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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
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Any losses incurred on a position taken by the liquidity
management team would be absorbed by that unit.
For more service-oriented tasks like FX collateral or
cash management, some firms utilizing this model
would charge a small fee to the asset owners that
would be added to the group’s P&L. The incentive in
these organizations was to maximize the use of the
asset owner’s supply and generate the most potential
profit. Effective cash management was seen as a
“hook” to help incent asset owners to place their
supply into the program.
In other organizations, the liquidity management
unit was run as a utility. FX collateralization and
cash management were provided free of charge and
all of the profits generated by the securities lending
team accumulated back to the asset owner. In these
organizations, there was an increased emphasis
placed on the efficiencies to be gained by co-locating
the cash coming in from the securities lending with
the broader pool of trading-related cash to be
managed. There was less emphasis placed on the P&L
of the trading portfolio. The two models—for profit
and utility—are shown in Chart 39.
In both the for-profit and utility model, the services
of the liquidity management team were voluntary.
No portfolio manager was required to place their
supplies into the program and, if a portfolio manager
so desired, they had the option of using some services
and excluding others. Thus, the relationship the
liquidity team could build with the portfolio managers
proved to be a key success factor.
Liquidity Management Unit Faces
Counterparty & Risk Challenges
Rather than being seen as competitors to bank
lending organizations, these liquidity management
teams were instead seen as important counterparts.
Indeed, these teams often worked extensively with
the bank lending teams as they leveraged off of
the organization-to-organization relationship. This
often proved easier than trying to trade directly with
counterparties that would otherwise be seen as peers
in the asset management space.
Free of Charge
Efficiently Use
Collateral
Service Goal
Generate Over
Performance
Fees &
Revenue Split
Cost Model
Source: Citi Business Advisory Services
Chart 39: Governance Options for Liquidity
Management Unit
Firm Utility
Profit and
Loss Center
“ We are building a cheapest-to-deliver model. Authority
and decision-making around collateral sits in one spot,”
— Asset Owner—Money Manager
“ In the past, we were different teams split between liquidity
management and securities lending. It made sense to
combine the two, and with OTC derivatives there is a
lot of cash coming in. This allows us to get the benefit
of the securities lending performance and the cash,”
— Asset Owner—Money Manager
“ Our securities lending expertise has allowed us to build
confidence with our managers and get them comfortable with
passing over responsibility to us to optimize their cash and
derivative transactions. This helps them value our team beyond
the millions we provide to any individual fund which can really be
seen as noise,” — Asset Owner—Money Manager
“ We aggregate up all the P&L and then allocate
it back to the underlying beneficial owners as
part of our revenue share arrangement. We
cover the indemnity to them through this
revenue share. It is easier to attribute the P&L
for securities lending which settles monthly. It
is harder to do for repo which accumulates,”
— Asset Owner—Money Manager
“It’s up to the portfolio manager on how they want
to use the group’s services. They can do any
piece. They can use us for our FX services and
keep their securities lending or they can decide
any combination,” — Asset Owner—Money Manager