In Europe, Hedge Funds Compete For Assets While Dealers Compete For Hedge Funds, Greenwich Study Finds

Competition is intensifying among European hedge funds trying to attract investor assets and among prime brokers fighting for hedge fund business, according to new research from Greenwich Associates. Greenwich Associates' 2005 European fixed income study suggests that a growing number

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Competition is intensifying among European hedge funds trying to attract investor assets and among prime brokers fighting for hedge fund business, according to new research from Greenwich Associates.

Greenwich Associates’ 2005 European fixed-income study suggests that a growing number of European hedge funds are relying on the capital introduction services of their prime brokers as a source of capital, as well as increasing their leverage ratios and boosting their trading volumes in an effort to achieve their target returns. At the same time, dealers are lowering credit quality requirements for collateral on their hedge fund repo business.

“These shifts together reflect a level of heightened competition between hedge funds and among the prime brokers and dealers that service them,” says Woody Canaday, a Greenwich Associates consultant.

When it comes to choosing a prime broker, hedge funds consistently report that their most important selection criteria are client service, trading capabilities, and financing/repo capabilities, the report found. But from 2004 to 2005, the proportion of hedge fund respondents citing capital introduction as an important factor in evaluating prime brokers doubled from 7% to 14%. “This shift clearly indicates that, as hedge funds proliferate in Europe, individual funds are having a tougher time attracting new capital,” says Greenwich Associates consultant Frank Feenstra. “This competition for assets is making it harder for hedge funds to build and even maintain assets under management, which in turn could be prompting them to increase leverage ratios and to trade more aggressively.”

European hedge funds increased their fixed-income trading activity last year as the typical fund turned over its portfolio three times, increased its leverage ratio and forged relationships with new fixed-income dealers.

“The average European hedge fund portfolio manager traded $6 billion in fixed-income securities in the past 12 months, as opposed to the $5 billion average reported among all the European fixed-income investors interviewed for this year’s research” says Peter D’Amario, a consultant at the Connecticut firm. “In order to generate trading volumes of that order, however, the typical hedge fund portfolio manager had to maintain turnover ratios twice that of other fixed-income investors.”

Hedge fund trading volumes are receiving a boost from increases in leverage ratios. In 2004, about 23% of hedge funds in Europe reported leverage ratios higher than three; in 2005, that proportion approaches 49%. Trading volumes also benefited from a market wide pick-up in the trading of government bonds, which represented almost half of hedge fund trading flows over the past 12 months.

Dealers are lowering credit quality requirements for collateral on their hedge fund repo business. In 2004, more than 45% of dealers refused to accept collateral of lesser quality than government bonds or agency securities; this year, nearly 70% of dealers are accepting collateral of lower credit quality. At the same time, the proportion of dealers listing below-investment grade bonds as the lowest quality of collateral that they would accept increased from 11% to 38%.

“The relaxation of collateral credit standards is a sign that dealers are becoming more aggressive in their competition for hedge fund business,” says Greenwich Associates consultant Giovanni Carriere.

Greenwich Associates asked its 2005 hedge fund research participants a series of questions concerning registration and compliance. Nearly 85% of hedge funds in Europe are registered with at least one regulatory authority, as opposed to just 57% of U.S. hedge funds. In both markets, large funds are the most likely to have registered. In Europe, for example, more than 90% of managers trading volumes between $1 billion and $10 billion say that their funds are registered with regulators.

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