HEDGE FUND NEWS
@ Thu 15 February 2007 : GMT

FINTAG COMMENT

Firstly, let me apologise for today's newsletter. Following a post Valentine's Day row with my other half, I have had an uncomfortable night on the sofa/couch/settee/seating arrangement and my review is a bit light although I do manage a small amount of ranting and raving.

We look at the rise of Bear Stearns prime brokerage due to FiNTAG firing Goldman's over its ART cloning product; and how the blue chip London Stock Exchange is now a distressed opportunity.

The SEC hire Private Dicks to follow my every move and I bemoan the quality of investors.

Other news:
Bank Fined USD2m for Losing a Laptop ... (bbc)

Hedge Fund Dog Bites Pompous Ass ... (bostonherald)

Trade Union Boss Slams Pirate Equity ... (hedgeweek)

Climate Change hits America ... (bbc)

The yen: 'Be careful what you wish for' ... (times)

Game Over for "Grand Theft Auto" Ex-CEO ... (cfo)

Major Banks and Wall Street firms are Unloading Bad Home Loans, as more Americans Fall Behind on Mortgage Payments ... (wsj)

BEAR CLIMBS TREE

Rivals gunning for Bear Stearns (financialnews-us)
Competition intensifies as banks battle for third spot in prime brokerage

A room close to St Paul's Cathedral in London was filled almost to bursting last week when Merrill Lynch hosted its European prime brokerage team meeting. The talk drew 130 people in person and on the phone. Five years ago, that would have been impossible: Merrill did not have that many employees in the European business.

Top 10 global prime brokers


But from a slow start in 2001 the bank has signed up 400 hedge fund clients. Last year it increased staffing by 22% and its global financing balances in the business by 50%.

Jeff Penney and Sylvan Chackman, who lead the prime broking team as co-heads of Merrill Lynch global markets financing and services, are ambitious. “We would expect to own the third-place spot as measured by revenues, market share and perception,” said Penney.

Gaining a top-three position should lead to significant revenues. Investment banks in total earn about $50bn (€40bn) a year from hedge funds, once sales and trading services are added to prime brokerage, according to an estimate by Dresdner Kleinwort last week.

Morgan Stanley, Bear Stearns and Goldman Sachs are the global leaders. But several banks are competing to make the grade. Prime brokerage, built on technology, accounting, securities lending and margin lending for hedge funds, is in the middle of what Bernstein Research analyst Brad Hintz has called a “land war” for market share.

However, prime brokerage, already a largely technical business, is a shrinking business, according to some. In addition, hedge fund launches slowed last year, according to Absolute Return magazine.

Joe Dickerson, an analyst with independent research house Atlantic Equities, said in a December report: “Our view is that the only credible challenge to the prime brokerage dominance enjoyed by Goldman Sachs and Morgan Stanley is Merrill Lynch,” largely based on the bank's powerful private client business, which provides a large captive collateral box of securities to lend to hedge funds.

While Merrill and UBS focus on all sizes of hedge funds - from the small ones to the behemoths - others, including Bank of America, have set their sights primarily on the $1bn-plus group.

It may help that their leaders have first-hand experience of how things work at the top three: Alex Ehrlich, head of UBS's prime brokerage, is a Goldman Sachs alumnus, as is Chris Pesce, head of Bank of America's operation. And Merrill's Penney and Chackman are from Morgan Stanley, as are several members of their team.

Five years ago, no rival could take on Morgan Stanley, Goldman Sachs and Bear Stearns, which have ruled prime brokerage for nearly three decades. Together, they control more than 66% of the prime brokerage market and generate $5.5bn in prime brokerage revenue, according to Hintz.

But competitors believe they can penetrate the market this year. Their confidence is based on several factors: the overall growth in hedge fund assets, to more than $1.5 trillion; the expected tipping point on years of investment and new hires at rival prime brokers; and, most of all, a perception that Bear Stearns, which shook up its prime brokerage leadership last year, is slipping.

Hintz wrote last year he expected Bear Stearns to see its margins hit by previous underspending in technology, its lack of scale outside the US and the smaller size of its hedge fund clients. However, he predicted Bear Stearns would hang on to its top-three spot.

Bear Stearns' co-head of equities, Bruce Lisman, said: “We have an exceedingly strong franchise in the United States and are likely to grow one internationally. There is no evidence that our position is slipping. We welcome the competition.” He said Bear Stearns' margin balances for hedge funds stood at more than $290bn and had grown at an average of 16% a year for the past five years.

A LipperHedgeWorld survey last year ranked Bear Stearns second in its market share of all hedge fund client assets. However, the results of prime brokerage league tables are often disputed. A survey by Global Custodian showed hedge funds rated Bank of America at number two among global prime brokers.

The newer entrants are trying to distinguish themselves in different ways. UBS and Merrill are courting mutual funds, which are increasingly shorting stock.

One of Merrill's selling points is its private client business - the biggest on Wall Street - which gives the firm a ready supply of stocks and customers to buy them. In Asia and Japan, Merrill has grown its prime brokerage business beyond equities into other strategies. It is also expanding its services to hedge funds, creating an in-house headhunting group to advise hedge funds on recruitment.

UBS in 2003 acquired ABN Amro's US prime brokerage business, for $250m. It has grown fast in Europe, where sources say the bank won the mandates to be sole or co-prime broker on five of the top six $1bn-plus hedge fund launches last year. Dickerson said UBS was a credible threat to the top two in Europe. It has multiplied its global prime brokerage revenues several times over and has more than 500 people in the division.

Bank of America's main selling point is its balance sheet and its heavy investment in its technology platform; the bank has 160 people devoted to prime brokerage technology. Parent Bank of America's tens of thousands of middle-market clients create a large base of loans that the bank can wrap together and sell to hedge funds.

Pesce said: “We will not risk any of these clients having a bad experience. They need nothing less than an amazing experience.”

LSE DOWNGRADED

Moody's cuts LSE closer to 'junk' on share buyback (financialnews-us)
Rating agency Moody's has slashed the London Stock Exchange's investment grade rating to two notches above 'junk' as it proceeds with plans for a share buyback following Nasdaq's failed takeover bid.

Moody's said yesterday it cut the LSE's senior debt ratings by one notch from Baa1 to Baa2, citing the completion of a share buyback worth £300m (€448m) in total by the end of September as the reason.

The buyback programme was part of the LSE's defence to bolster its stock price and increase dividend payments to shareholders in the face of Nasdaq's bid.

In a statement, Moody's said: “The rating downgrade reflects the resulting deterioration in leverage and debt-servicing ratios.”

The rating agency also cut LSE's corporate family rating from A3 to Baa1, and the LSE's issuer rating from A2 to A3.

Moody's said the issuer and senior debt ratings of the LSE are one notch lower than the corporate family rating because they take into account “the structural subordination of cash flow for the parent holding company".

The downgrade of the senior debt directly affects £248m worth of outstanding LSE bonds due to mature in 2016, which were sold last June by Barclays Capital, JP Morgan Cazenove and Royal Bank of Scotland.

Traders in London said there was little change in the price of the bonds immediately after the downgrade.

The LSE launched its share buyback programme at the start of the week as it celebrated its success in seeing off Nasdaq's £2.7bn hostile takeover bid.

LSE said its brokers, Lehman Brothers and JP Morgan Cazenove, had purchased more than 200,000 shares at an average price of just less than £12.70 on Monday.

LSE also has permission to spend a further £18m buying back its own shares from an authorisation received last year.

The LSE is not rated by the other main rating agencies Standard & Poor's and Fitch.

Shares in the LSE were trading down 0.08% at £12.74 today at 11:20 GMT.

CCTV

US regulators to tighten scrutiny of hedge funds (ft)
US regulators are strengthening market surveillance methods amid concern that hedge funds and other large investors are systematically engaging in hard-to-detect forms of insider trading.

The initiatives include a communication system in which regulators around the world can alert one another to suspicious trades and traders, and databases that track connections between funds, their investors and officers and sources of information about companies.

The efforts extend to the Securities and Exchange Commission's inquiry into whether the big Wall Street firms are warning favoured customers about pending large trades, and the SEC probe of research firms that pay employees of public companies to serve as consultants to hedge funds.

Authorities acknowledge that traditional methods of tracking insider trading, which do a fair job of catching individuals, are not as effective at ferreting out malfeasance by large institutional traders.

The surveillance systems flag stock and options transactions - by hedge funds or anyone else - when they profit from market-moving news, but it is hard for investigators to take the next step and prove the trades were improper rather than lucky.

"So many things that would be solid circumstantial evidence in a retail context aren't so solid in a hedge fund context," said Linda Chatman Thomsen, the head of SEC enforcement. "The fact that they were on the opposite side yesterday may be meaningless. The fact that a trade is large may also be meaningless."

The SEC has brought more than 300 insider trading cases in the past five years, most of them stemming from suspicious trades around market-moving events. But regulators and prosecutors fear they are failing to catch insider trading based on either knowledge of big orders or less obvious bits of non-public information.

"If you have a steady stream of access to inside information and you're not greedy, there's a good chance you won't get caught," said one securities law enforcer. "That's the hardest to detect."

The SEC is building a case-tracking system that can aggregate suspicious trades by account holder, as opposed to date or broker.

Concern about insider trading was one of the reasons the commission tried unsuccessfully to require the $1,100bn (€838bn, £561bn) industry to register and submit to examinations.

The New York Stock Exchange has been leading an effort, via the Intermarket Surveillance Group, to make it easier to share concerns.

THATS THE WAY TO DO IT

Building hedge fund firms that last (ftalphaville)
Opalesque provides some exclusive insight from Philip Duff, ex-Morgan Stanley CFO, on building successful hedge fund management firms.

Duff, speaking at the Managed Funds Association Network conference in Florida, identified drivers and challenges of the current asset management industry:

* Asset liability gaps of pensions and other institutions
* Rising correlations - “a by-product of globalisation”
* Lower returns across the board

As a consequence, investors find that their approach to investing and diversifying needs to change.

“Performance is not the only thing that matters,” Duff said, advising managers to consider and even strive to lower the reputational/exposure risk of decision makers and fiduciaries. Duff shared some statistics from FrontPoint Partners with the audience. On average, 15 months passed between the first contact with an investor and an actual investment. During this period, about 5.5 due diligence meetings, each involving three hours of “face time” took place. Moreover, 70 per cent of those meetings was spent on “infrastructure” - not on the actual investment strategy. Duff listed the following key aspects to building a “hedge fund powerhouse” :

1. Performance - It might not be everything, but without it, your funds go nowhere. Beyond performance, focus on distribution and correlation.
2. Offer advice - don't be a mere percentage in a portfolio, become a solution provider. Understand the problems and questions of your investor. Offer solutions.
3. Develop relationships on a personal and organisational level with your investors
4. Build a brand.

AUSTRALIA - THE NEW FRONTIER

Trafalgar Capital launches Australasian hedge fund joint venture (hedgeweek)
London-based hedge fund manager Trafalgar Capital Management has created a joint venture with Auckland-based David Copley to create hedge fund products focusing on the markets of Australia and New Zealand.

The joint venture, to be called Trafalgar Copley will draw upon the experience of Trafalgar Capital, which has five existing funds, and the local support of investment bank First New Zealand Capital. It is anticipated that the first product will be a blended equity long/short and credit strategy, to be launched later this year.

Copley will head the portfolio management team as managing director and chief investment officer together with Chris Aarons of Trafalgar Capital. Copley was formerly an executive director in the hedge fund group at UBS Investment Bank in New York and is currently head of securities at First New Zealand Capital, the country's leading investment bank. Robert Urquhart will join the team from Copenhagen Capital in March as a senior analyst.

Trafalgar Copley will be advised by a global advisory board including Andrew Peacock, a former Australian opposition leader and ambassador to the US; Andrew Edelmann, former head of the private banking and investment group at Merrill Lynch in New York; Rodney Jones, formerly a managing director with Soros Funds Management in Hong Kong and currently an advisor to US and UK hedge funds on Asian economies; Rob Campbell, head of one of New Zealand's leading family offices; and Lord Strathclyde, Trafalgar chairman and leader of the Conservative Party in the UK's House of Lords.

Says Copley: 'Chris and I are looking forward to working together on this exciting and innovative project. We are confident that Trafalgar Copley will be at the forefront of the burgeoning Australian and New Zealand hedge fund industry. The joint venture leverages our respective experience and expertise, and we believe we can identify and capitalise on global themes that subsequently play out in Australia and New Zealand.

'There is clear investor demand for original and sophisticated niche market products and we feel that the markets of Australia and New Zealand offer a wealth of opportunity to both international and local investors.'

Noting that both markets are growing rapidly, Copley adds: 'According to a report issued in 2006 by Axiss Australia on the hedge funds industry in Australia, the Australian investment fund market is now the fourth largest in the world, and it also has a mature and substantial superannuation industry. Later this year, New Zealand intends to make significant legislative changes, which we believe are extremely exciting for the development of, and local investment in, hedge fund products.'

Scott St John, chief executive of First New Zealand Capital, says: 'We are doing everything we can to contribute towards a solid start for David, and look forward to his ongoing contribution to our business as a non-executive director of FNZC.'

Founded in 2001, Trafalgar Capital Management is an independent, owner-managed, investment manager with five funds developed to meet specific client risk and return profiles: Trafalgar Fund (European market neutral), Trafalgar Trading Fund (dynamic long/short equity trading), Navigator Compass Fund (European statistical arbitrage), Trafalgar Advanced Fund (leveraged European market neutral) and Trafalgar Select Fund (multi-strategy fund investing in selected Trafalgar products).

First New Zealand Capital is a full service investment bank, operating in the equities, fixed-income, investment banking and private client fields. The firm, which has a strategic alliance with Credit Suisse Group, holds the leading market position in both equity and fixed-income secondary trading in New Zealand.

FOHFS RULE OK

Funds of funds maintain popularity with institutional investors (hedgeweek)
Andrew Collins, business development director with Fortis Prime Fund Solutions, argues that for the foreseeable future, funds of hedge funds are likely to remain a significant part of the hedge fund industry.

The growth in the assets of funds of hedge funds in 2006 and the beginning of 2007 continued unabated. This trend confounded many critics of the asset class who argue that the diversification benefits of funds of funds do not justify the double layer of management fees, particularly when viewed in the context of the modest returns they tend to deliver compared with the better performing single manager hedge funds.

If investors were dissatisfied with returns from funds of hedge funds, which did not perform particularly well last year, there was little sign of it in asset flows. Growth in the funds of funds area was particularly strong in 2006 at around 30 per cent.

The continued appeal of funds of funds is also evident from the point of view of investment managers seeking to consolidate their positions in the alternatives market. In 2005 alone just two transactions resulted in approximately USD50bn in funds of funds assets changing hands, with the acquisition in November 2005 of Permal, one of the five largest fund of hedge funds managers in the world with USD19.3bn, by Legg Mason, and the deal under which Julius Bär acquired GAM and its CHF66bn in assets under management from UBS.

All the indications are that these types of transaction are set to continue, amid a general trend toward consolidation in the asset management industry and continuing moves by large asset management groups to expand their presence in the alternative investments market through acquisition.

In addition, there is also the issue for institutions and pension funds entering the market of how to obtain capacity in some of the larger and more successful hedge funds that are closed to new investors. One option might be to seek that capacity through the acquisition of a fund management business that already has capacity with those underlying managers.

In the long run, it is possible that many institutions will opt for multi-strategy funds over funds of hedge funds, for reasons that include the desire to avoid a double management charge structure, especially as they become more familiar with the market. There is speculation that multi-strategy funds might eventually replace funds of hedge funds as the customary point of entry to the alternatives marketplace for new investors, but there is little sign that it is happening yet. Certainly the fund inflow figures for funds of hedge funds suggest that they are continuing to hold their own.

The double-charging issue is one that may in some cases be mitigated by deals that funds of hedge funds can strike with their underlying managers, but while some arrangements like this are in place, many of the most successful and sought-after underlying managers don't need to cut deals.

In fact, there is anecdotal evidence that some investors, funds of funds included, are paying managers performance fees in excess of the industry standard of 20 per cent - occasionally as much as 30 or 35 per cent. In these cases, the investor in the funds of funds may tolerate this level of performance fees provided they are receiving a satisfactory net return. Given diminished return expectations over the past couple of years, few investors would quibble with a 20 per cent return net of fees. Ultimately, managers who are ready to negotiate on fees or capacity may not be the best choice for funds of funds and their investors.

An exception, of course, is fledgling funds that have not yet had the opportunity to demonstrate sustainable strong performance. However, when funds are in their sweet spot of between USD500m and USD1bn in assets and their performance is good, it is more difficult for funds of funds to negotiate capacity and the underlying manager has more power to dictate investment terms.

Notwithstanding these issues, there is every indication that funds of hedge funds will continue to play an important role in the alternative investment strategies of institutional investors for some time to come. Only a handful of institutions today have the experience and expertise to put together a portfolio of hedge fund investments, and for many investors it will always make sense to draw on the fund selection and monitoring skills of others. For the foreseeable future, funds of hedge funds are likely to continue to be a significant part of the hedge fund industry.

In this environment, funds of hedge funds, and in turn their investors, can benefit by taking advantage of an integrated service offering. What makes Fortis unique in the market is that in addition to its traditional service offerings to funds of funds of administration and custody, in which it is a global leader in the alternative investments field, it is one of the very few banks that combines these services with the provision of leveraged finance to funds of funds.

As funds of hedge funds seek to demonstrate their competitiveness to institutions as an alternative investment solution, the opportunity to bring financing, custody and administration under the same roof may have increasing appeal.