Hedge funds have been the acknowledged kings of Wall Street for some time. Despite their poor performance in October there is rash of evidence that they will not be dethroned any time soon.
Gregory Zuckerman and Ian McDonald in the Wall Street Journal report that many large, high profile, hedge funds are taking steps to avoid SEC registration as investment managers. This effort may undermine the SEC’s effort to regulate the industry.
The fund firms are doing this a loophole the SEC left in their regulations. By extending their ‘lock-ups’, or the amount of time an investor is required to keep their money in a particular fund, the hedge funds are able to bypass registration altogether. The loophole was put in originally to keep private equity and venture capital firms out of the SEC’s reach.
“We have seen a rise in the number of firms asking for two-year lockups and the driver of that is probably the SEC requirements,” says Thomas Schneeweis, director of the Center for International Securities and Derivatives Markets at the University of Massachusetts. “If you can pull it off, let’s face it, you’d do it.”
The anticipated flood of registrations has not yet hit the SEC. This is due in part to these adjustments as well as good old-fashioned procrastination. It is unlikely that Wall Street firms care one way or another, because hedge funds have become such a large part of their businesses.
Michael Scotti in Traders magazine reports on the growing influence of hedge funds on Wall Street. The article is interesting in large part because it attempts to measure the extent of hedge funds’ growing importance.
How important have hedge funds been over the last few years? “They are the life blood of our industry,” commented one brokerage firm executive. He added that it has been hedge fund trading that has kept many firms in the black in recent years. “They kept us afloat.” Other executives agreed. “Where would institutional equity trading be today without hedge funds?” asked one executive. He pointed out that, in recent years, the order flow from traditional money managers has declined dramatically from the heyday of the late-90s. Also, some of these same institutions have cut their commission rates, due to regulatory and board pressures. These factors have forced them to take a backseat to hedge funds at brokerage firms.
Hedge funds have influenced a wide range of services that Wall Street firms offer. From trading, technology, research and securities lending. Although it is estimated that hedge funds now make up 30% of equity volume, securities lending is where Wall Street makes a lion’s share of its profits from hedge funds.
Hedge funds have changed Wall Street in that they have become the dominant pools of liquidity:
Today’s hedge funds are acting much like the Nasdaq wholesalers of the 1990s. So says Rob Hegarty, who heads the consultancy Tower Group’s securities and investments practice. The primary reason is that hedge funds are huge engines of liquidity. “They are trading for different reasons, but they are providing capital, taking on positions and creating tremendous turnover like the Troster Singers and the Mayer & Schweitzers used to,” Hegarty said. The difference, however, is that hedge funds are not required to make two-sided markets, which gives them the benefits without the burdens, he added.
How long hedge funds continue to dominate is an open question, however smart investors are always thinking about how to take advantage of changing circumcstances. Roger Nusbaum writing at RealMoney.com notes that there will soon be an ETF that tracks the returns on the brokerage sector. State Street Corp. (STT) has filed an application with the SEC for an ETF on the Keefe Bruyette Woods Capital Markets Index (KSX). The health of Wall Street is now ever more entwined with that of hedge funds. This ETF is one way investors can make a bet on the resilience of the hedge fund boom.