FOR PROFESSIONAL INVESTORS ONLY
Are Hedge Funds Shadow Banks?
Douglas Shaw
COO Fundamental Equity, BlackRock
April 2011
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
-$500,000
-$250,000
$0
$250,000
$500,000
$750,000
$1,000,000
$1,250,000
$1,500,000
$1,750,000
$2,000,000
$2,250,000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Ass
ets
($M
M)
Net Asset Flow Estimated Assets
Source: HFR 2010 Report
Recent flows have favoured the larger funds
$1,006
$459
$969
-$785
$4,716
$6,787
-2000
-1000
0
1000
2000
3000
4000
5000
6000
7000
8000
< $100 Million $100 to $250Million
$250 to $500Million
$500M to $1Billion
$1 to $5 Billion > $5 Billion
Net
Ass
et F
low
s ($
MM
)
Source: HFR 2010 Report
Banks might be, but hedge funds are not too big to “fail”
-2000
-1500
-1000
-500
0
500
1000
1500
2000
2500
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Q1
2010
Q2
2010
Q3
2010
Nu
mb
er o
f F
un
ds
Launches LiquidationsSource: HFR 2010 Report
Hedge funds frequently “failed” – few people noticed!
No burden on taxpayers
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”
8
Banks’ balance sheets
10
15
20
25
30
35
40
45
Q2
20
00
Q4
20
00
Q2
20
01
Q4
20
01
Q2
20
02
Q4
20
02
Q2
20
03
Q4
20
03
Q2
20
04
Q4
20
04
Q2
20
05
Q4
20
05
Q2
20
06
Q4
20
06
Q2
20
07
Q4
20
07
Q2
20
08
Q4
20
08
Q2
20
09
Q4
20
09
Q2
20
10
BoA Citi JPM GS ML MS
Huge expansion of banks’ balance sheets heralded the financial crisis
Source: Bloomberg
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
Qualified Fund Footprint as a Percent of NAV
Source: FSA HFS
0
200
400
600
800
1000
1200
1400
1600
Equity LongShort
Credit LongShort
FI Arbitrage EmergingMarkets
GlobalMacro
ManagedFutures
Multi-Strategy
Other Total
%
Oct 09 Survey Apr 10 Survey Sep 10 Survey
Hedge funds’ leverage not even on the same scale as banks’
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 $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.
0
1
2
3
4
5
6
7
8
9
$ T
rillio
ns (
US
D)
Capital Base Leverage
Jan2008
Jan2009
Jan2010
Jan2011
3x
8x
2x
4x
2x
4x 5x
2.5x
Total $9.7 trillion Total $3.2 trillion Total $3.7 trillion Total $5.3 trillion
Hedge Funds
Hedge Funds
Hedge Funds
Hedge Funds
Proprietary Trading
Proprietary Trading
Proprietary Trading
Proprietary Trading
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
0
10
20
30
40
50
60
70
80
90
100
<5 Days 6 Days - 15Days
16 Days - 30days
31 Days - 90Days
91 Days - 180Days
181 Days - 1Year
1 Year +
%
Portfolio Liquidity (as %) Financing Term (as %) Investor Liquidity (as %)Source: FSA HFS
Borrow (raise funds) longer term – but invest shorter term!
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
-$1,000
$0
$1,000
$2,000
$3,000
$4,000
$5,000
2002
2003
2004
2005
2006
2007
2008
2009
Q1
2010
Q2
2010
Q3
2010
Q4
2010
Ass
ets
($M
M)
Net Asset Flow Estimated AssetsSource: HFR 2010 Report
Fixed Income & Asset Backed Strategies
-$10,000
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Q1
2010
Q2
2010
Q3
2010
Q4
2010
Ass
ets
($M
M)
Net Asset Flow Estimated AssetsSource: HFR 2010 Report
Tiny flows back to Credit and FI strategies, into the larger ones, already much more heavily scrutinised
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
18
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
19
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