Janet Lewis at Investment Dealers’ Digest expounds on the complicated relationship between hedge funds and investment banks. To investment banks, hedge funds are both their best clients and their most innovative and fierce competitors. The growth in assets under management now allows some hedge funds to compete on an equal footing.

“In some respects, hedge funds are now to the brokerage firms what the brokerage firms were to the commercial banks 20 or 30 years ago,” says Brad Hintz, a financial institutions analyst at Sanford Bernstein. “They are light on their feet, profitably trading with different parts of the brokerage firm and playing one firm against another.”

Investment banks have changed the way they are organized and do business to position themselves most favorably with hedge funds. From prime brokerage, equity and fixed income research, and advisory investment banks feel the pressure to capture hedge fund revenues. Apparently it is challenging to coordinate all this work across the bank.

Figuring out how to best coordinate all these different types of activity is tricky. “They operate across markets and up and down the capital structure,” says the head of hedge fund relationship management at a US universal bank. “It’s challenging from a coverage point of view.”

Hedge funds have become fierce competitors with investment banks in many lines of business. This has lead to a hot market for talent as well. The Stalwart notes one reason why investment banks are paying out such huge bonsues this year. They fear defections to hedge funds and hope that these payouts can slow the exodus to the world of 2 and 20.

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