Jeff Banfield, Legendary Mastermind of Arbitrage

jeff banfield

Jeff Banfield is best known for his work as an arbitrageur

Jeff Banfield founded Banfield Capital Management in 1997 after working as a prop trader for several banks for many years. Banfield was allegedly involved in some insider trading shenanigans in February 2001 (or it could have been a kerfuffle, I’m not a regulation expert), and he left the firm in December 2001.

In 2004, Banfield reached an agreement with the OSC. Anyone accused of insider trading in Canada prior to 2005, in my opinion, is a victim of selective prosecution. Every record from that era should have an asterisk in the style of Mark McGwire or Sammy Sosa that says “may have been boosted through insider trading.”

Aside from that, Jeff’s track record at Banfield Capital was a cumulative return of 350%, compounding at 34%. (During the same time period, the S&P 500 compounded at 7%.) Interestingly, Jeff’s partners, most notably Danny Guy, bought out Banfield Capital Management, which eventually morphed into Salida Capital. Salida Capital exploded, but this isn’t necessarily a reflection of Banfield. (Salida’s strategies mostly were highly directional and speculative, as opposed to arbitrage).

Banfield was mostly managing his own capital after “retiring” from his firm. He was a frequent investor in Canadian hedge funds, including small, emerging funds. I believe he invested in funds managed by Salida, Leeward, and Sevenoaks, among others, but I’m not certain. In fact, I believe he worked out of Leeward’s offices for a time. All three companies are now extinct, possibly due to the Tiger Cub effect.

Banfield ran a hedge fund-focused research firm called JMO Research. JMO performed quantitative research on hedge funds. I reviewed some of the reports and found the methodology to be questionable, such as focusing on only 24 months of data. Many people examine hedge funds with short histories, which is completely meaningless.

Banfield made some noise as an activist advocating for more investor-friendly hedge fund terms. He delivered a speech titled Heads they win, tails you lose in which he railed against 2/20 compensation. He also claimed that most hedge funds do not live up to their promise of higher-than-market returns with lower-than-market risk. I have to agree that the majority of hedge funds are bad.

He appears to be attempting to take matters into his own hands, as he and partner Glen Gibbons launched their own hedge fund, Caravel Capital, in 2016. Gibbons has an interesting backstory as well. He worked for K2, a Toronto-based arb fund manager. He reportedly made $10-$15 million, bought a home in Hawaii or the Bahamas, and retired at the age of 29.

Then he returned to co-found Radiant Investment Management with partner Norm Kumar. Radiant is said to have started with $30 million from Bay Street luminaries such as Bill Holland and Gene McBurney. Radiant appears to have ceased operations in 2013. Gibbons then co-founded HGC Investment Management (which is still operating). During Gibbons’ tenure at HGC, the arbitrage fund performed admirably.

Caravel had about $30 million in AUM as of early 2018, with a fifth of that coming from the principals. Because the firm is based in the Bahamas, it is subject to the laws of that country. Neither the firm nor the founders are registered with the Ontario Securities Commission (and they don’t have to be if their activities are limited to the Bahamas).

Accredited investors with a minimum investment of $500k can invest in the fund (presumably, the Bahamian definition of an accredited investor). I could totally post a picture of Banfield’s place in The Bahamas, but I’m not going to. You think I can’t find a guy just because he moves to The Bahamas? You’re underestimating me. Understanding a person’s lifestyle is essential before you can trust them with your money.

Caravel’s strategy is described as follows:

Caravel Capital Funds seeks risk-averse and market-neutral investment opportunities.” Merger Arbitrage, Capital Structural Arbitrage, Convertible Arbitrage, and Relative Value Arbitrage are among the strategies.
I haven’t gone over the fund’s terms in depth, but I noticed that the 20% performance fee is paid quarterly.”

This could mean that if the fund does well in the first quarter of a year but then falls dramatically for the rest of the year, clients will be paying performance fees in a year in which they lose money. That appears to be “heads they win, tails you lose.”

Caravel Strategies

Since its inception in September 2016, the fund has delivered strong results, rising 74% (compared to 49% for the S&P 500) – including a single-month return of 13.96% in November 2017. It’s up around 4% this year. But, as I previously stated, short-term performance, good or bad, is irrelevant.

I read the newsletters that were previously available on their website (they’re no longer available) – newsletters can reveal a lot. Here’s what I discovered:

-In one letter, they state that they expect monthly returns of 1.5% to 2%. In another, they mention aiming for an annual return of 15-20%. If your monthly returns are 1.5% to 2%, that annualizes to 20-27%, indicating some inconsistency. Regardless, anything above 15% using arbitrage and market-neutral strategies AFTER 20% performance fees on a quarterly basis is pretty ambitious.

-In comparison to November 2017 – up 13.96%: The majority of the profit came from participating in a company’s financing, which included both a debt refinance and an equity raise. It appears that they were able to obtain cheap shares that doubled in three months, generating a 15% gross return to the fund (implying that the initial weight of the shares was 15%).

-In February 2018, they claim to have “predicted the current volatility by keeping a close eye on bond markets, currency markets, and irrationally exuberant investors.”

-I see they have arbitrage positions as well as what they call “catalyst” positions. They offer “alpha shorts” as well as “deep value” positions. They also had a lengthy Cobalt thesis (as of early 2018).

I really enjoy arbitrage – what’s not to like about almost free money? Banfield had a mantra that went something like this: “what we make, we keep”…he has always been obsessed with mitigating systemic risk and attempting to be market neutral.

Caravel, on the other hand, appears to combine an arbitrage core with the usual Toronto Hedge Fund 1.0 crappola. There will be large weights, macro forecasting, thematic investing, shorting, and value. On top of keeping a “vigilant eye on bond markets, currency markets, and irrationally exuberant investors,” that’s a lot of different strategies.

In my opinion, terms like “catalysts” are delusions – the belief that you have discovered some event that the rest of the market is ignoring. Being long cobalt is right out of the Salida / Leeward playbook. I could name a dozen managers who blew their brains out on such ideas, whether it’s molybdenum, uranium, coal, or whatever, but I can’t name anyone who got in and out of such themes on a consistent basis.

I’m not saying cobalt is a bad idea – I have no opinion on that. I’m not saying Caravel can’t come up with good ideas. But I strongly believe that betting on such ability to endure is a bad bet. (Since I wrote these words in April 2018, the cobalt theme appears to have faded, though I am no expert on the subject.)

“The Investment Manager may at any time adopt new strategies or deviate from the foregoing guidelines as market conditions dictate,” according to the fund’s documentation. As if the strategy wasn’t already ambiguous. I wouldn’t put Danny Guy’s money into this fund.

I am aware of one Canadian arbitrage firm with a much longer track record of value addition. I might write about them someday. But, in general, arbitrageurs will be driven to obscurity, and I want to find good managers I can work with for decades.

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