November 14, 2012

The hedge fund industry is expected to see a wave of new launches in the next year by traders who have lost their jobs at investment banks or who have left in search of better pay.

The start-ups are expected despite the unimpressive performance of other new ventures and questions about where they will find new capital to finance them.

New rules banning U.S. banks or those with U.S. subsidiaries from risky but potentially profitable proprietary trading are also encouraging some traders to make the move.

Mitt Romney's U.S. presidential election defeat means little chance of the wider regulatory bill being repealed, as he had promised.

"If you consider what's going on for (banks) at the moment from a compensation point of view, plus the increase in regulation and impediments to expressing risk...then working at a hedge fund looks like a compelling option at the moment," said

David Barenborg, a portfolio manager at BlackRock Alternative Advisors.

Among the most prominent names who have tried to launch this year are JP Morgan's Mike Stewart and Deepak Gulati, Citi's former head of proprietary trading Sutesh Sharma, and Nomura's Borut Miklavcic, who gained approval from Britain's Financial Services Authority for his LindenGrove Capital this month.

Other traders away from the proprietary businesses, such as so-called "flow" traders, who engage in market-making transactions for clients, are also leaving banks.

Antoine Cornut, a former head of flow-credit trading for Deutsche Bank, is setting up his own credit-focused hedge fund Camares Capital, two people familiar with the launch said.

Investment banks across the globe have slashed hundreds of thousands of jobs since a market peak in 2007, as tougher regulations and weak dealmaking force them to cut costs. UBS said last month it was winding down its fixed income business and cut 10,000 jobs.

Banks are also under pressure to cut bonuses and benefits, reducing the incentive to stay on at a bank with the promise of a more lucrative job elsewhere.

PROP DESKS SHUTTING

Proprietary trading, or trading with the banks own money, can closely resemble trading in the hedge fund business and has turned out big profits before the financial crisis.

But the U.S. Dodd-Frank bill, introduced under President Barack Obama, includes a ban, known as the Volcker rule, on proprietary trading because it is risky.

Under that rule, U.S. banks or banks with U.S. subsidiaries or branches - most major European and Asian lenders - were banned from betting with their own capital from July this year, but given until 2014 to comply.

Many banks were quick to dismantle their "prop" desks ahead of the rule, but others have taken a wait-and-see approach and may now have to make big cuts. This will likely mean several new launch attempts in the first quarter of next year.

"We will definitely see some new spin-outs over the coming year as most banks continue to plan ahead," said Daniel Caplan, European Head of Global Prime Finance at Deutsche Bank , which has worked with several of the major launches to come out of banks since the 2008 financial crisis.

He expects the next year will herald more start-ups in credit - one of the top performing and most popular sectors in 2012 - because many of the big ones so far have focused on trading equities.

The average credit hedge fund is up almost 9 percent this year, beating the average hedge fund's 4.3 percent, data from industry tracker Hedge Fund Research shows.

CAPITAL QUESTION

There is no guarantee traders will be able to raise sufficient capital to launch their own funds, however.

The bulk of the money flowing into the industry since the financial crisis has gone straight to the biggest names, leaving start-ups struggling.

Bank traders have instead found themselves snapped up by the big, established hedge funds - an offer some who fail to get planned launches off the ground will likely take.

Moreover, many of the biggest new ventures have failed to make their backers money.

Edoma Partners, set up by a former senior proprietary trader at Goldman Sachs and one of the most hyped launches since the financial crisis, said earlier this month it was shutting down after just two years, hit by poor returns and investor exits.

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