The trader’s dream of running a hedge fund can turn into a nightmare
I wonder whether I should set up a hedge fund.
By Tracy Corrigan, Assistant Editor
Published: 7:00AM BST 16 Jul 2010
It has occurred to me, in recent months, that this Telegraph gig, with its constant round of news meetings and strictly regulated editing processes, may be cramping my style – not to mention my earnings’ potential. To be honest, it would also be a lifestyle choice.
This is the sort of thinking that has prompted a mass exodus of traders from banks in the City and Wall Street in recent months, as the usual trickle of hedge fund start-ups has turned into a flood. Among the new crop of hedge fund entrepreneurs are traders from Goldman Sachs, BNP Paribas, Deutsche Bank and the former Wells Fargo.
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In my experience, there is always a push and a pull factor when it comes to changing jobs, and I reckon the same forces are at play for traders even though more money is at stake. The old routine starts to drag, the boss is a buffoon, business is struggling. An opportunity comes along to do something more prestigious/better paid, and the prospect seems all the more enticing.
The “push” in this case is tighter bank regulation following the financial crisis. In the US, there is new legislation to clamp down on proprietary trading – the use of banks’ own capital to make money (on a good day) from market movements. Even if proprietary trading is still allowed in Europe, banks will increasingly be required to set more capital aside, because of the risks involved. This measure is already having the desired effect of making banks rein back their activities in this area. As a result, proprietary traders are having their wings clipped, if not chopped off altogether.
On top of that, tighter oversight of bank remuneration will prevent traders from pocketing millions of pounds in bonuses in years when the bank that employs them has lost money; even when traders perform well, their profits – and therefore their bonuses – are likely to be smaller because they will no longer be allowed to make such big bets.
The pull of hedge funds is also considerable. There is less bureaucracy. They are not very corporate. The atmosphere is creative and intellectually stimulating. When hedge funds perform well, managers are rewarded handsomely. You go to work in a T-shirt and jeans, haircuts are optional, and you can dream up an impressive name, like Edoma or Roc.
There are, however, some pitfalls. First, ideally, one has a successful track record. I admit that this is where I fall down – perhaps I could market my fund as an alternative, alternative investment. Certainly, I can’t demonstrate the same sort of form as Greg Lippmann, the trader who helped Deutsche Bank make billions of dollars – and did rather well himself – by shorting the US mortgage market. Nor do I have his chutzpah: he gave his clients T-shirts emblazoned with the catchy slogan “I am short your house”.
Mr Lippmann’s new fund, reported to have raised $1bn (£651m) so far, is called Libre Max, which roughly translates as “Maximum Freedom”. I assume this refers to the fund’s investment style rather than the joy of emancipation from the banking industry. (On a cultural note, the inspiration for the name may be the 1981 French hit Il est libre max.)
But start-up money – or seed capital – can be difficult to come by. Many traders have their own cash to invest (another problem for me), but that is only the start. Banks, for regulatory reasons, are not longer willing to seed hedge funds and institutional investors are committing smaller sums.
The hedge fund industry suffered heavy redemptions and fund closures during the crisis, but generally performed well last year. Now things are getting harder again. The Eurohedge composite index fell 2.1pc in May and another 0.4pc in June. According to HFN, total hedge fund assets fell an estimated -0.76pc to $2.2 trillion in June, the second monthly decline in a row.
Then there is the growing regulatory burden facing hedge funds themselves, particularly in Europe, as a result of the widely detested Alternative Investment Fund Managers directive from Brussels. It’s not just that complying with these new rules is a hassle. It is also costly. For small and even medium-sized funds, these costs may change the economics of the business. Existing funds have another problem: even though they had a good year last year, may are not receiving the standard 20pc in performance fees, because their funds have not yet passed the peak reached in 2008, known in the trade as the high watermark.
How long will it be before some of the new batch of hedge fund managers start feeling nostalgic about their trading days at the big banks, which paid them decently and dealt with the regulatory burden? The current crop of managers may well include the next George Soros and John Paulson. But markets are tricky and investors will be picky. I’d better have a re-think.