Today's banking big guns have long since left their old-style private investment ways behind them and moved on to new territories. But now hedge funds are moving in for the kill
George Soros may be more interested these days in his charities and in geopolitics and philosophy than he is in finance. But, like an old sailor, the talent of smelling which way the wind is blowing has yet to completely abandon him.
Last week, Soros Fund Management announced it had hired Steven Mnuchin, the chief information officer at Goldman Sachs until last year, to run a new unit called SFM Capital Management.
Its business: lending money to companies, in particular to ones running into difficulties. On the surface, it looks as if Mnuchin, like many other ambitious young financiers in the past few years, is jumping from banking to the faster-growing hedge fund industry.
But scratch below the surface and a slightly different picture emerges. Mnuchin is, indeed, trading one industry for another but not in the way you might imagine.
In the past 12 months, the mainstream investment banks have been acting more and more like hedge funds. And the hedge funds? They are walking into territory traditionally occupied by the banks. The message: the investment banks are turning into hedge funds and the hedge funds are turning into banks.
Take a look at where the banks are making their money. Merrill Lynch estimated in June that the big four US investment banks, namely Goldman Sachs, Morgan Stanley, Lehman Brothers Holdings and Bear Stearns, had made twice as much money this year from trading as they had from mergers and acquisitions advice, as well as equity and bond underwriting.
In 2002, they made 50% more money from trading than they did from conventional investment banking, according to Merrill Lynch.
Much the same is true in Europe. In July, Deutsche Bank reported a doubling of its second-quarter net income as trading revenue surged. It said that trading of equity products was up 61% and debt trading increased 18%. Likewise, Credit Suisse Group posted its second straight quarterly profit, with its numbers boosted by trading in bond derivatives.
Trading in bonds, equities and derivatives? Isn't that the sort of thing hedge funds do?
At the same time, some of the hedge funds are looking more and more like old-style investment banks. The move by Soros into corporate lending is the most telling example so far. The new business will provide financing to companies and also purchase distressed assets.
But there are other signals of hedge funds imitating banks. They are, for example, fast becoming the crucial players in company takeovers and reorganisations. For example, earlier this year, the US hedge fund Cerberus Capital Management LP played a big role in WPP Group's takeover of rival advertising agency Cordiant Communications Group.
Lending money to firms? Power broking in takeovers? Isn't that the kind of thing banks used to do? What is happening is that old lines that divided one type of institution from another are becoming blurred. The reliance of banks on trading as a way of making money is partly a consequence of the bear market. There has been so little money to be made in M&A advice, IPOs or underwriting during the past three years that traders have risen in importance almost by default. They are the only people left making any money. Not surprisingly, they have become more significant within the banks for which they work.
Yet, at the same time, banks have cast an envious eye at the explosive growth of the hedge fund industry and thought they would like a slice of that action. The banks are moving into hedge fund territory as that is where the money is, and it would be a strange sort of bank that did not want to make as much easy money as possible.
Meanwhile, hedge funds are eyeing up territory that used to be owned by the banks. There are two reasons. Hedge funds have grown so fast, the market has become harshly competitive. When everyone is trading currencies, bonds and derivatives furiously, it becomes harder to make any money. To stay profitable, they have to move on. And they have seen where the action is. Nobody wants to lend to distressed firms right now or risk their own money restructuring companies.
In the financial market, as in most other fields of life, there is usually money to be made by doing the work nobody else wants to do.
Where will it end? After the financial revolution of the past two decades, the biggest gap in the market is for an old-style, private investment bank, or what the City of London used to call merchant banks, owned by partners who would commit their whole careers to one institution and one group of clients. It would provide finance and advice to companies and build up long and mutually beneficial relationships.
The big global investment banks have long since moved on from that territory. A good bet is that the hedge funds will move in, and it is no great surprise Soros should be one of the first to land on that shore. He has been ahead of the game before and may be again.
Bloomberg newsroom, Frankfurt
An ambitious objective
'Something completely new'
'Illusion of control'
Reasons to be cheerful
Total investment reaches £9m