Nicholas Roe outlines the reorganisation of London-based Deutsche Bank's Global Prime Services unit, reviews key trends in 2004 and looks ahead at 2005.
HW: What was the key trend in the hedge funds market in 2004?
NR: There were no particular strategy cyclical trends during 2004, everyone performed well in January and February, and then volumes and volatility flat-lined.
The most dramatic change to any one strategy was in the convertible arbitrage sector. During the months of March-August volatility 'dried up' coupled with no new issuance causing US-based funds and most Europeans to rethink their future.
There are only about 12 convertible arbitrage funds left in Europe, many funds closing during May-July. Outside of the US the view of the investors was that they had taken their exposure down from 12% on average to 5%, in the US they were looking to go below that.
Some of the larger longer established funds are banking on volatility returning in 2005. We're seeing some expectation of that in new funds launches, with at least 4/5 companies looking to launch convertible funds next year.
In the last quarter, due to the dramatic increase in corporate and investment banking activity, risk arbitrage and event driven strategies had the best quarter for a couple of years, with the S&P hedge fund index reporting a quarter of 3.66% on average for event driven funds.
HW: What is the impact of trends such as these on the prime brokerage space?
NR: As per the Eurohedge market share tables in April 2004, Deutsche Bank was the largest prime broker for arbitrage strategies so you would expect some impact, however, our business and the larger funds are diversified enough to protect themselves against the cyclical nature of these markets. Convertible arbitrage funds have become credit, capital structure and high yield managers and we have been able to add enormous value in these areas, especially now we have merged global markets and equities within the group. Had this happened several years ago when there was less depth in the hedge funds it would have had more impact.
When these larger funds have looked to diversify their strategies we have been the prime broker of choice, expanding our market share with the largest hedge funds globally. When Deutsche Bank entered the Prime Brokerage/Equity finance market we looked at areas where we could really add value and we focused on providing extra depth in securities lending, cross-margining, access to a wide variety of derivative products, and putting together the whole finance package for 'one stop finance' rather than just prime brokerage in isolation. Managers want their prime brokers to 'deliver the firm'. That has been our value proposition.
The challenge for us going forward is to continue to 'add value'. We've seen a number of the more established Global prime brokers - Lehman Brothers, Merrill Lynch, Bear Stearns, Credit Suisse First Boston - who only really gained momentum in the past two years in Europe - now have products in Europe competing on price alone.
HW: What is your edge in what appears to be an increasingly crowded market?
NR: The one thing we feel the market hasn't achieved is true consolidated finance and execution across all asset classes.
We have merged our Equities and Global Markets divisions to put us in a position next year to offer consolidated prime brokerage across foreign exchange, equity derivatives and derivatives clearance among all asset classes. Prime Brokers have traditionally occupied the 'middle space', it helps us enormously now that they are together, not just in terms of economies of scale but also in delivering the full scope of products to our client base in delivering the investment bank.
We know that the larger global funds don't distinguish between equity and fixed income, they are looking at a complete package.
HW: When will you be in a position to offer this consolidated package to the market?
NR: We are well advanced with our plans and we are budgeting to offer this in Q2 2005.
HW: What does this mean for funds of hedge funds?
NR: We have an array of products to suit funds of hedge funds, and any other investor, we offer the flexibility of access to a variety of hedge fund products coupled with some very powerful multi-layered reporting with a commercial strength risk platform, DB Risk Office, unique in this space.
HW: On the subject of Chinese walls and transparency, is regulation now in danger of impeding the growth of the business?
NR: We face constant questions about the extent of leverage and transparency across our hedge fund clients. It's all about "Do you see everything and can you put your hand on your heart and say you see the complete picture?"
At the end of day, we have to look at what we as a bank can control, and that is limited to the amount of business a hedge fund manager designates to us. It is the duty of the prime broker to ensure their credit support and exposure management is comprehensive, and the prospective investors looking to allocate should do due diligence to ensure that the Prime Brokers have all the processes supporting risk and margin management watertight.
HW: What do you see as the key growth areas/trends in 2005?
NR: The growth areas for us in Europe will be hedge funds launching leveraged long only funds, long short funds and long short strategies with a specific sector focus, credit related and high yield strategies.
Our ability to offer the whole equity finance package together with research and execution, is steadily giving us increased market share in this sector, with recent wins including Cazenove, Jupiter, F&C and Gartmore.
The trend towards consolidation will continue in 2005 - we already know of at least 10 funds of hedge funds that are being bought out or are looking for mergers/acquisitions.
Increased competition for prime brokerage business will also be a feature of 2005 - it seems that traditional prime brokerage is too high a barrier for many institutions who are offering synthetic prime brokerage.
Automatic execution/direct market access still has a 12 -24 month lifecycle in Europe. We're not quite seeing the race to the bottom that we saw in the US.
The consolidated finance and execution package that we will offer early in 2005 will separate us from our competitors, offering our clients one-stop solutions that they will not be able to get elsewhere. We are currently conducting intensive staff training to ensure the smooth roll-out of the package.
We will be distributing a lot more global markets products and we will continue to focus on our larger and strategic relationships to find ways in which we can add value and continue to delivering the entire Deutsche Bank package.