Tests await proprietary stars seeking hedge fund riches

Date: Wednesday, March 16, 2011
Author: Laurence Fletcher, Reuters

Many a top bank trader will struggle to replicate what ex-Goldman Sachs stars Pierre-Henri Flamand and Morgan Sze are doing: raising billions of dollars to start their own hedge funds.

Traders who have been paid well for years to bet banks' own money in markets -- so-called proprietary trading -- have no demonstrable track record to show investors now that U.S. regulation forces them to look for a job elsewhere.

"It is not a complete slam-dunk for us (to invest in a spin-out). The transition from prop trader to hedge fund manager is not totally obvious," said Patric de Gentile-Williams at FRM Capital Advisors, who has not as yet backed such funds.

Credit Suisse's Hedge Fund Investor Survey shows 52 percent of investors might be prepared to back a prop desk spin-out from day one -- but only if it had a three-year track record.

Investors may also be wary because the small outfits do not have the same internal controls as a bank and find it hard to meet strict compliance demands from large clients.

A lack of deal flow and a consequent lack of trading ideas may further complicate matters for the smaller firms, which would typically employ only five to 10 people.

That said, assets are steadily returning to the $1.9 trillion hedge fund industry after the financial crisis, and investors will be curious about perceived star managers setting up their own business.

But it's not only the stars who will be looking for a job.

"Do not underestimate the impact Pierre-Henri Flamand had on guys running prop desks. They are probably thinking 'I could do that'," said one prime broker, asking not to be named.

MORE TO COME

Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) has taken a lead as the U.S. Volcker rule forces banks to wind down proprietary trading desks, move them into other units at arm's length, or spin them off as hedge funds and earn fees as prime broker.

Prop trading accounted for 5 percent of Deutsche Bank's (DBKGn.DE: Quote, Profile, Research, Stock Buzz) 2009 revenues, JP Morgan Cazenove estimates, before the bank largely wound the unit down, and somewhere below 10 percent of Credit Suisse's (CSGN.VX: Quote, Profile, Research, Stock Buzz) equity revenues.

JPMorgan (JPM.N: Quote, Profile, Research, Stock Buzz) plans to move its prop traders to its asset management unit and is expected to seed the group with around $2 billion, while Morgan Stanley (MS.N: Quote, Profile, Research, Stock Buzz) is to spin off its Process Driven Trading unit by the end of 2012.

"I would say we have seen 10 or 15 percent of this (prop desks spinning out). You are very much at the beginning of the process," said FCA's de Gentile-Williams.

Traders will have been buoyed by the success of Flamand, former head of Goldman's Principal Strategies unit, who raised around $1 billion for his event-driven launch Edoma and later increased this to about $1.6 billion.

Flamand was succeeded by Morgan Sze, who now banks on raising $1 billion in Asia for his Azentus Capital.

"They are very confident, and I think they will get more," said a banker who asked not to be named.

But many will find it hard to match the couple.

"The next round -- the 2011 groups -- might find much of the supportive capital has gone," said de Gentile-Williams.

"It is not clear what the track record will be managing client money. You need to do a lot of work obtaining references," said Peter Rigg, global head of the alternative investments group at HSBC Alternative Investments Limited, which has backed Flamand's new venture.

Tim Gascoigne, global head of portfolio management at HAIL, adds that not all spinouts fare well. "The opportunity set you can get when you sit within a huge bank (is bigger) ... There have been managers out of banks who have launched macro funds, with a good track record, and not succeeded."