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Hedge Funds May Account for 40% of Bank Capital, Report Says

Date: Wednesday, November 25, 2009
Author: Saijel Kishan, Bloomberg.com

Hedge funds provided as much as 40 percent of the money raised this year by U.S. and European banks as they sought to offset losses and meet government capital requirements, according to Morgan Stanley.

Financial firms have raised about $200 billion from common stock and rights offerings so far this year, data compiled by Bloomberg show. Financial companies around the world have taken more than $1.7 trillion in writedowns and credit losses since the crisis began in mid-2007.

Government steps to increase regulation of the hedge-fund industry in the wake of recent fraud and trading scandals may be measured, Huw van Steenis, a London-based analyst, said in a report yesterday.

“We believe some policy makers realize the supportive role providers of risk capital can play,” he said in the report.

JPMorgan Chase & Co. and Goldman Sachs Group Inc. led 10 of the largest U.S. banks that repaid $68 billion to the U.S. Treasury in June, aided by funds raised in share sales. Paulson & Co., the hedge-fund firm run by billionaire John Paulson, bought a stake this year in Bank of America Corp. and told investors this month that he expects the stock to almost double in the next two years as writedowns ease.

Raising Capital

The government’s stress tests, which examined 19 of the largest U.S. financial companies, showed in May that 10 needed to raise capital to survive a longer, more-severe recession. Lenders announced plans over the next month to raise at least $100 billion to fill capital gaps and clear the way for repaying the Treasury’s bailout fund.

Bank of America, based in Charlotte, North Carolina, raised $13.5 billion in May by issuing common shares. New York-based Morgan Stanley issued $4.6 billion of shares in May, and raised an additional $2.4 billion in June.

Hedge-fund assets may rise to $1.75 trillion by the end of 2010, van Steenis said. The industry now manages $1.53 trillion, according to data from Hedge Fund Research in Chicago.

Sovereign wealth funds, foundations and pension funds have overtaken endowments and firms that invest on behalf of individuals as the biggest providers of capital to hedge funds, Morgan Stanley said.

“We nevertheless see risks, given the potential reputation damage to the industry, due to Madoff, Galleon and so on,” Steenis said in the report.

Raj Rajaratnam, founder of Galleon Group LLC, was arrested last month in what prosecutors are calling the largest hedge- fund insider-trading ring ever charged. Money manager Bernard Madoff was sentenced in June to 150 years in prison after pleading guilty to running a $65 billion Ponzi scheme.

Prime Brokerages

Revenue from prime brokerages, which provide hedge funds and other clients with services such as stock lending and clearing trades, may rise 15 percent to 20 percent next year, according Morgan Stanley.

As much as 32 percent of the equity revenue generated by Credit Suisse Group AG, Deutsche Bank AG and Barclays Plc during the first half of this year came from their prime-brokerage businesses, Morgan Stanley said.

Hedge-fund strategies based on supply-and-demand research rather than arbitrage bets based on price differences will “matter more” over the next 12 months, Morgan Stanley said.

Funds that will receive more money from investors include macro funds, or those that seek to profit from broad economic trends by trading everything from bonds to commodities; equity funds; and commodity-trading advisers, which use computers to decide when to trade securities, according to the bank.

Morgan Stanley said it was seeing “growing interest” in distressed and emerging-market hedge funds as well as those that trade convertible securities and invest in companies going through events such as mergers and spinoffs.

Hedge funds are mostly private pools of capital whose managers take a share in the profits from speculation on whether the price of assets will rise or fall.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net;