Sunday, March 27, 2005
Why Stan Wins in Picking Prop Traders
Barron's Online
Monday, March 28, 2005
FUND OF INFORMATION
Trading Places
Ex-hands of investment banks find running money on their own is a different game
By LAWRENCE C. STRAUSS
IF TOM WOLFE WERE WRITING Bonfire of the Vanities today, chances are his "master of the universe" character would be a proprietary-desk trader at a prestigious investment bank who launches a hedge fund.
Sherman McCoy, the investment-banker protagonist of that classic 1980s novel, would have a new title: general partner of the Distressed Event-Driven Arbitrage Opportunities Fund.
A few recent high-profile examples of people on the trader-hedge-fund-manager career path include Eric Mindich and Dinakar Singh, who both left Goldman Sachs to start multibillion-dollar hedge funds.
In many ways, it's a sensible move. Mindich and Singh offer considerable trading talent, not to mention the institutional knowledge they soaked up at a well-regarded firm like Goldman -- which has become perhaps the premier farm team for hedge-fund talent.
"Prop desks," as they are known, are "one of the few viable avenues to recruit talent for hedge funds," says Neal Berger, president of Apogee Asset Management, which runs a multi-strategy hedge fund.
The Goldman cubs aren't necessarily representative of this trend, which has been unfolding for a long time. For one thing, these two startups have tremendous scale. When a fund launches with billions of dollars under management, it has the resources to buy the necessary infrastructure, whether for monitoring risk control or compliance. As one hedge-fund manager who opted for anonymity, puts it, "You can afford to hire a lot of smart people."
Hedge-fund trade publications, however, are chock full of items about prop-desk traders launching hedge funds, many of them much smaller than Mindich's Eton Park Capital Management.
But investors considering plunging into a new hedge fund run by a former prop-desk trader should be cautious.
"There's great talent" working on prop desks, observes Cynthia J. Nicoll, chief investment officer at Tremont Capital Management, which invests in hedge funds on behalf of its clients. "But just because someone has run proprietary money doesn't necessarily mean they're going to run a great hedge fund."
There are big differences between trading money for an investment bank's house account and running an independent hedge fund.
"On a prop desk, it's not as if you have $1 billion or $5 billion in front of you every single day," says a hedge-fund manager who uses a long/short equity strategy. "The capital is allocated as the opportunities appear." But in running a hedge fund, there is the "pressure of earning returns on a static pool of assets," the manager continues.
"That very institutional infrastructure they have taken for granted is no longer available to them," says Joan Kehoe, head of international operations for PFPC, which handles administration for asset managers, including hedge funds.
Tom Ortwein, president of Highbrace Capital, a fund of hedge funds in Greenwich, Conn., notes that in a hedge fund, "you don't just lighten up and capital gets reallocated." Working on a prop desk, he says, is "not the same as having a single pool and a finite set of parameters in which you're operating." Ortwein was formerly head of capital markets at CIBC.
Apogee's Berger, a former prop-desk trader who went on to start his own hedge fund, notes that on a trading desk, "There's no concept of I'm up 1%."
He adds: "In investment-banking terms, you're really just talking about nominal profits and losses, with no regard to any type of capital base; it's very difficult to manage risk in the same way you would in a hedge fund."
Working at a large investment bank offers other advantages, including oversight of trading. But when you're working on your own, nobody's looking over your shoulder anymore to make sure you're not nuts.
Another advantage of working on a prop desk is getting a sense of a firm's order flow, which can provide a definite edge. "Like it or not, prop desks take advantage of that," explains Ortwein. "Certainly, they know which way the order flows are going."
Investment banks also have the benefit of numerous trading contacts, as well as proprietary research. For hedge funds, "It is a whole lot different to rely on a brokerage firm to find the other side of the trade for you," says Ortwein.
"Sitting on a prop desk, you have access to a very large organization, contacts and research," says Tremont's Nicoll. "Unless you can duplicate that at the hedge-fund level, it's not necessarily a good result."
She says that plenty of traders have done that, including Brevan Howard Asset Management, a firm launched in 2002 by Alan Howard, formerly Credit Suisse First Boston's global bond trading chief.
In vetting funds, Tremont and other funds of funds wrestle with these issues constantly. A key consideration, Nicoll says, is whether the traders founding a fund were "credible and meaningful decision makers at the prop desk."
That's not always easy to discern.
"As a trader at a bank, I am well aware of my trading performance," says Berger. "However, an employer looking at my track record will have a hard time verifying my claims."
Nicoll points out that as prop traders launch a hedge fund, they need to demonstrate that they can generate ideas in a new setting. And, she stresses, the fund's compensation scheme "has to make people want to work as a team and want to stay."
There are other contrasts between trading desks and hedge funds.
"Prop-desk traders have the benefit of trading flexible risk capital with strict guidelines and are judged over a yearly time horizon," explains Bruce Amlicke, chief investment officer of Blackstone Alternative Asset Management, a $9.3 billion fund of funds. "In a hedge fund, performance is scrutinized on a monthly basis. That's a lot of pressure, especially when you're building a business -- and the success of that new business is largely driven by those early returns." (Hedge-fund investors typically review returns each month.)
Amlicke maintains that it's a much easier transition coming from another hedge fund than from a trading desk. Assessing traders-turned-hedge-fund managers hinges on two questions, in his view: "Does the trader have what it takes to generate outsized returns outside of a structured institutional setting, and can that trader build and run a business?"
Running a business requires a different set of skills than trading does, often entailing outsourcing, which costs money.
PFPC's Kehoe estimates that startup firms need at least $100 million in assets under management "to sustain their expense base."
The startups she has seen close within 12 months of launching -- they weren't all founded by traders -- typically weren't able "to garner the assets quickly enough to sustain their expenses."
Investors can face a dilemma: A new hedge fund with a big-name trader has no track record. But if an investor waits too long, even a few months, to see a record develop, there's a risk the fund will be closed to new investors.
Ortwein says "there are a ton of talented" prop traders. But running $3 billion out of the gate is a daunting task. So "one does need to be cautious," Berger, the hedge-fund manager, avers. "The last chapter has yet to be written on whether these superstar guys spinning out of investment banks are going to live up to the hype."
Going Long
There's been considerable interest lately in long-only funds, which account for a tiny portion of the roughly $1 trillion of hedge-fund assets.
At least one hedge-fund firm is ditching that strategy, however. GoldenTree Asset Management, based in New York City, announced recently that it was returning $1.2 billion in long-only separate- account business to investors.
GoldenTree oversees $6.5 billion in bank loans, high-yield bonds, distressed stocks, real estate and other assets. In a statement, the firm's chief investment officer, Steven A. Tananbaum, said that "in the current environment for high-yield we believe we can offer the best value to our clients by being total-return managers."
The long-only accounts were hampered by not being able to short or use leverage, as well as being measured against an index, he said. Sound sort of like expensive mutual funds, don't they?
E-mail comments to editors@barrons.com3
URL for this article:
http://online.barrons.com/article/SB111179676353990064.html
Monday, March 28, 2005
FUND OF INFORMATION
Trading Places
Ex-hands of investment banks find running money on their own is a different game
By LAWRENCE C. STRAUSS
IF TOM WOLFE WERE WRITING Bonfire of the Vanities today, chances are his "master of the universe" character would be a proprietary-desk trader at a prestigious investment bank who launches a hedge fund.
Sherman McCoy, the investment-banker protagonist of that classic 1980s novel, would have a new title: general partner of the Distressed Event-Driven Arbitrage Opportunities Fund.
A few recent high-profile examples of people on the trader-hedge-fund-manager career path include Eric Mindich and Dinakar Singh, who both left Goldman Sachs to start multibillion-dollar hedge funds.
In many ways, it's a sensible move. Mindich and Singh offer considerable trading talent, not to mention the institutional knowledge they soaked up at a well-regarded firm like Goldman -- which has become perhaps the premier farm team for hedge-fund talent.
"Prop desks," as they are known, are "one of the few viable avenues to recruit talent for hedge funds," says Neal Berger, president of Apogee Asset Management, which runs a multi-strategy hedge fund.
The Goldman cubs aren't necessarily representative of this trend, which has been unfolding for a long time. For one thing, these two startups have tremendous scale. When a fund launches with billions of dollars under management, it has the resources to buy the necessary infrastructure, whether for monitoring risk control or compliance. As one hedge-fund manager who opted for anonymity, puts it, "You can afford to hire a lot of smart people."
Hedge-fund trade publications, however, are chock full of items about prop-desk traders launching hedge funds, many of them much smaller than Mindich's Eton Park Capital Management.
But investors considering plunging into a new hedge fund run by a former prop-desk trader should be cautious.
"There's great talent" working on prop desks, observes Cynthia J. Nicoll, chief investment officer at Tremont Capital Management, which invests in hedge funds on behalf of its clients. "But just because someone has run proprietary money doesn't necessarily mean they're going to run a great hedge fund."
There are big differences between trading money for an investment bank's house account and running an independent hedge fund.
"On a prop desk, it's not as if you have $1 billion or $5 billion in front of you every single day," says a hedge-fund manager who uses a long/short equity strategy. "The capital is allocated as the opportunities appear." But in running a hedge fund, there is the "pressure of earning returns on a static pool of assets," the manager continues.
"That very institutional infrastructure they have taken for granted is no longer available to them," says Joan Kehoe, head of international operations for PFPC, which handles administration for asset managers, including hedge funds.
Tom Ortwein, president of Highbrace Capital, a fund of hedge funds in Greenwich, Conn., notes that in a hedge fund, "you don't just lighten up and capital gets reallocated." Working on a prop desk, he says, is "not the same as having a single pool and a finite set of parameters in which you're operating." Ortwein was formerly head of capital markets at CIBC.
Apogee's Berger, a former prop-desk trader who went on to start his own hedge fund, notes that on a trading desk, "There's no concept of I'm up 1%."
He adds: "In investment-banking terms, you're really just talking about nominal profits and losses, with no regard to any type of capital base; it's very difficult to manage risk in the same way you would in a hedge fund."
Working at a large investment bank offers other advantages, including oversight of trading. But when you're working on your own, nobody's looking over your shoulder anymore to make sure you're not nuts.
Another advantage of working on a prop desk is getting a sense of a firm's order flow, which can provide a definite edge. "Like it or not, prop desks take advantage of that," explains Ortwein. "Certainly, they know which way the order flows are going."
Investment banks also have the benefit of numerous trading contacts, as well as proprietary research. For hedge funds, "It is a whole lot different to rely on a brokerage firm to find the other side of the trade for you," says Ortwein.
"Sitting on a prop desk, you have access to a very large organization, contacts and research," says Tremont's Nicoll. "Unless you can duplicate that at the hedge-fund level, it's not necessarily a good result."
She says that plenty of traders have done that, including Brevan Howard Asset Management, a firm launched in 2002 by Alan Howard, formerly Credit Suisse First Boston's global bond trading chief.
In vetting funds, Tremont and other funds of funds wrestle with these issues constantly. A key consideration, Nicoll says, is whether the traders founding a fund were "credible and meaningful decision makers at the prop desk."
That's not always easy to discern.
"As a trader at a bank, I am well aware of my trading performance," says Berger. "However, an employer looking at my track record will have a hard time verifying my claims."
Nicoll points out that as prop traders launch a hedge fund, they need to demonstrate that they can generate ideas in a new setting. And, she stresses, the fund's compensation scheme "has to make people want to work as a team and want to stay."
There are other contrasts between trading desks and hedge funds.
"Prop-desk traders have the benefit of trading flexible risk capital with strict guidelines and are judged over a yearly time horizon," explains Bruce Amlicke, chief investment officer of Blackstone Alternative Asset Management, a $9.3 billion fund of funds. "In a hedge fund, performance is scrutinized on a monthly basis. That's a lot of pressure, especially when you're building a business -- and the success of that new business is largely driven by those early returns." (Hedge-fund investors typically review returns each month.)
Amlicke maintains that it's a much easier transition coming from another hedge fund than from a trading desk. Assessing traders-turned-hedge-fund managers hinges on two questions, in his view: "Does the trader have what it takes to generate outsized returns outside of a structured institutional setting, and can that trader build and run a business?"
Running a business requires a different set of skills than trading does, often entailing outsourcing, which costs money.
PFPC's Kehoe estimates that startup firms need at least $100 million in assets under management "to sustain their expense base."
The startups she has seen close within 12 months of launching -- they weren't all founded by traders -- typically weren't able "to garner the assets quickly enough to sustain their expenses."
Investors can face a dilemma: A new hedge fund with a big-name trader has no track record. But if an investor waits too long, even a few months, to see a record develop, there's a risk the fund will be closed to new investors.
Ortwein says "there are a ton of talented" prop traders. But running $3 billion out of the gate is a daunting task. So "one does need to be cautious," Berger, the hedge-fund manager, avers. "The last chapter has yet to be written on whether these superstar guys spinning out of investment banks are going to live up to the hype."
Going Long
There's been considerable interest lately in long-only funds, which account for a tiny portion of the roughly $1 trillion of hedge-fund assets.
At least one hedge-fund firm is ditching that strategy, however. GoldenTree Asset Management, based in New York City, announced recently that it was returning $1.2 billion in long-only separate- account business to investors.
GoldenTree oversees $6.5 billion in bank loans, high-yield bonds, distressed stocks, real estate and other assets. In a statement, the firm's chief investment officer, Steven A. Tananbaum, said that "in the current environment for high-yield we believe we can offer the best value to our clients by being total-return managers."
The long-only accounts were hampered by not being able to short or use leverage, as well as being measured against an index, he said. Sound sort of like expensive mutual funds, don't they?
E-mail comments to editors@barrons.com3
URL for this article:
http://online.barrons.com/article/SB111179676353990064.html
# posted by Tom @ 5:07 PM 
