Jon Hitchon outlines recent changes at Deutsche Bank (DB) and reviews the key hedge fund trends tracked by the Global Prime Services business.
HW: What is the current size of the Global Prime Services operation at Deutsche Bank?
JH: In terms of overall revenues, including futures and options clearing, it is approximately USD 1 billion a year. DB finances in excess of EUR 180 billion in balances and in terms of number of relationships, we finance and service in excess of 450 fund complexes.
HW: How would you describe the current growth rate of the business (2005 vs 2004)? Have you met your targets?
JH: We are up 40 per cent in revenues year-on-year and in terms of underlying profitability we are up 100 per cent.
We've exceeded our targets both in terms of top-line profitability and top-line growth.
Management's expectations going forward are fairly aggressive, but on the basis of our run rates for Q4 2005 going into 2006, I am fairly confident of meeting these targets.
HW: What is the breakdown of revenue by region?
JH: Our competitive strengths are very much aligned with the global footprint of Deutsche Bank. In terms of revenue splits, about 20-25 per cent of Deutsche Bank's revenues come out of Asia-Pacific, around 40-45 per cent comes out of Europe and the balance comes out of North America. It's a regionally diverse trading platform, which aligns well with our footprint from a Prime Services point of view.
HW: How is the business structured and who are the heads of the key groups?
JH: In Prime Services we have a Global Head of Prime Brokerage - Mark Haas - he has a number of different groups around the globe catering for both US and international clients.
In terms of Securities Lending, we have just hired a global head named Anthony Byrne, who joins DB from a hedge fund and previously worked with us and also with NatWest. He is well known to us with good derivatives capabilities and will lead an excellent team.
We're moving Jane Hammond from the sales side to the supply side, and she will be coordinating our supply with our lenders both on an agency and principal basis.
On the coverage side we have three regional heads - Lane Hocking, Paul Busby and Ben Sofoluwe - and we are also integrating them into synthetic equity, into trading both on the short and long side. We think there are quite a lot of leverage points there.
Greg Maccafferty runs our Asian (ex-Japan) product, Lane Hocking runs our Japanese product, John Dyment runs our capital introduction team and Frank Nelson handles the sales effort under the direct leadership of Barry Bausano.
The final area is Synthetic Equity, which is broken down by region. It forms the basis of providing innovative financing solutions to our client and optimisation of our inventory.
The Prime Services business is very symmetrical; we have taken an approach where it doesn't matter whether the transaction goes through the synthetic equity or prime brokerage route - the client gets the same leverage and financing levels without internal arbitrage.
The overall risk, whether it is recourse or non-recourse financing, is handled by Fred Bird and his 14-strong highly quantitative team to work out the best solutions for our clients.
The whole team is well-experienced and many have been working with hedge funds over many years.
HW: Your focus appears firmly on being a provider of solutions. Can you provide examples of these solutions?
JH: We pride ourselves on coming up with innovative solutions. We have numerous financing structures within prime services and we focus on looking at one-off difficult transactions, whether it's using cross-margining for bank loans or CDS intermediation, which we are taking to a new level.
For example, I recently spoke to a group with a USD1.5 billion private equity pool. They are looking to securitise that pool, finance it and distribute it out to other third-party investors, which plays very well to our distribution capabilities.
Another example is a firm who is buying a residual lease stub from Bank of America and is looking for a way to finance it - we have come up with a solution for them.
HW: Which market segments are you targeting?
JH: Our goal going forward into 2006, from a strategic point of view, is to be a lot more visible in the European and Asian markets as far as winning new mandates is concerned. If you look at the Bank's value proposition and where it stands in Asia and in Europe, it's a natural shoe-in for us because effectively our banking franchise, our sales and trading franchise and our private wealth management franchise all play extremely well across both emerging markets and established markets ex-North America.
In North America we have always focused on the larger funds. They are a strong referral source and we would much rather go after the 20-30 large players and provide them with smart solutions than focus on catering to smaller funds with a plethora of services.
HW: What about the smaller players in Asia?
JH: We do not need to focus on the smaller players in Asia. What we see in Asia are two trends. Firstly, we're seeing the large US hedge funds and some European funds allocating a greater percentage of their capital into the region. So we have a shift of assets into a region where we already have an intrinsic footprint that is a physical, hard infrastructure as opposed to lots of representatives.
The other trend is being driven from financial institutions, where groups are spinning out with USD 1 billion size funds - as a major banking group we are well placed to tap into these funds through other parts of the group that already have a relationship with these institutions.
HW: Are deal flow sizes going to be maintained and what opportunities do you see going into 2006?
JH: Going into 2006 we will continue to see deal flows of the same scale, but my biggest concern is the tremendous crowding we are seeing in the same types of trades; the barriers to entry are now lower.
However, if you closely examine the short-term swings in the market, relative to funds trying to capture performance each month, they have actually created a short cycle momentum market, and I suspect there is another strategy out there that can go against this trend and make money.
HW: What are you going to roll-out in 2006?
JH: We're going to focus more on the consulting side for the larger hedge funds, particularly with the CFOs and COOs, providing advice or acting as a sounding board. We are treating this as a research product and we are already finding that these COOs and CFOs want more dialogue on issues ranging from corporate finance, though to systems and even inheritance tax planning.
The other area we will focus on is quantitative tools from a securities lending point of view; we think that market is too opaque, there is a lot of demand for much more quantitative and research data not only as it relates to the short side, but also to the long side.
HW: What key trends are you seeing in the hedge funds space?
JH: One key trend is convergence, where on the one hand classical managers, from an asset gathering point of view, are effectively morphing into long only beta and also alpha, and on the other hand you have alpha generators, primarily around the quantitative space, who have started to move into the long only or passive index side.
The other key theme is that there is a lot of competition going on now around private equity and distressed debt, bank loans and work-outs, so there is a cross-over with some of the private equity groups, with a number of activist hedge funds getting involved in this market.
The continuing institutionalisation of the larger hedge funds is the third theme. I do think there are some risks in this move; if you look at some of the large multi-strategy funds that have expanded into risk insurance or energy trading, do they have the wherewithal and capital base do weather any shocks in the system?
HW: How do you cater for these fundamental shifts?
JH: There have been real shifts in the market. There are about 8,000 funds out there and there have been a number of surveys such as the one conducted by Sanford Bernstein on the so-called 'half life' of hedge funds - the average long short fund does not last beyond 2-2.5 years, a lot of the smaller funds are struggling to raise assets and the years of starting with a billion dollar mandate are starting to wane. Institutions are now starting to exercise a great deal of influence on how a hedge fund is constructed.
We look at the hedge funds market from a holistic, Bank-wide view. From a sales and trading point of view, we are pretty much in the top three across all the key asset classes, whether this is rates, credit, currencies, equity derivatives, distressed debt, bank loans etc.
We have a very symmetrical platform, not just from a sales and trading point of view, but also from a financing perspective, so these trends play very well to Deutsche Bank in terms of the financing and the balance sheet. It's a fine balance to ensure we create value-added solutions for our clients versus the wholesale model of simply putting a whole lot of volume through the platform in terms of numbers of accounts.
We have been very consistent with our business model over the past six years, and in spite of all the well-publicised movement of senior managers, it's a testament to the robustness of the Deutsche Bank platform that we are continuing to see very strong growth.
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