Q&A: Asset Alliance CEO Says Prop Trader Talent A Boon For Hedge Funds

Aug 10 2010 | 1:33pm ET

With Wall Street banks facing new regulations that will severely curtail their prop trading businesses, many talented traders are weighing their options. One obvious route—start or join a hedge fund. But while it sound simple enough, not all traders are cut out to run a business. Bruce Lipnick, chief executive officer of Asset Alliance, an alternative investment firm that specializes in acquiring, seeding and growing hedge funds, explains the trend and tells us how the hedge fund industry will benefit.

Can you briefly explain the trend of traders leaving banks for hedge funds?

What we’re seeing is that Wall Street firms are changing some aspects of how they do business, and that is spurring more traders to leave the major banks and consider hedge funds. We’ve seen reports that Goldman Sachs is moving a good number of its proprietary stock traders into its asset management division.  Citigroup is reportedly spinning off some proprietary trading business into a separate hedge fund group. These movements suggest that being a trader at a large bank might not be as lucrative or stable as it once was.

What are some of the main factors behind the trend?

One of the main catalysts is the recently passed financial reform law in Washington. This law limits the amount of proprietary trading and investing in hedge funds that banks can do, bringing them closer to a purely commercial model.  At the same time, the big banks are reducing lines of credit for traders and making overall cutbacks to their trading businesses.

Before the financial crisis, being a proprietary trader for a major bank was a somewhat “easy” business, with unlimited capital and a good 20-30% of the trading profits. Why would a trader want to go anywhere else? Now, in the post-crisis environment and given the new legislation, there is a sense that traders are being pressured to leave, if not downsized all together, and/ banks are being forced into a non-trading business model. Furthermore, the hedge fund space is offering competitive compensation plus autonomy. At boutique operations such as Echotrade, traders can receive as 50% -- or as much as 60% - of trading profits if they’re putting up some personal capital.

How will this trend affect the hedge fund industry?

One major effect is that the hedge fund space now has more access to a large pool of trading talent that it wasn’t really reaching before. There are some highly skilled and experienced traders at the major Wall Street banks – it’s not a coincidence or secret that prop trading has long been one of the more lucrative businesses for Wall Street. 

Today, given the pressure that big banks are under, more traders are receptive to the idea of joining or starting their own hedge fund, which would essentially become their own private business – a chance to build equity with their talent. This means we could see more emerging hedge fund managers in need of capital, and investors will have the opportunity to invest with hedge fund managers who formerly traded the capital of some of the world’s largest banks.

What challenges and/or risks might this trend present?

The main challenge is how successfully a trader can convert themselves into a hedge fund manager. Trading and running a business are two different things, and it isn’t always that easy to make the transition. Start-up hedge funds require capital, as well as help with distribution, compliance and product development.  It’s possible that many traders just want to trade – it’s what they do best – not necessarily worry about marketing their funds, managing overhead and building their platforms or working directly with limited partners or institutional investors.

How do you anticipate investors responding to this movement?

A lot of how investors respond will depend on how well traders make their transition, who they partner with in order to create a hedge fund that is in line with institutional investment standards. Investors require even emerging hedge fund managers to have a certain amount of infrastructure and processes in place before investing capital. That said, investors will also likely view this trend as a unique opportunity to potentially participate in what was previously a highly profitable, inside business for the big banks. 

How do you see this trend evolving in the future?

My sense is that we will continue to see movement. There is an opportunity for the hedge fund industry to attract a substantial amount of new talent and develop emerging managers to help fill the growing demand for alternative investments. I believe that good traders can be converted into successful hedge fund managers, and that they will increasingly see value in building equity in their own fund. Meanwhile, the big banks are trying to figure out how to keep their lucrative proprietary trading business while complying with the new financial reform law. They have a limited amount of time to find a way to keep participating in this space, and we should expect to see more news on these plans in the months to come.


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