As prime brokers pull the plug on big and small clients, is there any way back to the good old days for hedge funds?
It was fun for a while – watching investment banks bow to hedge funds, offering them ever more generous terms in order to win their business and clambering over each other to try to please the new financial institutions that looked set to take over the world and steal investment banking business as well as investment banking talent.
But the power struggle of the past few years has ended abruptly, and the banks have emerged as the winners.
An increase in margin requirements for the smaller hedge funds, whose business prime brokerages could survive without, was only to be expected. But to seize the assets of valued and important firms such as Carlyle Capital was unthinkable one year ago.
Are banks biting the hand that feeds them, destroying the high-velocity traders that have boosted their spread and commission earnings? Perhaps, but what choice do they have? The hedge fund boom, as it will undoubtedly come to be called, looks as if it is over. About 9,000 hedge funds have been set up: there aren’t that many investment geniuses in the world.
In January, Wall Street scoffed when Bank of America said it would be selling its prime brokerage business but one has to wonder if it was on to something.
How many hedge funds will still be here in six months’ time? Even if they don’t collapse in spectacular failure, many will be forced to hand cash back to investors, and the majority of credit and arbitrage hedge funds will be six feet under by Christmas. As for macro players, if they still feel they can make returns by working out what is going to happen in the global markets, perhaps they should be retained to work for the central banks instead and hang the expense. One-third of all funds may be gone by year-end.
Of course, there will always be niche investment opportunities and niche styles but how many times can a hedge fund change strategy without losing the pension funds and institutional investors that it needs in order to grow assets and make that 2% management fee?
Diversification is not necessarily the saviour – the multi-strategy firms have proved that. If a multi-strategy fund has invested in a fund that has not been able to unwind, it will face losses. One has to commend those multi-strategy funds that have a team model instead of a fund of funds model. If Citadel has been hit by losses in an RMBS underlying investment, it can simply reallocate the money to another team, and investors in the multi-strategy will suffer less – and the public doesn’t have to know.
If Citadel ends up buying Bank of America’s prime brokerage business, as was first mooted, then perhaps it is a sign that all is not lost in the hedge fund world. But don’t hold your breath.