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California's hedge fund king

Thomas Steyer sits atop Farallon Capital Management, a $33 billion San Francisco hedge fund. So why does he still drive a Honda, wear old plaid ties, and support Barack Obama, whose tax policies would take money out of his own pocket?

By Adam Lashinsky, senior writer
September 22, 2008: 4:01 AM EDT

Thomas Steyer of Farallon is at the center of a network of San Francisco investment pros.
Thomas Steyer and his wife, Kat (in glasses), promote mortage relief alongside California Governor Arnold Schwarzenegger.

(Fortune magazine) -- As the summer of 2008 drew to a close, many hedge fund managers were worried about coaxing their returns out of negative territory by the end of the year. Thomas Steyer, who founded the giant Farallon Capital Management, was worried about his hedge fund, but he was also losing sleep over getting Barack Obama elected president. For the first time in its 22-year history, Farallon was on track for a calendar-year loss. At the end of June the firm's flagship fund was off a little more than 5%, according to an investor report obtained by Fortune, and Farallon hasn't made up the lost ground since.

So Steyer cancelled his vacation plans this summer - as he did last year when the credit crisis began - to stay abreast of Farallon's $33 billion worth of investments. But he also spent a good part of the time preparing for an Aug. 17 fundraiser at San Francisco's Fairmont hotel, with performances by Jackson Browne and Graham Nash. The event collected $7.8 million, the biggest single-night haul of Obama's nearly two-year-old campaign.

Many of Steyer's sort - that would be financial masters of the universe - want nothing to do with a candidate who promises to boost every imaginable kind of tax they pay. Steyer, instead, is the type who thinks his crowd ought to be pitching in more. "There is definitely a strain in American capitalism where people believe that they have made the money on their own, basically working single-handedly as an individual to create wealth for themselves," he says in a rare interview at Farallon's downtown San Francisco offices with commanding views of Alcatraz and the glimmering bay. "I completely disagree with [that line of thinking]. I mean, they are the beneficiaries of literally over a thousand years of people creating a system and sacrificing."

One sacrifice Steyer embraces, for example, is Obama's intention to boost personal tax rates from 34% to 40%, a move abhorred by many on Wall Street. He notes that the increase merely returns those taxes to Clinton-era levels. "We have to get back to a sense of shared national purpose and that we are connected and responsible for each other," he says, at times choking up with emotion over, believe it or not, tax policy. "The taxes proposed by Obama seem completely consistent with the idea we would actually try to do something together as opposed to scratching out the most for ourselves as individuals."

This soak-the-rich mindset is one of the many ways that the 51-year-old Steyer embodies a different breed of investment professional than the Gucci loafer-wearing, Range Rover-driving, Bordeaux-inhaling traders who have made Greenwich, Conn., and Manhattan bubble over in recent years. In contrast, Steyer is a self-made billionaire and unreconstructed liberal, a financial whiz with a hankering for social justice, an athlete as well as a mathlete. He's a guy's guy who requires guests at his annual Christmas lunch to bring a poem to read.

It should come as no surprise, then, that Farallon, during its 22 years in business, has always looked for investment ideas that are outside the New York feedback loop. Steyer's strength has been applying a philosophy known as "absolute return" to different investment ideas including risk arbitrage, distressed debt, real estate, and emerging markets.

Despite his business success and political connections, he is virtually unknown outside of hedge funds or California politics. Operating quietly is easier in a town where tech titans like Oracle (ORCL, Fortune 500)'s Larry Ellison and VCs like Kleiner-Perkins's John Doerr grab the attention. Still, running a mega-hedge fund in one of the world's most important financial centers has caught the attention of his peers. "He's done everything he can to keep his head low, and I highly respect that," says Jim Coulter, the San Francisco-based founding partner of private equity heavyweight TPG. "He's like the best restaurant in town that only the locals know. They tend to have the best food."

Typically, Steyer agreed to speak with Fortune only about politics and the philanthropies he supports with his wife, Kat Taylor, the granddaughter of a prominent San Francisco banker. (A dynamic duo on the progressive San Francisco philanthropy scene, their TomKat Foundation precedes by several years the similar-sounding SoCal phenomenon that is Tom Cruise and Katie Holmes.) A typical passion project for the Steyers is One California Bank, a community bank in Oakland whose mission is to provide capital for small businesses and mortgages in a neighborhood other banks avoid.

Farallon (which takes its name from a chain of shark-infested islands in the Pacific Ocean, 27 miles west of the Golden Gate) operates around the world, but its vibe is California cool. Steyer, a New York City native, professes the love of a convert, praising his adoptive state's "incredibly positive attitude about the future, its open-mindedness, and its people's willingness to take a chance." Steyer and his partners at Farallon were not open-minded when it came to discussing the firm's operations. They refused to be quoted about Farallon, its funds, and investments for this story, but plenty of friends, associates, and competitors did agree to talk, especially about what makes the firm stand out.

What does make Farallon's corporate culture different from many funds is its California-ness. It's not so much that Farallon is laid-back as that it's reasonable. Fund managers who have a bad year do see their pay slashed, but they aren't fired. Independent thinking is highly valued. "Being out here in California has allowed Farallon to separate from the pack," says Meridee Moore, a longtime Farallon partner who now runs her own firm, Watershed Asset Management.

That independent thinking led Steyer to become a pioneer in using the "absolute return" concept for his hedge fund. In plain English, absolute-return investing might be called trying one's hardest not to lose money. In Steyer's argot, it means focusing not merely on the potential returns of an investment but, more important, on the risk-adjusted returns. It treats every investment - whether a residential mortgage, a common stock, or a parcel of land - as a bond, with an implied rate of return. The result is a strategy that neither shoots the moon nor tends to lose much in tough times. It also uses relatively little leverage, further protecting against losses. Absolute-return devotees include investing rock star David Swensen, who manages the Yale endowment and who was an early investor in Farallon. The philosophy also helps explain how Farallon has achieved a 16% compound annual return since 1986, compared with about 10% for the S&P 500 index.

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