Hedge funds are drastically rethinking the way they recruit new employees as a decade-long production line of trading talent from investment banks has ground to a halt.
Some of the world’s biggest hedge funds, including Man GLG, Brevan Howard and Tudor Investment Corporation, have been forced to design new training programmes because they can no longer count on attracting seasoned traders from Wall Street and the City of London.
US banks culled their ranks of proprietary traders following post-crisis regulation that all but banned them from the often contentious practice of trading and investing for their own profit in an effort to prevent large losses.
Trading used to generate huge profits for investment banks, but since the introduction of the landmark Dodd-Frank act five years ago, this trend has reversed. Goldman Sachs, once renowned for its prop trading prowess, last year reported its lowest total trading revenues since 2005.
The dearth of talent has meant hedge funds, once used to snapping up the best performing prop traders, have been forced to tear up the traditional way of hiring staff.
“Pre-crisis the vast majority of hedge fund hires were ex-bank traders. Today hardly any are,” says Mark Jones, co-chief executive of Man GLG, and who takes part in the fund’s recruitment.
“Joining the hedge fund industry from anywhere other than a bank was a rarity 10 years ago, but the supply from the banks has largely dried up”.
As a result some hedge funds are starting to believe that training up their own talent makes more sense than simply relying on costly hires from their rivals. “It is more expensive to hire established talent, and more hedge funds may soon realise it is a better business proposition to grow talent,” said Mr Jones.
At Man GLG, one of the world’s largest hedge funds by assets, its graduate training programme, which was launched in 2013, focuses on training up junior staff to the point where they can take charge of investing billions of dollars.
Other hedge funds have adopted similar programmes. Brevan Howard, which was itself founded by a group of ex-Credit Suisse prop traders, this year launched its own in-house training programme in response to the lack of suitable candidates coming out of investment banks.
Tudor Investment Corporation, one of the world’s oldest hedge funds, has backed a joint venture with HC Technologies, called LaunchPad, where a small group of rookies will be given the chance to hone their skills making bets on bonds, currencies, commodities and other markets.
“Previously, the industry could largely get a free ride from the training going on at banks,” says Mr Jones of GLG. “Taking on graduate talent is still alien to the average hedge fund, most try to do lateral hires. I believe we are ahead of the curve”.
This new approach to training hedge fund managers comes in the wake of the Volcker rule — named after former Federal Reserve chairman Paul Volcker — which prohibits banks from making speculative bets from their own accounts. The rule is one of the critical provisions of the Dodd-Frank financial reform legislation.
As well as reviewing the way in which they recruit, hedge funds are also having to rethink their relationships with clients.
In the past, investors in hedge funds were wealthy individuals seeking short-term knockout returns. Now, clients are more likely to be a large pension fund or endowment who prefer lower octane, stable returns as they look to diversify their investment portfolio.
Traders are expected to grind out a fairly modest and consistent profit for his or her client, providing large amounts of information about individual trades and reassurances about compliance procedures to jittery pension fund trustees
This means the new generation of hedge fund recruits have to be trained to interact with outside investors, which demands a broader set of skills.
The proprietary trader was once one of the most revered animals of finance. Encircled by flickering trading screens, these near-mythical figures appeared to answer to no one apart from their own profit and loss number, frequently earning the largest bonuses of all investment bankers.
Investors in hedge funds believe that although the prop trader as a species is extinct, the industry will gradually become more comfortable in adopting new ways of recruiting and training staff.
“It is not that there is a dearth of talent all of a sudden,” says Anthony Lawler, a portfolio manager at GAM, an investor in hedge funds.
“It is that learning to trade on a prop desk was just one avenue. The industry will adjust”.
Prop traders struggle to adapt
Helped by their own legend as the archetypes of the modern-day financial “Masters of the Universe”, many of Wall Street’s highest earning proprietary traders raised billions in capital by investors who were confident they could replicate their success at the bank on their own.
But many of those who grew up under the pre-crisis regime have struggled to adapt to trading outside an investment bank.
“We tend to be sceptical about ex-prop traders,” says GAM’s Anthony Lawler. “They are not used to running capital for outside investors, and therefore have a different mentality. They could just allocate a billion dollars to one idea a year, and then sit back. When you are running a fund, you can’t do that.”
Edoma Partners, founded in 2010 by Pierre-Henri Flamand, the former co-head of Goldman’s prop desk, closed down just two years after raising $2bn in one of the most hyped hedge fund launches since the crisis because of poor performance and investor redemptions. Mr Flamand has since joined Man GLG.
Four months later Benros, a London-based fund co-founded by Daniele Benatoff and Ariel Roskis, both ex-Goldman prop traders, closed down after its largest investor pulled out its money.
More recently, a $510m equities hedge fund set up for KKR by Bob Howard, the former chief executive of Goldman’s US equities and credit proprietary unit, shut its doors in 2014.
Mark Jones, co-chief executive of MAN GLG, argues that many ex-prop traders have been successful after leaving banks, but acknowledges that more hedge funds will be forced to look elsewhere for the traders of tomorrow.
“The idea that ex-prop traders can’t make money is wrong, but there is not going to be a return to prop traders coming out of banks anytime soon, in my view,” Mr Jones said.
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