FOR PROFESSIONAL INVESTORS ONLY Are Hedge Funds Shadow Banks? Douglas Shaw COO Fundamental Equity,...
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FOR PROFESSIONAL INVESTORS ONLY Are Hedge Funds Shadow Banks? Douglas Shaw COO Fundamental Equity, BlackRock April 2011 Slide 2 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 Yesterdays risk dispersion is todays shadow banking Slide 3 Hedge Fund Industry 1990 2010 Source: HFR 2010 Report Slide 4 Recent flows have favoured the larger funds Source: HFR 2010 Report Slide 5 Banks might be, but hedge funds are not too big to fail Source: HFR 2010 Report Hedge funds frequently failed few people noticed! No burden on taxpayers Slide 6 Source of Hedge Fund Borrowings September 2010 Source: FSA HFS Source of funding means counterparties have much protection against hedge fund failure Slide 7 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 Slide 8 8 Banks balance sheets 10 15 20 25 30 35 40 45 Q2 2000Q4 2000Q2 2001Q4 2001Q2 2002Q4 2002Q2 2003Q4 2003Q2 2004Q4 2004Q2 2005Q4 2005Q2 2006Q4 2006Q2 2007Q4 2007Q2 2008Q4 2008Q2 2009Q4 2009Q2 2010 BoACitiJPMGSMLMS Huge expansion of banks balance sheets heralded the financial crisis Source: Bloomberg Slide 9 9 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 Hedge funds balance sheets are not on the same scale Slide 10 Qualified Fund Footprint as a Percent of NAV Source: FSA HFS Hedge funds leverage not even on the same scale as banks Slide 11 Capital invested by hedge funds & prop. trading desks 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 Total in Position $9.7tr$3.2tr$3.7tr$5.3tr Source: Hedge Fund Research, Inc., Credit Suisse, BlackRock * Proprietary Trading Desk Capital Base and Leverage, BlackRock Alternative Advisors estimates. Hedge Funds Proprietary Trading Slide 12 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 Slide 13 Maturity Transformation Hedge Fund Style Source: FSA HFS Borrow (raise funds) longer term but invest shorter term! Slide 14 Hedge funds didnt 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) Slide 15 Credit Arbitrage Strategies Source: HFR 2010 Report Slide 16 Fixed Income & Asset Backed Strategies Source: HFR 2010 Report Tiny flows back to Credit and FI strategies, into the larger ones, already much more heavily scrutinised Slide 17 17 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 Slide 18 18 Whats 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 Whos the target? Who gets the proceeds? * Source: http://openeuropeblog.blogspot.com/2010/10/europes-worst-kep-secret.html, quoting Le Monde Slide 19 19 The following notes should be read in conjunction with the attached document: 1.Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Services Authority. Registered office: 33 King William Street, London, EC4R 9AS. Tel: 020 7743 3000. 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