Davidson Kempner Capital Management

Marvin Davidson and Tom Kempner

Davidson Kempner Capital Management was founded by Marvin Davidson in 1983 as a family office to manage his retirement money. Davidson, a former managing partner at Bear Stearns, left Bear Stearns when it became clear that Jimmy Cayne would succeed Alan “Ace” Greenberg.

Motivated by his extensive experience in risk arbitrage and convertible arbitrage, Davidson sought to run his own money in a non-correlated, risk-averse manner.

The original focus of the firm was on the three pillars of merger arbitrage, distressed debt, and opportunistic credit, which tend to be uncorrelated with each other. Opportunistic credit involved purchasing assets at 70 to 90 cents on the dollar, aiming for par or a higher price (ie. buying at 70 cents on the dollar and selling at 85 cents), while merger arbitrage targeted spreads on announced deals.

The firm initially managed ~$20 million of Davidson’s money. By 1987, with Tom Kempner joining—who brought expertise as a Goldman Sachs bond trader specializing in distressed debt—Davidson Kempner began raising outside capital.

Raising outside money and global growth

Throughout the late 1980s and early 1990s, the firm experienced significant asset growth, which then plateaued for about five years. From 2000 to the pre-GFC (Global Financial Crisis) period in 2007, assets surged from $1 billion to $14 billion. During this time, Davidson Kempner began investing in the equity “stub” of distressed names, leveraging their deep knowledge on the credit side. Tom Kempner approved allocating 1% of the portfolio to this strategy, which proved successful and led to further expansion into special situations, L/S equity, L/S credit, and convertible arbitrage, evolving the firm into a true multi-strategy fund.

During the GFC, Davidson Kempner, like many others, faced challenges. Tony Yoseloff, the current Managing Partner and Chief Investment Officer, identified an opportunity to focus on longer-duration, less liquid private equity-style distressed investing. The firm attracted capital for lockup funds to support illiquid strategies with longer investment horizons. This approach allowed them to take control of businesses, influencing their strategic direction and cash flow allocation.

Davidson Kempner's expansion also included a significant European presence, starting in the early 1990s, with the opening of a London office in the early 2000s. Post-GFC, the firm capitalized on European banks' asset sales, resulting in a strong period for acquiring assets and substantial hiring. The firm also established a presence in Asia with a Hong Kong office in 2010, initially focusing on equities and later expanding into credit, with significant investments in India and China.

Davidson Kempner achieved a 7% annualized return with a 4% annual variance over the two decades (as of 2022, per Bloomberg). The firm does not use leverage.

Tony Yoseloff

Tony Yoseloff, the current Chief Investment Officer, began his career as an intern with the firm. A Princeton undergraduate with a Columbia J.D./MBA, Yoseloff was initially drawn to investment banking and consulting, like many of his peers. However, he noticed a job posting from Davidson Kempner, then a small, relatively unknown family office. He was the only applicant for the full-time merger arbitrage analyst position. The firm, recognizing his potential, decided he would be better suited for opportunistic credit and distressed investing, setting him on a path toward fundamental investing rather than event-driven strategies.

Yoseloff joined Davidson Kempner around the turn of the century when many investment-grade credits were downgraded to high yield. Early in his career, he was assigned as a primary analyst to numerous situations and given early risk-taking responsibilities due to the relatively small size of these positions in the firm’s overall portfolio.

Yoseloff’s credit investing experience and mentorship under Tom Kempner have shaped his focus on downside protection. Known for his rigorous risk assessment, he always evaluates potential problems and loss magnitude. If you interview with Tony, keep this in mind.

The late 1980s, when Davidson Kempner was in its formative years, presented a different landscape compared to today. The absence of ETFs owning bank loans made it a simpler time for investing. By the late 1990s, however, the market had evolved significantly, with expanded issuance sizes and types, making many distressed situations more complex and opportunities more scarce.

Research Process

Davidson Kempner has a collaborative culture. This approach leverages shared resources and knowledge across different strategies. The firm utilizes common resources such as quantitative and qualitative research teams to support and integrate new strategies effectively.

When Davidson Kempner was founded, analysts and PMs were generalists. As the firm expanded, it became impractical to maintain this structure. Today, the firm hires specialists based on their sector expertise rather than asset class expertise. The risk arbitrage team remains distinct, while the opportunistic credit team is organized into five areas: corporate credit for the US, Europe, and Asia, and global teams for real estate and structured products. These teams are further divided by industry, countries, and product types.

Team members at Davidson Kempner do not work for a specific fund; instead, they contribute across all strategies within their area of expertise. This structure allows the firm to be a versatile capital provider, responding to sellers who seek to unload assets rather than targeting specific funds. For instance, a hotel expert can lend to hotels, invest in hotels through private transactions, or trade REITs, regardless of the asset class.

This organizational model also benefits employee retention. By exposing team members to various asset classes within their sector specialty, they gain a broader investment experience, moving from debt to equity or from public to private markets. This versatility helps mitigate the effects of cyclical downturns and prevents constraints that might force suboptimal ideas into the portfolio (ie. a public credit analyst wants to get a public credit name into the portfolio in all market environments even when there are better alternatives).

Decision-making at Davidson Kempner is not centralized but involves individuals who have demonstrated their capabilities within the firm. However, investment decisions are subject to firm-level risk oversight for public investments and an approval process for private investments. If the firm is uncomfortable with position sizes, it imposes limits at the team level.

For investments aligning with patterns the firm has invested under previously, the team members present their ideas to Tony and another PM for review. For ideas that do not fit previous patterns, the firm has a "scream if you hate it" process to evaluate whether the idea merits further consideration.

For merger arbitrage positions, the firm uses a risk-based approach to sizing. They assess the market-implied probability of a transaction closing and compare it with their internal probability assessment, sizing positions based on the difference between the market and internal probability, and quantifying potential downside.

For public strategies which are judged on a more short-term basis, the firm employs traditional risk management tools for relative value strategies like long/short credit and equity, which involve daily risk assessments. However, Davidson Kempner does not enforce an outright sale if a PM reaches a risk limit, as the firm does not use leverage.

In risk arbitrage, where deals often have high probabilities of closing, the price moves quickly if a deal falters. Therefore, quantitative risk management methods are sufficient. In contrast, opportunistic credit investments have wider outcome dispersion and take longer to realize value, requiring qualitative risk management.

The firm avoids macro overlays, such as currency or interest rate hedging, believing they introduce additional risk. Instead, each portfolio is hedged at the portfolio level and the PMs have autonomy in buying/selling individual securities.

Idea generation

Davidson Kempner is drawn to opportunities to acquire substantial amounts of debt from companies experiencing temporary difficulties, particularly those that were formerly rated investment grade. These situations often involve indiscriminate selling, providing strong collateral and a significant margin of safety, which makes them attractive investment opportunities. In the private market, the firm prioritizes investments with robust downside protection, focusing on industries that are either out of favor or distressed.

Fee structure

Management fee ranges from no fee to 1.5% of net assets, contributed or invested capital. The performance fee for more liquid strategies is 20% of net realized and unrealized capital appreciation and for illiquid/private is 15-20% carried interest on net capital appreciation upon realization. 

Investment team profile

With $45 billion under management, the firm is known for its strong culture, which is supported by the collaborative process previously described. The only downside is a common consequence of this culture: employees don’t leave.

Marvin Davidson, a University of Michigan undergraduate, holds an MBA from Harvard Business School (HBS). Similarly, Tom Kempner graduated from Yale and also holds an MBA from HBS. Tony Yoseloff earned his undergraduate degree from Princeton and holds both a J.D. and an MBA from Columbia. It’s safe to assume that the firm predominantly attracts graduates from elite institutions.

On a global basis (encompassing employees in the U.S., Europe, and Asia), the primary observation is that the firm significantly favors candidates from Columbia, Harvard, and UPenn. The preference of Columbia and Harvard graduates aligns with the backgrounds of the founder and the current CIO. UPenn is considered the leading finance school in the US.

To a lesser extent, Duke, NYU Stern, and Cornell also feature prominently. I’m somewhat surprised by Duke’s representation given its southern location. Still, Duke is a top university, and a senior partner or top performer at DK advocating for a school may have led to its strong representation.

At the graduate level, more than half of the 250 data points I analyzed have a graduate degree. Among those with MBAs, the top schools represented are HSWCCs: 9 alumni from Columbia Business School, 9 from Harvard Business School, 7 from Stanford GSB, 9 from Wharton, and 2 from Chicago Booth.

In Europe, the firm's employees predominantly hail from leading schools. UK graduates heavily come from Oxbridge, LSE, and Imperial College. For non-UK Europeans, a few have studied at the Grande Écoles, and Bocconi University, Italy’s top university.

In Asia, given the firm's focus on China and India, candidates are often from Peking University and Tsinghua University, the top universities in China.

The firm's employees typically have backgrounds in investment banking, whether in private or public investing. Prominent bulge bracket firms represented among current and former employees include Goldman Sachs, Morgan Stanley, JPMorgan, Jefferies, and Citi.

Due to DK’s reputation in distressed and high-yield credit, many employees have restructuring investment banking experience from firms such as Lazard, Moelis, Houlihan Lokey, Guggenheim, Rothschild, Jefferies, Miller Buckfire, and Millstein. Those with legal backgrounds come from top law firms like Wachtell, Lipton, Skadden, and Paul Weiss.

Given DK’s event-driven equity strategies, many professionals have moved to or from major multi-manager firms like Citadel, Millennium, SAC/Point72, as well as single-manager firms with event-driven fame such as York, Pentwater, and Candlestick. Finally, some employees have experience or have moved to top distressed investment firms such as Silver Point and Apollo.

No big surprises in talent demographics for a top-tier multi-strategy hedge fund such as Davidson Kempner.

Future direction

Tony (Yoseloff) stated Davidson Kempner has no intention to go public. Both Marvin Davidson and Tom Kempner’s prior employers, Goldman Sachs and Bear Stearns, were run as partnerships. They founded the firm on an arms-length agreement. It will continue to be that way.

The firm periodically admits new partners and retiring partners gradually return their shares. As a private firm, Davidson Kempner has benefited from solely serving its limited partners, not external shareholders. Partners are expected to invest a significant portion of their net worth in the firm and are collectively the largest investors across all their products, creating strong incentive alignment.

Looking ahead, Davidson Kempner envisions opportunistic credit and risk arbitrage continuing to play crucial roles in portfolios. With the current trend toward retail investors, there is an opportunity to address the under-allocation of multi-strategy hedge funds amongst high-net-worth retail investors.

Please let me know if you have information on DK that I might have missed and/or where I am wrong (as long as you are not being a d*ck.)

Thanks for reading. I will talk to you next time.