Investors, Dismayed by Losses at Sears, Pull Money From Hedge Fund

The storied investing empire of Edward S. Lampert is shrinking.

David Geffen, the entertainment mogul, got out in 2007. Members of the Ziff family cashed out more recently, between 2011 and earlier this year. And more investors are heading for the exits, discouraged by the declining fortunes of Mr. Lampert’s signature stake in Sears Holdings.

Near its peak in 2006, Mr. Lampert’s hedge fund, ESL Investments, managed more than $15 billion. As recently as the end of 2011, it still managed more than $10 billion. But the disclosed total last year was less than $6 billion.

On Tuesday, ESL Investments announced that for the second consecutive year, it had reduced the size of its stake in Sears Holdings to meet investor redemptions, dropping below 50 percent for the first time since 2008.

While Mr. Lampert is not selling any of his personal stake in the company, which he created by combining Kmart with Sears, Roebuck & Company, his firm said that it had distributed 7.4 million shares, then worth $411 million, to investors who exited in 2013. The distribution cut his fund’s stake to 48 percent from 55 percent. The remaining Sears stake of 51.6 million shares, worth $2.6 billion, remains ESL’s largest holding.

The move is the latest sign of investor disenchantment with Mr. Lampert, who was once hailed as a canny value investor in the same league as Warren E. Buffett. His partnership has included big-name investors like Mr. Geffen, the Ziffs and members of the Tisch family, which owns 21 percent of the Loews Corporation. Thomas J. Tisch, who manages certain Tisch family assets, is a Sears director.

A spokesman for Mr. Lampert declined to comment on the investor exits.

Mr. Lampert, 51, is a onetime protégé of financial luminaries like Robert E. Rubin, who once led a takeover stock trading desk at Goldman Sachs, where Mr. Lampert briefly worked, and the Texas investor Richard Rainwater, who helped Mr. Lampert start his own fund in 1988, the year he turned 26.

He gained majority control of Kmart as it emerged from bankruptcy in 2003 after investing in its debt at distress prices. With that and a minority stake in Sears, he merged the two companies in 2005. At the peak in 2007, Mr. Lampert has said, his original investment in Sears had increased 20-fold. But the price fell about 75 percent in the marketwide downturn of 2008, and after a strong two-year rebound, it has fallen back over the last three years amid heavy losses. Sears lost $3.1 billion in 2011, $930 million in 2012 and $1 billion in the first nine months of this year.

The news of the ESL redemptions hit Sears stock hard on Wednesday, when it fell $4.63, or 8.3 percent, to $50.92. It fell even further on Thursday, to $49.98, down 1.9 percent. The shares have fallen 21 percent this week.

Both Sears and Kmart “have been deteriorating for years,” said Mary Ross Gilbert, a securities analyst at Imperial Capital in Los Angeles. In a report this year, she said the retail operations had underperformed because of “the lack of a cohesive strategy, management talent and capital support.” After a succession of four other chief executives under his control, Mr. Lampert took the job himself in February.

Mr. Lampert said he remained intent on transforming Sears “into a membership-focused company and on creating long-term value for shareholders. My significant personal ownership in the company is a sign of my confidence and alignment with all shareholders.”

In recent years he has moved to break Sears into pieces, selling stores and spinning off parts of its smaller Sears Hometown and Outlet Stores as well as Sears Canada; he is also considering separating its Lands’ End catalog clothing unit and auto service centers.

Although he has traded in and out of a few dozen stocks since 2007, Mr. Lampert has held onto a handful of core holdings like Sears and the car retailer AutoNation, according to a tally by Dealogic. He sold most of what had been a 41 percent stake in AutoZone, worth $3.2 billion from 2009 to 2012, as the stock price doubled. But he has held on to a 41 percent stake in AutoNation, worth $2.5 billion.

Some investors say Mr. Lampert has failed to deliver with Sears.

Margaret Black-Scott, president of Beverly Hills Wealth Management, which manages $500 million, said that ESL’s stake in the “big old names” of Kmart and Sears had “run up on anticipation” that Mr. Lampert’s “buy-and-hold approach would build value,” similar to that created by Mr. Buffett.

Instead, she said, “you have not seen the fulfillment of what people expected. You’ve not seen the value built from their skeletons. They expected this new humongous company to be built out of what I would call yesterday’s stores. So now it’s sort of, ‘You know what? I’m out of here.’”

But some Sears investors still have faith. Bruce Berkowitz of Fairholme Capital Management, which owned 20 percent of Sears in September, said the spinoffs had helped deliver about $10 a share in assets to Sears holders, and the chain’s loyalty program, Shop Your Way, “now has over one-quarter of all Americans as reward members.”

Some of the recent investor withdrawals may have also been influenced by the stringent lockup terms imposed by Mr. Lampert. When ESL raises funds from outside investors, it typically requires them to keep their money with ESL for five years.

In 2007, Goldman Sachs led a $3.5 billion investment in ESL by wealthy individuals and institutions, which included a lockup that expired at the end of 2012. Investors who wanted to keep their money in at that point had to agree to another five-year lockup.

The marquee investors who have withdrawn were reluctant to discuss their rationale.

Ziff Brothers Investments, a family office of three sons of the publishing billionaire William Ziff Jr., began winding down its ESL investment in late 2011 and finished this year, according to a person briefed on the move. A spokesman for Ziff declined to comment.

Mr. Geffen, who founded three record companies and helped found the film studio DreamWorks SKG and is now retired, told Fortune magazine in 2006 that he had made more money from a $200 million investment with Mr. Lampert in 1992 than he had “from all the businesses I’ve created and sold.”

But in an email last month, he said, “I have not been an investor with ESL since 2007.” He added, “During the many years I was with Eddie he was very successful and his returns were extraordinary.” He declined to discuss why he exited, explaining that Mr. Lampert “is a friend of mine.”