Tom Steyer's Investment Style: How This Hedge Fund Investor Became a Billionaire

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As we continue our studies of the world's best investors, we come to hedge fund billionaire Tom Steyer -- a man who may need some introduction.

Activism and charity aside -- he is a noted environmental advocate and leading Democratic philanthropist -- Steyer's nearly quarter of a century at the head of the San Francisco-based Farallon Capital has resulted in a spectacular streak of investment excellence. But he is perhaps better known for his more recent charity involvement than for the investing prowess that made him a billionaire.

Rather than focusing on his philanthropy, however, this article will examine the investor himself, and the investment philosophy and skills he used to become a billionaire.

Inside Tom Steyer's Investment Style

Unlike fellow hedge fund billionaire Stanley Druckenmiller, Tom Steyer's route to a 10-figure net worth was steeped in elite institutions from day one. After graduating from Yale, where he served as captain of the soccer team, Steyer started his career in finance at Morgan Stanley (MS 1.81%). After earning his MBA at Stanford, he joined Goldman Sachs (GS 1.59%), where he worked in the firm's legendary merger arbitrage group led by future Treasury Secretary Robert Rubin.

After Goldman, Steyer became a partner at the San Francisco-based private equity firm Hellman & Friedman. Then, in January 1986, Steyer founded Farallon Capital, the hedge fund that would make him a billionaire.

At Farallon, Steyer and his team employ a number of core investment strategies including credit investments, long/short equity, merger arbitrage, real estate investing, and direct investments in private companies. Such strategies are more complex than the typical buy-and-hold philosophy emphasized by The Fool, though Steyer describes himself as a fundamentals-based investor, not a trader.

Either way, the results speak for themselves. Despite reportedly losing 36% in 2008, Farallon still managed to average a 13.4% annual rate of return from its founding in 1986 to 2012 -- when Steyer stepped down from day-to-day management -- versus a 9.5% annual return for the S&P 500 index over the same interval.  The company's assets under management today are estimated to total over $21 billion across all of its different funds and investment strategies. As to where the hedge fund firm sees opportunity, investors can at least partially gain a sense by parsing Farallon's recent SEC filings.

Farallon Capital's current stock holdings

Per SEC rules, investment companies with more than $100 million in assets under management must file a Form 13F each quarter. SEC rules require 13F filings to detail only the publicly traded equities in which a fund manager has a current long position at the end of a given filing period.

Especially since hedge funds like Farallon employ strategies that involve short-selling in addition to the holdings detailed in a 13F filing, the stocks listed in the filing might not give a complete picture of why Farallon holds a position. However, with that important caveat in mind, here are Farallon's 10 largest long equity investments according to its most recent 13F Form.

Data Source: SEC

In looking at this data, a few things jump out. First, several of the positions from the filing are clearly merger arbitrage trades. Briefly, merger arbitrage is when a fund simultaneously buys and shorts the stocks of two merging companies, and collects the minute spread that remains until the deal closes. For example, EMC's acquisition by Dell actually closed after this filing period ended, so EMC is now no longer a publicly traded company. 

Another clear example of this is the strategy at work is Farallon's over $300 million combined wager on Microsoft and LinkedIn. For those unfamiliar, Microsoft reached an agreement to buy LinkedIn for $196 per share in June. LinkedIn stock trades at roughly $190 today, and Farallon's merger arbitrage strategy is designed to collect the $6 per share difference between that price and the agreed upon price when the deal closes later this year. Both Microsoft's and LinkedIn's boards have already approved the acquisition. However, should the deal fall through for any reason, Farallon will lose money on the position.

Farallon has employed this strategy with great success over the course of its existence; Steyer first learned the arbitrage business under Rubin during his years at Goldman Sachs.

While Farallon's portfolio certainly involves many more positions and private investments outside of these examples from its 13F, hopefully this brief exploration provides a bit more insight into the methods of one of the world's most successful hedge funds and its billionaire founder.