Will the Volcker Rule Crush Banks' Hedge Fund Businesses?

Includes: KBE, KRE, XLF
by: The Business Insider

On Friday, after it was announced that under the proposed financial reform bill banks could only invest 3% of their capital into hedge funds, John Carney at CNBC argued that in fact this would prove to be a massive boon to the banks. For one thing, banks are mainly interested in hedge funds for the management fees, not so much for the upside appreciation directly

The new limit will now give the banks an excuse to reduce the amount of capital they commit to a hedge fund, which was mostly done to convince clients that the banks had "skin in the game." In fact, banks were being forced to commit more and more money to the funds to compete against other funds.

At Goldman Sachs (NYSE:GS), for instance, some hedge funds were pitched to outsiders as very attractive because the company and its employees were the largest investors in the fund.

But it turns out, the 3% limit is only part of the equation.

Chris Kotowski at Oppenheimer describes the rule thusly:


The bailout ban obviously should remind you of Bear Stearns and other firms, who were forced by the market to bail out internal hedge funds. Obviously the market had the expectation that these firms would step in for a bailout. If banks are banned from these bailouts, that would seem to take away one of the selling points of a bank-sponsored hedge fund. The bank's backing basically means nothing, and offers no more security than a hedge fund run independently.

An investor choosing between various funds must ask: okay, what's so great about this bank-sponsored hedge fund?

So while the 3% limit has its advantages, one major selling point is gone.

Disclosure: No positions

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