Alpha - September 2007 - (Page 26)

Barry Bausano Hedge funds are among banks’ and brokerage firms’ most coveted clients. When times are good, prime brokers line up to loan hedge funds money and securities and to help them expand their businesses. But in unstable market conditions, like the recent subprime meltdown or the 1998 collapse of hedge fund Long-Term Capital Management, prime brokers can be quick to cut off funding rather than jeopardize their own businesses — a move that can spell the end for ﬁrms like Sowood. Few people in the prime brokerage industry know the hedge fund side of the business better than Bausano does. After graduating from Harvard University in 1985 with a BA in economics, Bausano began his career as a fixed-income trader in the New York office of Kidder, Peabody & Co. In 1991 he moved to Robertson’s Tiger Management, where he worked as head trader for fixedincome and currency derivatives. Two years later he joined David Gerstenhaber, his former boss at Tiger, to help launch Argonaut Capital Management, a $400 million macro hedge fund. But after the fund fell more than 25 percent in the first eight months of 1994, Bausano left to go to New York–based Steinhardt Partners. He spent two years there as an international macro portfolio manager before decamping to Bacon’s Moore Capital Management in London. In 1999, Bausano left Moore Capital and returned to New York, where he — BARRY BAUSANO, founded Red Wolf Capital CO-HEAD OF GLOBAL PRIME Management, which ran the FINANCE, DEUTSCHE BANK $100 million Credit Suisse First Boston Macro Strategies Fund. In August 2002, Bausano wound down the fund, which was due to mature at the end of that year, and joined Deutsche Bank as global head of hedge funds, where he was responsible for identifying hedge fund client needs and selling solutions from Deutsche’s suite of products. The big German bank had launched its prime brokerage unit only three years earlier. Jonathan Hitchon, who now co-leads prime brokerage with Bausano, and James Rowen, who subsequently defected to SAC Capital Advisors, built the business from scratch, leveraging Deutsche’s strength in swaps and other derivatives products. “Sophisticated players spend a lot of time thinking about price behavior, volatility and correlations of the assets we hold in hedge fund portfolios,” says Bausano, pointing to the more than 30 Ph.D.s seated just outside his office glued to computer monitors, looking for red flags. Deutsche’s army of quants comb through portfolio after portfolio looking for signs of trouble in asset quality, collateral amounts, asset concentrations, strategy changes and other critical measures to help define the terms of margin lending for each hedge fund. For their part, hedge funds have learned that relying too heavily on any one prime broker can be disastrous. In the aftermath of LTCM’s 1998 collapse, prime brokers, afraid that other managers pursuing fixed-income strategies could suffer a similar fate, marked down portfolios, forcing several hedge funds to sell positions at bargain prices to meet margin calls. Among the victims were Eagle Capital Management in Bloomington, Minnesota — which closed its doors soon after; Old Greenwich, Connecticut–based Ellington Management Group; and New York’s MKP Capital Management. MKP and Ellington ﬁled lawsuits against their prime brokers, seeking damages for what they alleged to be the forced liquidation of their portfolios; the cases were eventually settled out of court for undisclosed amounts. To protect themselves from being squeezed, many hedge funds have been trying to negotiate better terms with their prime brokers, as well as look for other sources of ﬁnancing. “In the past few years, the most savvy hedge funds have moved away from their dependence on prime brokers for financing,” says Brian Cornell, managing director at $14.6 billion fund-of-hedge-funds ﬁrm Mesirow Advanced Strategies in Chicago. “They have either made long-term agreements with prime brokers that require significant lead time to affect any changes in the terms or have gone to main street ﬁnancing to come up with permanent or semipermanent capital.” Bausano, for his part, says that the relationship between prime brokers and hedge funds has matured into something of a partnership, where ﬁrms like his are more attuned to managers’ strategic management of their liabilities. “Most successful hedge fund managers do constant, intense risk analysis, including assessments of volatility, leverage and liquidity,” he says. Despite the recent market troubles, Bausano thinks that the hedge fund industry is positioned for long-term growth, particularly as more and more pension funds increase their allocations to alternative assets. Alpha Senior Writer Frances Denmark recently sat down with Bausano in his New York ofﬁce to discuss the relationship between prime brokers and hedge funds during turbulent times. Alpha: How have the recent shocks in the markets affected hedge funds and their relationship with their prime brokers? Bausano: I think the overall environment for hedge “If pension funds all achieved a 10 percent allocation to hedge funds, industry assets would more than double.” funds is better today than in 1998, when Long-Term Capital Management got into trouble, and the industry is more sophisticated. Market conditions are much better now in terms of the underlying growth rate in the economy, corporate earnings and capitalization to the banking system. The industry has better risk management and operational infrastructure designed speciﬁcally to support distressed situations. Additionally, we’ve already seen immediate and unequi- 26 • INSTITUTIONAL INVESTOR’S ALPHA • SEPTEMBER 2007

Table of Contents Feed for the Digital Edition of Alpha - September 2007

Contents Letter from the Editor Longs & Shorts Pension Corner: Keeping the Faith The Good Guys: Going Public Interview: Barry Bausano - A Delicate Balance Cover Story: Cruel, Cruel Summer Profile: Phil Cooper - Alternative Flight Plan Strategies: Marshall Wace - TOPS in Its Field Profile: Fortis Investments - Banking on Alternatives Research Center: Top Equity Trading Firms Alpha Bytes: Desktop Duel Unhedged: Commentary - The Taxman Cometh

Alpha - September 2007

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