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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
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51
the shift toward more and more asset managers
extending into convergence products discussed in
the introduction to this paper, there is an increased
number of firms that fit this profile and even many
of the hedge funds interviewed for Parts I & II of this
year’s survey are starting to think more holistically
about supply and internalizing these capabilities,
sometimes even creating their own broker-dealer to
facilitate their efforts.
In part, this move reflects concerns about the
increased cost of borrowing sell-side balance sheet
to support trading strategies as Basel III and other
regulations drive up demands on swap and financing
counterparts. The move also reflects recognition
about the opportunity to more fully utilize the
organization’s assets for its own benefit and reduce
the operational costs and inefficiencies of having
multiple internal teams managing their own supply
in isolation.
While only a subset of asset owners have moved in
this direction to date, the option may become more
attractive if indemnification is priced explicitly
into current lending arrangements. Some survey
participants noted that the cost of establishing an
internal team may become close to the cost of paying
an external lender for indemnification, increasing the
incentive to insource this capability.
Organizations Struggle with Split Asset Pools
in Multiple Silos
Asset owners with fund management capabilities
that fit the profile cited above typically have three
pools of liquidity they will look to manage across
their organization—their cash, their high quality liquid
assets (HQLA) and their other securities. Today, those
assets are split across multiple internal and external
facing teams. This is illustrated in Chart 36.
Internal securities lending teams will take portions of
the firms’ HQLA and other securities and put those
assets out on loan to their network of borrowers in
order to earn both the return on the securities and
the return on the reinvestment of the collateral that
comes in against those loans.
In the meanwhile, trade financing teams will
help manage the fund level cash, work with the
organization’s prime brokerage network to ensure
assets to cover short exposures and put out assets to
act as collateral for margin loans. Wherever possible,
these teams will be looking at the asset manager’s
own internalization opportunities to reduce financing
requirements or looking to best direct supplies to
enhance the organization’s return on assets (ROA)
with its key counterparts.
The derivatives clearing organization will be managing
a pool of collateral to post against their obligations
“ Liquidity is the game—we are less sensitive to price than liquidity,”
— Asset Owner—Money Manager
“ Having collateral management in house is flexibility… It’s hard
to profit if you outsource. That’s why we decided to in-house the
securities lending. We used to give 2/3 to our custodian. After
18 months of discussion, we started to do this in house just last
week,”— Asset Owner—Money Manager
Source: Citi Business Advisory Services
Chart 36: Fragmented Approach to Liquidity Management
Securities
Lending
Trade
Financing
Derivatives
Clearing
FX &
Treasury
Asset Leaving Organization
Asset Entering Organization
Cash
HQLA
Other
Securities
ASSET POOL OWNERS