Transcript Title (24 pt Arial, bold)

Are Hedge Funds Shadow
Banks?
Douglas Shaw
COO Fundamental Equity, BlackRock
April 2011
FOR PROFESSIONAL INVESTORS ONLY
What is a Shadow Bank?
Poorly defined:
• SIVs
• GSEs
• Finance companies
• Credit hedge funds
• Securities lenders
• Levered loan funds
• Money market mutual funds…
Maturity and credit transformation
Yesterday’s risk dispersion is today’s shadow banking
Hedge Fund Industry 1990 – 2010
$2,250,000
$2,000,000
$1,750,000
Assets ($MM)
$1,500,000
$1,250,000
$1,000,000
$750,000
$500,000
$250,000
$0
-$250,000
Net Asset Flow
Source: HFR 2010 Report
Estimated Assets
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
-$500,000
Recent flows have favoured the larger funds
8000
$6,787
7000
Net Asset Flows ($MM)
6000
$4,716
5000
4000
3000
2000
$1,006
1000
$969
$459
0
-1000
-$785
-2000
< $100 Million
Source: HFR 2010 Report
$100 to $250
Million
$250 to $500
Million
$500M to $1
Billion
$1 to $5 Billion
> $5 Billion
Banks might be, but hedge funds are not too big to “fail”
2500
2000
Number of Funds
1500
1000
500
0
-500
-1000
-1500
Source: HFR 2010 Report
Launches
Liquidations
Hedge funds frequently “failed” – few people noticed!
No burden on taxpayers
Q3 2010
Q2 2010
Q1 2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
-2000
Source of Hedge Fund Borrowings – September 2010
Unsecured Borrowing
PB Borrowing
Repo Borrowing
Synthetic Borrowing
Source: FSA HFS
Source of funding means counterparties have much protection
against hedge fund failure
Credit Transformation
Banks bundling mortgages, tranching & selling them
• Especially the risky mortgages
Complex & Befuddling
• investors
• regulators
• rating agencies
• insurers
• even banks themselves
Hedge funds were the early warning system
• shorted into the bubble
• presented to G7 Philadelphia 2007
• http://www.bbc.co.uk/programmes/b00m67vv
“The Big Shorts”
Banks’ balance sheets
45
40
35
30
25
20
15
10
Q2 2010
Q4 2009
Q2 2009
Q4 2008
Q2 2008
Q4 2007
Q2 2007
Q4 2006
Q2 2006
Q4 2005
Q2 2005
Q4 2004
Q2 2004
Q4 2003
Q2 2003
Q4 2002
Q2 2002
Q4 2001
Q2 2001
Q4 2000
Q2 2000
MS
ML
GS
JPM
Citi
BoA
Huge expansion of banks’ balance sheets heralded the financial crisis
Source: Bloomberg
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Hedge funds’ balance sheets are not on the same scale
The leverage indicator is estimated using a rolling (24-month window fixed effects) regression of hedge fund returns on a variety of market-based risk factors. It is the sum of the
coefficients on these risk factors and is thus a measure of the aggregate sensitivity of hedge fund returns to movements in underlying prices.
‘All hedge funds’ includes market neutral (excluding equity hedged), directional, equity (including equity hedged), fixed income and fund-of-funds style families of active funds
reporting to HFR database; weighted by assets under management in each style family.
Source: HFR, BIS calculations
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Qualified Fund Footprint as a Percent of NAV
1600
1400
1200
%
1000
800
600
400
200
0
Equity Long Credit Long FI Arbitrage
Short
Short
Source: FSA HFS
Emerging
Markets
Oct 09 Survey
Global
Macro
Apr 10 Survey
Managed
Futures
MultiStrategy
Other
Sep 10 Survey
Hedge funds’ leverage not even on the same scale as banks’
Total
Capital invested by hedge funds & prop. trading desks
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1 Jan
2008
1 Jan
2009
1 Jan
2010
1 Jan
2011
Total Amount of
Securities
Owned by Hedge
Funds
$5.7
trillion
$2.8
trillion
$3.2
trillion
$4.8
trillion
Total Amount of
Securities
Owned by
Proprietary
Capital*
$4.0tr
$0.4tr
$0.5tr
$0.5tr
Total in
Position
$9.7tr
$3.2tr
$3.7tr
$5.3tr
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Total $9.7 trillion
Total $3.2 trillion
Total $3.7 trillion
Total $5.3 trillion
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$ Trillions (USD)
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Hedge
Funds
Hedge
Funds
5
4
Proprietary
Trading
Hedge
Funds
Hedge
Funds
3
2.5x
2
3x
2x
2x
1
8x
Proprietary
Trading
Proprietary
Trading
4x
0
Jan
2008
Jan
2009
Capital Base
Proprietary
Trading
5x
4x
Jan
2010
Leverage
Source: Hedge Fund Research, Inc., Credit Suisse, BlackRock
* Proprietary Trading Desk Capital Base and Leverage, BlackRock Alternative Advisors estimates.
Jan
2011
Maturity Transformation
Reliance on short duration repo markets converted risky long
term assets to near cash
Money Market Funds drifted into longer maturity asset
backed paper (and some were befuddled in so doing)
• Valuation problems in BNP money funds heralded the financial crisis
Banks became highly levered and ran mismatches between
• long dated assets that became illiquid &
• short term funding that was withdrawn as confidence in ability to value
assets evaporated causing further asset sales at depressed prices
Borrow short term – Lend long term
Maturity Transformation – Hedge Fund Style
100
90
80
70
%
60
50
40
30
20
10
0
<5 Days
6 Days - 15
16 Days - 30
31 Days - 90 91 Days - 180 181 Days - 1
Days
days
Days
Days
Year
Portfolio Liquidity (as %)
Financing Term (as %)
Investor Liquidity (as %)
Source: FSA HFS
Borrow (raise funds) longer term – but invest shorter term!
1 Year +
Hedge funds didn’t always get asset maturity right
When withdrawals were at the peak in winter 08/09
• Some hedge funds could not close asset positions quicker than the
investor redemptions to which they were responding
So some hedge funds restricted redemptions through
• Gates
• Sidepockets
• Suspensions
• As allowed by their prospectuses
Some clients were surprised and disappointed
But hedge funds did not exceed their powers (generally)
Credit Arbitrage Strategies
$5,000
$4,000
Assets ($MM)
$3,000
$2,000
$1,000
$0
Source: HFR 2010 Report
Net Asset Flow
Estimated Assets
Q4 2010
Q3 2010
Q2 2010
Q1 2010
2009
2008
2007
2006
2005
2004
2003
2002
-$1,000
Fixed Income & Asset Backed Strategies
$35,000
$30,000
$25,000
Assets ($MM)
$20,000
$15,000
$10,000
$5,000
$0
-$5,000
Source: HFR 2010 Report
Net Asset Flow
Estimated Assets
Tiny flows back to Credit and FI strategies, into the larger ones,
already much more heavily scrutinised
Q4 2010
Q3 2010
Q2 2010
Q1 2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
-$10,000
To Conclude:
Hedge Funds are not shadow banks
• Significantly less levered
• No credit transformation
– though sought to profit from those who did
• Some maturity transformation
– not in the expected direction!
– generally asset / shareholder mismatches well managed
• No claim on the tax payers
Responding well to increased scrutiny
• Regulators’ surveys
• AIFMD
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What’s next?
•Clamp down on “speculators”
• “It was obvious that one day Greece would have to face this kind of
problems, and I knew that problems would arise because we - the French,
the Germans, ECB President Trichet, the Commission and myself - had
been discussing the perspectives of what was not at that time known as
so-called Greek crisis……
• …..The Greek crisis could have been avoided, but not starting last year,
starting two or three decades ago”* Jean Claude Juncker, twice President of
the Council of Europe, Luxembourg Prime Minister
•Financial Transaction Taxes
• Who’s the target?
• Who gets the proceeds?
*Source: http://openeuropeblog.blogspot.com/2010/10/europes-worst-kep-secret.html , quoting Le Monde
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