JAT Capital, Down 20%, Is a Lesson in Volatility A year ago, John A. Thaler was the talk of Wall Street. His hedge fund was up more than 30 percent, defying a broad slump in the market and the debt turmoil in Europe. Investors, starved for returns, scrambled to hand him their money. This year, things appear to have cooled off for Mr. Thaler. Rapidly. His JAT Capital is down nearly 20 percent so far, according to internal documents from the fund, as big concentrated bets on consumer stocks have plunged. Investments in the mattress maker Tempur-Pedic, which has fallen 70 percent since April, have punctuated the fall. Much could change for Mr. Thaler and his fund before the year ends. Managers have recovered big losses in a single month, or exacerbated them beyond repair. John A. Paulson, who rose to fame and fortune with a prescient bet against the subprime mortgage market, has done both. Yet the sudden reversal of fortune for Mr. Thaler is another cautionary tale for investors who chase the returns of the latest must-have managers. As institutions like pensions plow tens of billions of public dollars into hedge funds every year, many are struggling to locate new talent. But in the fast-money world of hedge funds, what has investors raving one year can drive them mad the next. "Investors move in herds," said Hany A. Shawky, a professor of finance at the business school at the State University of New York at Albany. Once a hedge fund manager gets noticed one year, there's a buzz, one or two publications write about them and they get flooded with money. He added, "Sometimes they are not really ready to invest that kind of money," The world of hedge funds has always been opaque. Managers are notoriously secretive, refusing to tip their hand even to their own investors, which can help create an image of the wily genius beating the markets. In reality, returns are often volatile, and managers rarely repeat stellar gains year after year. One academic study that tracked hedge fund performance found that the average hedge fund investor made about 6 percent a year from 1980 to 2008, a return only slightly better than United States Treasury securities. "There's a life cycle for all hedge fund managers," said Robin Lowe, head of equities investing at the Man Group's fund of hedge funds. The mathematics of putting up large percentage gains as you become larger is much more difficult. The whole incentive of why you're doing something changes. Mr. Thaler, a former Merrill Lynch analyst who specializes in technology, media and telecommunications companies, has historically made big gains - and taken big risks. Such bets have paid off. His returns are historically higher than most competitors. He jumps into his best ideas with a fervor that can mean big wins or big losses. By the end of April, for instance, his top five stock picks represented about 43 percent of his $2.3 billion in assets, according to a potential investor briefed on the fund who did not want to be identified as revealing confidential information. But his bloody first half is as much about losses on long-term bets like Tempur-Pedic as negative bets on companies like Alibaba.com and Weight Watchers gone wrong. In the case of Alibaba.com, the Chinese Internet site, the company was taken private, sending share prices higher. Weight Watchers and Sears, two additional short positions, rose when the company or insiders bought up shares. Mr. Thaler noted that his biggest losses came from bets on the consumer sector, which contributed to 81 percent of the losses through April. The firm lost a top analyst, Jonathan Lennon, who departed to start his own fund, Pleasant Lake Partners, in January. "While I am a firm believer in evaluating everything we do based on the process rather than the outcome," Mr. Thaler wrote in his letter to investors, "it is difficult for me to ignore the loss we have taken in this sector, the volatility it has added to the funds and the fact that this loss and volatility has forced us to play defense in other sectors of the book." As such, the losses have prompted Mr. Thaler to revert to his core specialty, the technology, media and telecommunications industries, where he first made his name as a portfolio manager. Mr. Thaler, 36, earned his stripes at Shumway Capital Partners, a hedge fund that shut down in 2010. While there, he worked as a technology analyst and eventually took over as a portfolio manager of one the fund's most important funds, earning nearly 19 percent for investors in 2006. In late 2007, Mr. Thaler started JAT Capital with about $200 million. Chris Shumway, the founder of Shumway Capital and a former top lieutenant of the highly successful investor Julian Robertson, believed so strongly in Mr. Thaler that he gave JAT Capital seed money. Mr. Shumway, who now manages his own money and has invested start-up capital with a number of his former portfolio managers, still advises Mr. Thaler on business decisions, according to people briefed on the matter who asked for anonymity because the information was confidential. In marketing materials, Mr. Thaler says he still deploys the same investment strategy he had at Shumway. Like many managers in his field, he dives into companies he thinks are undervalued and those he thinks are overvalued, taking on 60 to 100 positions at any time. Unlike some managers, Mr. Thaler typically holds more short positions in his portfolio than long ones. Through a spokeswoman, Mr. Thaler declined to comment for this article. Over the last few years, Mr. Thaler's success has won many admirers. And his strategy, while volatile, has worked. In 2008, when the Standard & Poor's 500-stock index was down about 37 percent and hedge funds lost more than 20 percent, Mr. Thaler lost just 6 percent. In 2009, he gained 20 percent and the year after put up a respectable 10 percent. Last year, when the average hedge fund lost 5 percent, Mr. Thaler scored a gain of roughly 17 percent. Those gains have also allowed Mr. Thaler to ascend the hedge fund pecking order, having recently sold a condo on the Upper East Side and taken an 11,000-square-foot home, with seven bedrooms and 9 1/2 bathrooms, in Greenwich, Conn. Some things, however, have not changed. An avid baseball fan, Mr. Thaler sponsors a team each year and plays shortstop. Returns like Mr. Thaler's can be hard to ignore for institutional investors, especially when interest rates are idling near zero and the market is troubled with volatility. But other factors have also helped fuel Mr. Thaler's rapid growth to roughly $2.3 billion from a little more than $1 billion last year. Some investors looked to Mr. Thaler after Mr. Shumway closed down his hedge fund in 2010. And top competitors, like Chase Coleman's Tiger Global and Philipe Laffont's Coatue Management, were already turning investors away, according to investors who considered placing money with Mr. Thaler. Whatever the case, money has flowed in so fast that Mr. Thaler, who was an economics major at the University of Chicago, decided last year to close his hedge fund to new investors. Now, those who squeaked in could be feeling buyer's remorse because their first year with Mr. Thaler is turning out to be a big loss. Part of the challenge of growth is what to invest in. With more money to put to work, the range of investments needs to expand. In part, Mr. Thaler's move into consumer-related investing reflects an effort to broaden his portfolio. In his letter to investors, he acknowledged that the move had been wrongheaded. That Mr. Thaler's fund has been volatile is not entirely unexpected. At the end of last summer, the fund was up more than 30 percent, sending institutional investors into a tizzy, according to one consultant who looked into the fund and did not want to be identified because the matter was private. A short while later, a drop in some of the fund's largest holdings, like Green Mountain Coffee Roasters, ate up nearly half of JAT Capital's gains before the year ended. "The performance of the funds over the last seven months has been a great disappointment to the team and to me personally," Mr. Thaler wrote in his quarterly letter to investors. After any period like this, we are left to examine the drawdown and review if a change should be made.