Hedge Fund "Hotels" in Asia
" Each problem has hidden in it an opportunity so powerful that it literally dwarfs the problem. The greatest success stories were created by people who recognized a problem and turned it into an opportunity."
Joseph Sugarman
A broad overview. The concept of the hedge fund hotel was initiated in the late 1970s by the then little known broker, Furman Selz. It started out as office space on 237 Park Avenue in Manhattan, N.Y. in what was then known as the Pan Am Building (located directly over Grand Central Station). This took the form of space sub-leasing, the provision of electronic trading screens (later known as Bloomberg terminals), dealing room back office facilities, plants and even lunch on Fridays! Why? Because the small broker realized that by effectively nuturing some of its trading clients it could establish a quid pro quo of brokerage commissions for this "hotel" support.
This was the origin of prime brokerage and a developing realization that business could be built organically with the then blossoming hedge fund client (typically an ex-mutual fund guy with a few coins and penchant for entrepreneurialism).
Back to Furman Selz. With the financial industry consolidating in 2001 there began the ING-Furman Selz fund of hedge fund (FoHF) initiative. Not only could you access some of the hotel fund managers but in a portfolio format - great for the institutional investor and even greater for the promoter given the opportunity to generate additional fee income on the product marketing side. In the meantime the bigger players, like Merrill Lynch also jumped into the fray and started the first overseas PB operation under the umbrella of Merrill Lynch Intl Bank in the late 1980s.
To close the loop. Eventually firms started to pull back from the office leasing business as they found that the expenses they provided to the hedge funds kept on rising exponentially. They could hardly make the manager pick-up the tab. Typically though, 90% of managers that left the confines of the "hotel" continued to do business with their "prime". In addition, this period saw significant reductions in the cost of technology and telecom rates making it easier for a manager to set out on his own.
Today the hedge fund industry is pretty much the leading money maker for IBs and brokers on "The Street" throwing off US$6.5 BLN in revenues in 2004 and comprising roughly 40% of total equity trading revenues. With US$1.325 TLN in industry capital managed by approx. 8,500 funds (single managers and FoHFs) it is big business and likely to get even bigger - albeit below what had been a 15-20% AUM CAGR in the late 1990s and early 2000s.
Of additional interest is the current make-up of the PB participants. Roughly 60% of global prime brokerage business is dominated by three houses - Morgan Stanley (MS), Goldman Sachs (GS) and Bear Stearns (BS). Each has a "hold" on a different hedge fund industry niche. Morgan Stanley is strongest in servicing offshore funds especially out of Europe and Asia via their Hong Kong office; GS is strong in U.S. onshore product, new jumbo managers (usually former GS prop traders) as well as in Japan, where they hold a well-attended "meat-market" event showcasing emerging Japan managers each November at the Four Seasons Hotel in Tokyo; while BS is strongest in relative-value strategy funds like convertible arbitrage, fixed income with a focus on U.S. managers.
Why Back To the Future with hedge fund hotels? Its simple really. Hedge fund hotels can be a profitable entre for a growing prime brokerage business operation. Not really an already established one but a mega-IB wannabe. Your customers are effectively home-grown and assuming you have effective due diligence (which is often times very suspect given the natural conflict of interest to get the business regardless of how the alpha is generated). The up-and-coming PB hotel owner can even serve the capital introduction platform. The latter is the PBs attempt to showcase favorable managers to their best institutional clients.
But the conflicts can make the relationship between manager and PB a little tense, particularly if the fund AUM takes off and the manager expands products and fund offerings to other more potentially specialized PB platforms. What happens then? I guess it is better to have 20% of some business than 100% of nothing! So the battle of negotiating power between PB and fund manager is an ongoing one of struggle as each attempts to protect their valuable "margin" on the hedge fund value chain. And today, the Asian hedge fund value chain is very valuable indeed.
In 2006 there are an estimated 100 such hedge fund hotels, mostly in the U.S. on the east coast but also in many others cities like Chicago, Boston, San Francisco etc. They are even sprouting overseas in places as far afield as London, Geneva, Paris, Hong Kong, Singapore and Tokyo - in short, to wherever the hedge fund "bug" (or "locusts" for all you German speakers out there) has bitten and taken hold. Which is one reason why the hotel business model has arrived in Asia.
This brings us to Hawaii. Rather than "Why?" one might pose the question "Why not?" Why not anywhere for that matter? Really. The truth is that for a particular region it sometimes makes sense with the right mix of trading talent to exploit whatever natural advantages might exist. Twinning time zones in the U.S. and Tokyo suggests that there might be particular advantages for a hedge fund manager wanting to be closer to Asia and desrious of a U.S. lifestyle for his family. So why not Hawaii? Maybe because the big IBs are not there.
Interestingly, the growth rate experienced in hedge fund industry AUM (if they can be believed from the various"authorities" that exist) has actually started to slow down in the U.S. and to a lesser extent Europe since 2002/03. Only in Asia (specifically Japan) and from an arguably lower starting point has the growth rate been an impressive 30-35% every six months (since the Nikkei low in May 2003). This has not gone unnoticed by many big PBs ramping up their operations in Hong Kong, Singapore, Tokyo and Sydney. There is probably one being set up in Shanghai as I write!
What this all means is that competition for the Asian hedge fund manager coin is certainly going to heat up. And more competition means a trend towards commoditization and lower brokerage commission fees. That is great for hedge fund managers and potentially investors. Which is why the issue of conflict of interests in some of these ventures is particularly interesting and conveniently overlooked.
Remember, the Asian hedge fund industry is moving from about 4-6% of total hedge fund AUM (or a speck in the ocean) in 2005 to potentially 15% by 2011 (a pretty big lake). That makes Asia a particularly appetizing piece in the developing hedge fund industry pie. Mahalo.
" Each problem has hidden in it an opportunity so powerful that it literally dwarfs the problem. The greatest success stories were created by people who recognized a problem and turned it into an opportunity."
Joseph Sugarman
A broad overview. The concept of the hedge fund hotel was initiated in the late 1970s by the then little known broker, Furman Selz. It started out as office space on 237 Park Avenue in Manhattan, N.Y. in what was then known as the Pan Am Building (located directly over Grand Central Station). This took the form of space sub-leasing, the provision of electronic trading screens (later known as Bloomberg terminals), dealing room back office facilities, plants and even lunch on Fridays! Why? Because the small broker realized that by effectively nuturing some of its trading clients it could establish a quid pro quo of brokerage commissions for this "hotel" support.
This was the origin of prime brokerage and a developing realization that business could be built organically with the then blossoming hedge fund client (typically an ex-mutual fund guy with a few coins and penchant for entrepreneurialism).
Back to Furman Selz. With the financial industry consolidating in 2001 there began the ING-Furman Selz fund of hedge fund (FoHF) initiative. Not only could you access some of the hotel fund managers but in a portfolio format - great for the institutional investor and even greater for the promoter given the opportunity to generate additional fee income on the product marketing side. In the meantime the bigger players, like Merrill Lynch also jumped into the fray and started the first overseas PB operation under the umbrella of Merrill Lynch Intl Bank in the late 1980s.
To close the loop. Eventually firms started to pull back from the office leasing business as they found that the expenses they provided to the hedge funds kept on rising exponentially. They could hardly make the manager pick-up the tab. Typically though, 90% of managers that left the confines of the "hotel" continued to do business with their "prime". In addition, this period saw significant reductions in the cost of technology and telecom rates making it easier for a manager to set out on his own.
Today the hedge fund industry is pretty much the leading money maker for IBs and brokers on "The Street" throwing off US$6.5 BLN in revenues in 2004 and comprising roughly 40% of total equity trading revenues. With US$1.325 TLN in industry capital managed by approx. 8,500 funds (single managers and FoHFs) it is big business and likely to get even bigger - albeit below what had been a 15-20% AUM CAGR in the late 1990s and early 2000s.
Of additional interest is the current make-up of the PB participants. Roughly 60% of global prime brokerage business is dominated by three houses - Morgan Stanley (MS), Goldman Sachs (GS) and Bear Stearns (BS). Each has a "hold" on a different hedge fund industry niche. Morgan Stanley is strongest in servicing offshore funds especially out of Europe and Asia via their Hong Kong office; GS is strong in U.S. onshore product, new jumbo managers (usually former GS prop traders) as well as in Japan, where they hold a well-attended "meat-market" event showcasing emerging Japan managers each November at the Four Seasons Hotel in Tokyo; while BS is strongest in relative-value strategy funds like convertible arbitrage, fixed income with a focus on U.S. managers.
Why Back To the Future with hedge fund hotels? Its simple really. Hedge fund hotels can be a profitable entre for a growing prime brokerage business operation. Not really an already established one but a mega-IB wannabe. Your customers are effectively home-grown and assuming you have effective due diligence (which is often times very suspect given the natural conflict of interest to get the business regardless of how the alpha is generated). The up-and-coming PB hotel owner can even serve the capital introduction platform. The latter is the PBs attempt to showcase favorable managers to their best institutional clients.
But the conflicts can make the relationship between manager and PB a little tense, particularly if the fund AUM takes off and the manager expands products and fund offerings to other more potentially specialized PB platforms. What happens then? I guess it is better to have 20% of some business than 100% of nothing! So the battle of negotiating power between PB and fund manager is an ongoing one of struggle as each attempts to protect their valuable "margin" on the hedge fund value chain. And today, the Asian hedge fund value chain is very valuable indeed.
In 2006 there are an estimated 100 such hedge fund hotels, mostly in the U.S. on the east coast but also in many others cities like Chicago, Boston, San Francisco etc. They are even sprouting overseas in places as far afield as London, Geneva, Paris, Hong Kong, Singapore and Tokyo - in short, to wherever the hedge fund "bug" (or "locusts" for all you German speakers out there) has bitten and taken hold. Which is one reason why the hotel business model has arrived in Asia.
This brings us to Hawaii. Rather than "Why?" one might pose the question "Why not?" Why not anywhere for that matter? Really. The truth is that for a particular region it sometimes makes sense with the right mix of trading talent to exploit whatever natural advantages might exist. Twinning time zones in the U.S. and Tokyo suggests that there might be particular advantages for a hedge fund manager wanting to be closer to Asia and desrious of a U.S. lifestyle for his family. So why not Hawaii? Maybe because the big IBs are not there.
Interestingly, the growth rate experienced in hedge fund industry AUM (if they can be believed from the various"authorities" that exist) has actually started to slow down in the U.S. and to a lesser extent Europe since 2002/03. Only in Asia (specifically Japan) and from an arguably lower starting point has the growth rate been an impressive 30-35% every six months (since the Nikkei low in May 2003). This has not gone unnoticed by many big PBs ramping up their operations in Hong Kong, Singapore, Tokyo and Sydney. There is probably one being set up in Shanghai as I write!
What this all means is that competition for the Asian hedge fund manager coin is certainly going to heat up. And more competition means a trend towards commoditization and lower brokerage commission fees. That is great for hedge fund managers and potentially investors. Which is why the issue of conflict of interests in some of these ventures is particularly interesting and conveniently overlooked.
Remember, the Asian hedge fund industry is moving from about 4-6% of total hedge fund AUM (or a speck in the ocean) in 2005 to potentially 15% by 2011 (a pretty big lake). That makes Asia a particularly appetizing piece in the developing hedge fund industry pie. Mahalo.
posted by Franklin Scruggins | 6:07 AM
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