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Tim Quast
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November 8, 2005

Hedge Funds to the Rescue: The Growing Influence of Hedge Funds on Wall Street

By Michael Scotti

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  • Hedge Funds to the Rescue: The Growing Influence of Hedge Funds on Wall Street

Love em or hate em. No one can deny the impact that hedge funds have had on the institutional equities business in recent years and will continue to have. That influence was subtly highlighted only last month when mutual fund giant Fidelity Investments named Brian Conroy, a hedge fund executive and former head trader at SAC Capital Management, to oversee its equity trading department. To be sure, Conroy was a well-respected Wall St. veteran-Goldman Sachs and J.P. Morgan-before moving to the hedge fund world. But the hire may indicate that the normally insular Fidelity is open to new equity trading ideas, possibly even opportunistic ones.

"That's a big statement," said one brokerage firm executive commenting on the hire. He wondered if Fidelity was looking to become more aggressive in its trading style, adding that he found it interesting it hireda person without mutual fund experience.

Separately, Janus Funds last month announced plans to move to performance-based management fees, which is a page right out of the hedge fund playbook. Granted, the money manager's upside for beating its respective bogey is a mere 15 extra basis points-not exactly the eye-popping 20 percent of the profits that hedge funds normally receive. Still, the concept forces an alignment of the shareholders and the manager's interests. That's similar to the relationship between hedge funds and their investors.

The Life Blood

How important have hedge funds been over the last few years? "They are the life blood of our industry," commented one brokerage firm executive. He added that it has been hedge fund trading that has kept many firms in the black in recent years. "They kept us afloat." Other executives agreed. "Where would institutional equity trading be today without hedge funds?" asked one executive. He pointed out that, in recent years, the order flow from traditional money managers has declined dramatically from the heyday of the late-90s. Also, some of these same institutions have cut their commission rates, due to regulatory and board pressures. These factors have forced them to take a backseat to hedge funds at brokerage firms.

"I would bet that the long-only volume from the traditional managers is about a quarter of what it was in 2000," estimated Seth Merrin, CEO of Liquidnet, a brokerage firm that electronically matches orders on buyside trading desks.

Consequently, many believe that the relationship between the traditional buyside shops and the full-service brokers has been altered due to economics: Research and trading are expensive to operate. And when full-service brokers analyzed the amount of high-touch services required by their long-time institutional accounts-clients who had just undergone a belt-tightening-they saw that hedge funds offered higher margins.

"I think the traditional long-only funds were the kings of the Street and got whatever they asked for," Merrin said. "They were the primary revenue generators."

According to Brad Hintz, a brokerage analyst at Sanford C. Bernstein, hedge funds are the fastest growing-and most profitable-segment of the asset management industry. With about $1 trillion in assets, they have expanded at a 17 percent compounded annual growth rate over recent years.