From Sell Side to Buy Side

Terry Flanagan

A recent announcement by a Credit Suisse hedge fund spin-off has increased the exodus of sell-side bankers and traders into their own private ventures.

As they are known in today’s markets, prop desks are slowly becoming more antiquated thanks to pending regulatory reform, such as the Volcker Rule. The rule to end proprietary trading, set to be enforced by July 21, continues to garner controversy as it will bring an end to internal hedge funds at investment banks.

Frustrated sell-side talent have been shuffling into private ventures long before the cut-off date, but it seems that as July 21 draws nearer, many more banking veterans are making the leap—which spells a positive change, according to some market participants.

“It is too early to determine the true effect of the Volcker Rule on the U.S. banking or asset management industry,” said Ron Geffner, an attorney in the financial services group at Sadis & Goldberg. “I expect there will be both positive and negative impacts on the industries. For example, buy-side fund managers may have fewer concerns about a bank competing on trades, thus both may benefits from the new dynamic.”

Credit Suisse is just the latest broker-dealer to bid farewell to one of its internal hedge funds. Credit Value Partners (CVP), spun-off from Credit Suisse’s hedge fund business, is led by notable former names from Credit Suisse’s distressed debt team including Donald Pallard, Michael Geroux, Grant Pothast and Howard Sullivan.

The firm began with an initial $500 million under management and is now open for outside business, with an aspiration to raise an additional $400 million. Accredited investors are welcome to get in on CVP’s specialized, non-investment grade corporate debt strategies, provided they invest a minimum of $5 million.

The Credit Suisse spin-off takes place shortly after a string of other large broker-dealers have exhibited the same trends.

Fellow European banking giant UBS announced plans to start an Australia-based global macro hedge fund called MST Capital, to be led by Gerard Satur, current head of UBS macro strategic trading, former Morgan Stanley proprietary trader Jeremy Hooper and Matthew Mulcahy, a former Pimco executive.

MST is gearing up at a positive time for global macro. The Eurekahedge Macro Hedge Fund Index declined 1.4% in 2011, outperforming the broader Eurekahedge Hedge Fund Index, which declined by 4.1%.

For some market participants, prop desks that turn into hedge funds usually represent one of the few alternative investment vehicles that withstand the test of time, due to their top-tier bank legacies.

“When you’re high in the ranks within an organization, the next step is to come out and start a hedge fund,” said Nathan Anderson, director at merchant bank Tangent Capital. “You have a lot of clout as a managing director, or chief investment officer, and guys that have an investor base backed by an old firm tend to be the ones that are successful, versus the guys that face plant when they start from scratch.”

While the Volcker Rule specifically affects only the U.S., and U.S. operations controlled by foreign entities, market regulatory reform is spreading.

Australian-based Macquarie Bank recently announced that it is to revamp its New York-domiciled structured products proprietary trading desk into a banked-owned, but separately-run, distressed debt-oriented hedge fund as a means of attracting outside capital over the next few months. The move is allegedly not in response to the Volcker Rule, but rather an effort to comply with the pending global Basel III capital adequacy and liquidity directive, put forth by the Basel Committee on Banking Supervision.

The new fund will carry on its focus on distressed mortgage bonds, collateralized debt obligations and even more esoteric asset-backed securities.

Under Basel III, banks would be required to withhold a liquidity pool of capital reserves to cover any losses incurred by the prop desk. A hedge fund that manages solely client assets wouldn’t necessitate the same constraints.

Macquarie currently has a hedge funds division that includes a number of other funds.

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