who co-founded hedge fund company Avenue Capital.
Bass bit, and in 2001 the group seeded Restoration Capital Management with $15 million. Bass remains an investor today.
The original Bass seed money has grown into a distressed-debt fund that manages $365 million out of its third-floor office in Greenwich, Conn. Now in its tenth year, Restoration Holdings, the flagship fund, has been in the black every year except one, when it lost a disappointing 1.01% in 2009. From inception in March 2001 to the end of April, Restoration Holdings produced an annualized net return of 10.02%, with a Sharpe ratio of 1.79—and with zero leverage.
Restoration Holdings has also outdone the indices: it gained 140.02% from inception through April, compared to a rise of 99.10% for the Merrill Lynch High Yield Master Index and 136.37% for the Credit Suisse/Tremont Event Driven Distressed Index. One distinguishing characteristic is Restoration's relatively low volatility in a field crowded with funds that go through wild swings. The AR Distressed Index plunged in the chaotic markets of 2008, then soared in 2009, making for a deep V-shaped performance chart.
By contrast, Restoration's performance stayed on a relatively straight line through the period, hovering above the volatile distressed index.
Restoration was up 8.84% in 2008, making money while many other hedge funds were losing. But the fund's flat results during the 2009 market recovery hurt investor confidence, which contributed to a redemption run that cost Restoration more than a third of its assets. The fund went from $615 million at the end of 2008 to $383 million at the end of 2009.
Restoration is now trying to rebuild its asset base. While the managers are still cautious and concerned about the strength of the market recovery, Restoration has repositioned its portfolio, cutting back on its short positions and adding new long positions in senior debt of late-stage reorganizations.
"We remained too negative too long," Lawrence says. "We underestimated the positive effects of the government stimulus program. We were also concerned about more redemptions. So we stayed too long on the sidelines. It is painful to us and disappointing."
As Lawrence points out, the 2009 performance also highlights a key part of the Restoration philosophy: managing risk well enough so that even if a major investment theme turns out to be wrong, the impact is small. Restoration is designed to produce steady and methodical performance through good times and bad while also protecting principal.
"The focus in the firm is on a diversified portfolio and not taking an outsize position in any one investment," Lawrence says. "We also don't have the volatility that some funds do. We know we don't appeal to every investor. But some investors really appreciate good, steady returns without volatility."
While steady returns may be what Restoration pitches, what investors frequently remember about their first encounter with Restoration is that its two key managers are both women. Restoration was founded by Lawrence and Ivona Smith (right), a pair of distressed-debt specialists who had worked together at two previous firms.
Restoration now has three more analysts, as well as two people in operations, two in client services and a client services manager. The office relocated last year from Manhattan to Greenwich, Conn., where Lawrence lives.
The senior member of the team and the managing partner of the firm, Lawrence was establishing herself in the distressed-investment field at a time when it was very much a men's club. "Pam is one of a handful of women portfolio managers in this space," says Michael Meagher, co-founder of the Seaport Group, a New York broker/dealer with roots in distressed investing. Meagher has known and worked with Lawrence for nearly two decades. "She is a pioneer in the sense that she was one of the early women focused on distressed securities."
Meagher says that Lawrence came to distressed investing from a different angle than many who take up the trade. The niche is commonly associated with rough-edged and aggressive men who have a sense that distressed investing is somehow in their DNA. Lawrence was different, Meagher says—a patient and methodical student of corporate investment and debt who eventually found herself drawn to distressed investing.
"Many of the people who run distressed funds do so because at an early age that is what they felt they were destined to do," Meagher says. "Pam evolved over time."
Growing up, Lawrence never considered finance of any sort as a possible career. Her destiny, she figured, was to be a public school teacher. Instead, she eased into Wall Street and worked her way up from the bottom.
Lawrence grew up in modest circumstances in Chappaqua, N.Y., showing an early aptitude for math and a capacity for hard work. Her father was a teacher in a residential treatment center for emotionally troubled youth. Her mother ran a luncheonette in town, and as a teenager Lawrence waited tables after school and on weekends. Her grades earned her a merit scholarship, and her family's financial status was low enough for her to get a financial aid scholarship. The two paid her way through Marymount College (now part of Fordham University), which was located then in nearby Tarrytown.
She earned her Bachelor of Arts from Marymount in 1974 with a major in psychology and a minor in education. In preparation for a teaching career, Lawrence worked for a semester as a student teacher in her senior year and was surprised at how unappealing the job seemed to her. Still, she continued on her chosen career path and took a job teaching fifth grade in Chappaqua. "I loved the kids," Lawrence says. "But it wasn't challenging enough for me. I knew there was something wrong with the picture."
She switched to a job as an office assistant in another school district and eventually got work as an administrative assistant in a financial firm in Manhattan. Lawrence worked for two female stock analysts at Bessemer Trust and quickly decided she had come to the right place. She enrolled in the night MBA program at Pace University, ultimately obtaining her degree in 1980.
Her two bosses recognized potential in Lawrence and, working through a women's financial professionals association in New York, helped her find a job as a junior analyst in the New York pension fund office of Grumman (now Northrop Grumman). The next stop for Lawrence was a job as a trader and analyst at the William Rosenwald family office, which managed money for the Sears, Roebuck heirs. She was the only female member of the investment team.
Lawrence stayed nine years and learned the foundation of what would become her investment philosophy and style. She worked for a chief investment officer who practiced a value investing style based around buying assets at discount while keeping a focus on preserving capital.
"The big takeaway from that experience was their philosophy," Lawrence says. "As the chief investment officer would say, markets go up and markets go down, but you won't lose money if you buy assets at a discount to value. We focused on each individual investment: what the downside was, what the upside was. That investment philosophy is my foundation, and the Rosenwald office is where I consider that I started my career."
The office invested in just about every part of the capital structure, and Lawrence was assigned to write a summary each quarter of every investment in the portfolio. The work was often tedious, but it sharpened her writing skills and expanded the range of her investment knowledge.
She left Rosenwald for a job as an analyst in the value investing firm David J. Greene and Co., which focused on equities. Lawrence decided after a year that she preferred debt. "Equity investing became uninteresting to me," Lawrence says. "It was more about estimating company earnings, valuation multiples, waiting for companies to report quarterly. It seemed very uneventful."
In 1988 she joined Magten Asset Management, a pioneer high-yield distressed-debt investment firm that took large positions in companies with the aim of becoming a major player in restructuring. She arrived in the heady days of the junk bond boom spurred by Drexel Burnham Lambert, which resulted in plenty of dicey debt to sort out. "It was a really exciting time for high-yield debt," Lawrence says.
One of the biggest bankruptcy cases of the 1980s was the Revco drugstore chain, which filed for protection in 1988. Magten started buying senior unsecured debt in Revco at about 50 cents on the dollar and continued buying, becoming the biggest creditor. Magten founder Talton Embry wound up chairing the creditor committee, closely assisted by Lawrence. He ultimately turned the job of chairing the committee over to Lawrence so he could concentrate on running Magten.
"He had enormous confidence and trust in Pam," says Brad Eric Scheler, a senior partner in the law firm Fried, Frank, Harris, Shriver & Jacobson, who represented bondholders in the case. "She is extremely smart. She is also well prepared. She is someone who has a command of facts. She also has a great personality. She is engaging instead of being nasty and confrontational, so she is able to get better results. She has the skills and the ability to reason, to understand the perspective of others and to get them to see her perspective."
Revco finally emerged from bankruptcy in 1992, and the restructuring turned out to be a highly profitable investment for Magten. "I started to realize that bankruptcy investing was very interesting and made a lot of sense to me," Lawrence says. "You could buy senior debt, which made you first in line. You can protect downside, and you can get great returns."
With the Revco bankruptcy completed, Lawrence moved on in 1992, joining Whippoorwill Associates, a distressed investor based in White Plains, N.Y., as a managing partner, portfolio manager and head of such back office functions as operations, accounting and investor relations. Whippoorwill gave her the full range of experience running an asset management firm, both from the investment team side and the operations side. "It turns out that it was a great experience," Lawrence says. "It taught me how to manage a fund and run an investment management business."
When Lawrence arrived, the firm was managing less than $100 million. When she left in 1999, it had $650 million under management. One of the analysts she met there was Ivona Smith, who would remain one of her closest associates. Smith had taken a more direct route to distressed investing, influenced first by a course in the subject on her way to an MBA at the New York University Stern School of Business. After graduating in 1996, she joined Ernst & Young in its restructuring advisory group, then landed a job at Whippoorwill.
In 1999 Citigroup's Tribeca Capital Management hedge fund operation recruited Lawrence to manage a distressed portfolio, and she brought Smith along to help run it. They stayed a year, but they agreed that working inside the vast corporate structure of a big bank was uncomfortable and limiting. Lawrence began talking with Smith about leaving to form their own hedge fund based around their specialty in distressed investing.
Among Lawrence's large network of contacts was Marc Lasry, founder of the giant distressed hedge fund firm Avenue Capital. Lasry had heard that the Edward Bass organization was looking to seed a distressed hedge fund, so he put Lawrence in touch with them. Avenue Capital now manages an estimated $19.7 billion in assets and has connections to the Bass family, so Lasry's introduction immediately opened doors for Lawrence.
A senior executive in the Edward P. Bass Group, who asked that his name not be used, says the organization had been searching for someone to run a distressed fund who was both highly qualified and interested in running a low-volatility strategy. The quest led Bass to Lasry. "We asked him, is there an A player out there? He said we should meet Pam. She is an A player," says the executive.
In late 2000 Lawrence had a two-hour phone conversation with members of the Bass organization, then flew to Fort Worth two weeks later for a meeting. Two weeks after that, she flew back with Smith for a second meeting. Bass executives quickly concluded they had found the right emerging manager and pledged $15 million. In March 2001 Restoration launched as a two-person firm in New York.
The timing was awkward, coming as the dot-com bubble burst and the terrorist attack on the World Trade Center on September 11 sent markets into free fall. Restoration had its $15 million seed money from Bass, and Lawrence put her own money into the fund, but it took almost a year to land new investors.
Still, Restoration proved that it could survive tough times, posting a net return of 3.55% from inception in March through the end of 2001, and another 3.67% gain in 2002. Then Restoration began putting up its best numbers to date, gaining 24.27% in 2003 and 20.06% in 2004. Restoration's annual net returns stayed in the 9% to 12% range for the next four years, including its 8.84% gain in the market meltdown year of 2008.
Asset growth began slowly, rising to $33 million by the end of 2002, $47 million in 2003 and $79 million in 2004. But after the big back-to-back gains in 2003 and 2004, investors began to take notice of Restoration. Assets jumped to $148 million in 2005, $279 million in 2006 and $421 million in 2007, peaking at $615 million in 2008.
Restoration steers clear of large corporate restructurings that can get messy and lead to drawn-out resolutions that are difficult to project. The firm invests in small and midsize companies, where it encounters less competition and complexity.
Unlike some distressed investors who shop for debt selling at 20 to 30 cents on the dollar, Restoration prefers less battered firms where debt is typically priced in the 70 to 80 cents range—an indication that a company is more likely to emerge from reorganization and pay off debts. In some cases Restoration comes in near the end of a restructuring to purchase debt at or above par where a payout that includes accrued interest can provide relatively quick profits. The potential returns in a Restoration investment might not always be as large, but neither is the chance of having the investment become worthless.
One example: Pilgrim's Pride, the Texas poultry company that filed for bankruptcy reorganization in December 2008. Restoration monitored the proceedings, and as the bankruptcy neared resolution, the price of Pilgrim's Pride's debt rose. Restoration decided that debt holders would likely get paid off plus accrued unpaid interest. So Restoration started buying senior bonds at 92% of par in July 2009, with the full position coming in at an average price of 104%. It also bought unsecured trade claims at an average price of 71%. When the case settled, the accrued interest brought the payout on the bonds to 114% and the trade claims to 107%. Restoration calculated the internal rate of return on the bonds at 39% and the trade claims at 98%.
In general, Restoration focuses on secured and senior debt, and it avoids buying debt that might be converted to equity stakes in companies, since that can complicate an exit strategy. Positions are kept small and spread among different sectors, with typical positions starting at about 1% of assets and growing to as much as 3% to 4% over time. Restoration also shorts both equity and debt as a hedge against its positions and to generate returns when its long positions don't.
Restoration has found its opportunities in a number of different sectors. For example, the firm began shorting retailers in 2007 and continued in 2008. In one case, Restoration played both sides of a distressed investment. In early 2008 Restoration shorted certain senior subordinated bonds at troubled department store chain Neiman Marcus when they were trading at about 60%. The bonds went all the way to 30%, at which point Restoration covered its short position. Then it noticed that the spread between the price of Neiman senior subordinated bonds and the price of protection on Neiman's senior unsecured debt (credit default swaps) had gotten out of whack, reaching a spread of 20 basis points. So Restoration bought the senior subordinated bonds at the deeply discounted price while simultaneously shorting the senior unsecured debt by buying CDS. The series of trades in Neiman debt returned 21% over five months.
The Neiman play was part of a bearish posture Restoration began taking in 2007. Restoration started adding short positions to its portfolio, first targeting home builders, then mortgages, then broker/dealers like Lehman Brothers. At the same time, Restoration began scaling back long positions, holding more assets in cash and adding short positions both through equity plays and credit default swaps. The shorts proved particularly helpful in 2008, accounting for almost all of the gains that year.
But Restoration maintained its bearish posture well into 2009, missing out on the market recovery that boosted returns for distressed investors who bought debt at what had been fire-sale prices during the bottom. Restoration didn't ramp up its long positions in distressed debt, held more cash aside for possible redemptions, and continued playing short positions that were now not paying off well.
It was a misstep, resulting in Restoration's first losing year. Restoration recorded three of its worst months ever in 2009, dropping 2.41% in March, 1.94% in April and 2.24% in July. The results were troubling to some of Restoration's investors, who watched other distressed investors post double-digit gains. Lawrence and Smith tried to remind investors of how well the fund performed in 2008 when other hedge funds tanked, and that the combined two-year period 2008-2009 compared favorably.
"A lot of our investors were very happy with our results in 2008," Smith says. "But toward the end of 2009, there were more people expressing frustration. We focus on the two-year return. We made money over the two-year period."
By the end of 2009, Restoration began shifting course, reducing its shorts and venturing cautiously back into long distressed-debt positions. Returns stayed positive each month in the last quarter of 2009 and through the first quarter of 2010.
But Lawrence remained cautious, not convinced of the recovery's staying power. Restoration focused on investing in debt near the end of restructuring, when prices are often higher than in the early stages. "We are still very concerned about the credit markets and the economy in general," Lawrence says. "So we are focusing on investing in the later stage of a company's restructuring—the last three to nine months, when you have a lot more information and less risk. We are focusing on smaller companies that are restructuring and upon exit from bankruptcy will cash us out."
One of those investments was Asarco, an Arizona copper mining company that entered bankruptcy in 2005, where it languished for the next five years. With the drawn-out case nearing an end, bonds that had unpaid accrued interest were now fetching a hefty premium instead of selling at discount. Restoration bought Asarco bonds at 150% of par and within two months got back 156% with the accrued interest.
Lawrence and Smith say that while they remain wary of market volatility for the rest of this year, they anticipate lots of opportunities for more aggressive distressed investing in 2011 and 2012 as corporate bonds mature and put pressure on companies that must refinance debts.
"There is a huge wall of maturities coming our way," Smith says. "Some of those companies are going to have to file for reorganization because they won't be able to get refinanced. We are looking at a nice potential wave of distressed opportunities. But until we see it, we will be pretty conservative in the portfolio."
Lawrence and Smith are now trying to rebuild Restoration's asset base. Restoration is also looking for new investors in its existing funds, hoping to get back up to $600 million and possibly grow to as much as $1 billion under management.
Getting there, Lawrence and Smith acknowledge, won't be easy or quick. But one thing they have, they say, is patience.
"In terms of raising money, we are trying to be a lot more focused, to get the right investors in the fund," Smith says. "We are making a push for pensions, institutions, family offices. We are happy to grow slowly."