Over the summer Citigroup quietly sold off most of its remaining $6 billion in alternative-investment assets. Citi isn’t the only U.S. bank bailing out of alternatives. In early 2011, Morgan Stanley completed the spin-off of FrontPoint Partners, a hedge fund firm it had bought in 2006 for $450 million at the urging of then-CEO John Mack. Goldman Sachs Group has been redeeming certain assets from its alternative-investment funds. This summer JPMorgan Chase & Co. spun off its private equity unit, New York–based One Equity Partners.
U.S. banks are reacting to the so-called Volcker rule — named after former Federal Reserve Board chairman Paul Volcker — which limits the capital they can invest in hedge funds or private equity. These divestitures mark a big reversal. U.S. banks were keen to build up hedge fund businesses before 2008, embarking on M&A and development strategies that now seem like costly mistakes. The only exception is JPMorgan, which bought New York–based Highbridge Capital Management in 2004; the $25 billion firm now ranks among the world’s largest hedge fund firms.
But the Volcker rule, which also bars banks from proprietary trading, poses a dilemma. Banks hope to offset the loss of trading profits with steady fee income; to that end, many are emphasizing wealth management. These days, the need for wealth managers to give clients access to alternative investments is greater than ever. So banks with wealth management ambitions have to figure out how to offer such products tomorrow. And if they do so by developing in-house expertise, they must understand what went wrong yesterday.
U.S. banks must decide if they want to be “an evaluation machine that aims to pick the best managers for the best strategies and offer that up to private wealth clients or have a captive, in-house hedge fund business,” says Andrew Laurino, a partner with New York–based consulting firm Tiger Bay Advisors. Banks can run hedge funds, but “they need to design these businesses to operate autonomously or under an independent asset management business,” he adds.
Banks often lack a culture of investment management. That may explain why big alternative-investment firms like Blackstone Group, Carlyle Group and KKR & Co. look better placed than the major banks to bolster their hedge fund businesses. (It helps that these powerhouses are unfettered by the Volcker rule.)
Citi made a big push into hedge funds in 2004 by launching Tribeca Global Management, formerly a proprietary trading division, and staking it with capital. Tribeca had already hit some speed bumps when Citi agreed to acquire New York–based Old Lane Partners for $800 million in April 2007, as much to retain two of its partners, Vikram Pandit and John Havens, as to own Old Lane, a $4.5 billion hedge fund firm with a short, mediocre track record. Four months later Citi announced it was shutting down Tribeca to focus on Old Lane; it closed the latter firm in 2012.
One of the reasons often cited for JPMorgan’s relative success with Highbridge is the hedge fund firm’s functional autonomy: It has its own headquarters and brand name. Most hedge fund managers are entrepreneurs; because managers want to see their names on the door, it’s tough for a large institution like a bank to keep the best talent. Also, investors in recent years haven’t ascribed any great value to bank-run hedge fund firms.
The pre-Volcker lure of proprietary trading — more profitable, if more volatile, than sleepy asset management — also hurt banks’ efforts to develop hedge funds. Banks were reluctant to let star traders become hedge fund managers. Yet often these same stars would quit to start their own hedge fund firms.
As banks seek to comply with Volcker, Goldman, JPMorgan and others have moved talented prop traders into asset management, a sign that they might start rebuilding their hedge fund ranks. Another possibility: As the founding principals of many top hedge fund firms enter their later years, some will be looking for an exit strategy. A new round of bank hedge fund acquisitions could be in the offing. • •
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