Citigroup is moving ambitiously on a number of fronts. Aside from changing the leadership at Tribeca, the bank is in negotiations to buy at least a stake in Amaranth Advisors LLC, the hedge fund that has lost about $6 billion since the beginning of the month, mostly on bad natural-gas bets. The talks could fall apart, but if Citigroup takes a stake in Amaranth, it would mark the bank's latest effort to expand its alternative-investment business, which includes hedge funds, private equity and real estate.
So should bulges get into hedge funds? Yes and no. As the Journal article points out, they certainly have the high net worth and institutional customer base locked down. On the other hand, they have too much bureaucracy and overhead to be nimble. Furthermore, the truly great managers know that they can get their own client base and open up shop without restrictions. Thus, banks can wind up serving as breeding grounds for mid-level PMs to polish their skills before taking the client base over to their own funds.
What may be a better idea is to have a more involved joint back office (JBO) arrangement where the bank supplies the infrastructure, clients, and some amount of proprietary capital, and in return takes a bigger cut of the profits and imposes certain return/alpha hurdles that the fund must meet in order to continue the relationship. So long as the hurdles are met the bank stays completely hands-off and lets the fund run its strategy as it sees fit. If performance is not in line with expectations, however, it may either step in or terminate the relationship – assuring that there’s a floor to its losses. The bank may further hedge its risk by entering into JBO agreements with funds that are negatively correlated in their strategies and/or sectors.
In any case, just my thoughts – would love to hear some comments on the feasibility and profitability of such an arrangement.
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