Goldman stars fall back down to earth
Of all the Wall Street tribes rendered extinct by the financial crisis, few carried the same symbolism as the Goldman Sachs proprietary trader.
While many financial institutions employed traders to make bets using their own capital, the prop traders of Goldman managed to attain a near mythological status for their ability to make the bank, and themselves, vast amounts of money.
Archetypes of the modern day financial “Masters of the Universe,” the Goldman traders were revered inside the bank for the billions of dollars in profits they generated, and eyed suspiciously by outsiders for their pay packets, along with their potential to generate conflicts of interest with the bank’s regular clients.
But the party was brought to an end by the post-crisis “Volcker Rule” in the US, which effectively banned banks from speculating using their own capital. Scores of these often young, predominantly male, residents of the prop desk were shown the door.
The logical next career step was to continue trading by launching their own hedge funds. Helped by their own legend, many of Goldman’s highest earning prop traders raised billions in capital by investors who were confident they could replicate their success at the bank.
Yet several years on, several of the highest profile hedge fund launches of the alumni of the Goldman Sachs prop desk, referred to inside the bank as its Principal Strategies unit, have not gone to plan.
Last week KKR, the private equity group, closed a $510m internal hedge fund which Bob Howard, ex-head of Goldman’s US equities and credit proprietary unit, was hired to run in 2010, along with a team of traders from the bank.
Industry observers are asking why traders who managed to make consistent returns while at Goldman have struggled when operating within their own hedge funds.
While there is a long tradition of bank traders graduating to become fund managers in their own right, investors in hedge funds are quick to point out that running an investment business requires very different skills from working on a prop desk.
“When you add in regulatory and compliance, and the need to raise money, it is a daunting task,” he says.
The closure of Mr Howard’s KKR hedge fund was the latest in a string of post-crisis hedge fund ventures by esteemed ex-Goldman traders that have shut down.
Edoma Partners, founded in 2010 by Pierre-Henri Flamand, a former co-head of Goldman’s prop desk, closed down just two years after raising $2bn in one of the most hyped hedge fund launches. Mr Flamand, who lost his investors 7 per cent of their capital, cited “unprecedented market conditions” for the closure.
Four months later Benros, a London-based fund co-founded by Daniele Benatoff and Ariel Roskis, both ex-Goldman prop traders, closed down after its largest investor pulled out its money.
One factor hedge fund investors point out as potentially disadvantaging former prop traders who go it alone is the absence of the same quality of information as when they were working in banks. While so-called Chinese walls are in place to stop any bank trader receiving non-public information, more general information relating to trading flows can help traders have a better idea of the direction of markets.
“We always ask them if they will be as ‘in the flow’ as they used to be when running proprietary capital,” says Alper Ince, managing director at Paamco, a California-based fund of hedge funds that selects emerging managers.
Similarly, where once bank prop traders were allowed to run books with high-leverage multiples – meaning that small profits, or losses, were vastly amplified – few investors in hedge funds will permit their managers to borrow at a similar level. This, says one veteran hedge fund manager in London who has never worked on a bank prop desk, can mean traders are unable to make the same returns once they are on their own.
However, most investors agree that the struggles of prop traders who set up hedge funds simply reflect a brutally competitive industry where any mistake is quickly made public, and few manage to stay in business for long. “Whether a new hedge fund will work well is idiosyncratic to each manager,” says Mr Ince. “While many have failed, there are also many examples of very successful prop desk spin-offs which have built strong track records”.
Not all of Goldman’s post-Volcker generation of former prop traders have failed at launching hedge funds. Morgan Sze, another former co-head of Goldman’s Principal Strategies group, raised $1bn in the launch of his Azentus fund in Hong Kong in 2011 and has increased its assets since.
Learning curve
While some of Goldman Sachs’s recent alumni have struggled in setting up hedge funds, the bank has a long record of launching the careers of some of the industry’s most successful managers, writes Miles Johnson.
Och-Ziff was founded by Daniel Och, a former Goldman proprietary trader, in 1994 and has since grown to become one of the world’s largest hedge funds by assets. Ahead of the financial crisis Mr Och took the then rare step of listing the company on the New York Stock Exchange.
Eton Park, another successful US hedge fund, was founded in 2004 by Eric Mindich, who had worked as a proprietary trader at Goldman for over a decade, as did Kenneth Brody and Frank Brosens, who co-founded the Tactonic hedge fund.
Most recently Anthony Noto, who in his role as global co-head of technology banking at Goldman led stock market listings for companies such as Twitter, joined the Coatue hedge fund.
Apart from Goldman, alumni from several other former bank proprietary traders have succeeded in creating some of the world’s largest hedge funds. The British-born Alan Howard, co-founder of Brevan Howard, worked as a fixed-income trader at various banks before building Brevan into managing about $40bn.
However, all of these former prop traders launched before the financial crisis, when investors in hedge funds were more willing to back new managers.
Investors argue that launching a hedge fund in the 1990s was even easier, as there was less competition for good trades and capital.
“It was much easier to launch back in the 1990s, when there were more market inefficiencies,” says Troy Gayeski of SkyBridge Capital, a fund of hedge funds. “Now there isn’t nearly as much low-hanging fruit in the majority of strategies as there was then.”