Hedge funds/ asset managers continue to find opportunity in capital markets and shadow banking

Citadel announcing this week that they will become a dealer of US treasuries becomes another proof point that hedge funds continue to take on sell-side market making activities filling a growing liquidity void in credit and loan products. Although Citadel has no desire to become a primary dealer at this point, it will hold substantial dealer inventory to meet client demands. Citadel’s broker dealer arm will handle this business as it already does with equities and FX. This continues the trend that as Western banks both in the US and Europe are required by regulators to reduce their balance sheets, hedge funds, asset managers will continue to full fill the supply side of this demand vacuum. We already see this as an increasing number of hedge funds are building portfolios of syndicated loans, private equity and real estate. Also a few hedge funds have started the securitization of mortgages and loans even to the point of securitizing and packaging “peer-to-peer” debt. The main point is as bank balance sheets shed high demanding RWC products, hedge funds and asset managers will move into supplying these products. Increased liquidity will be provided and an increase of revenues for hedge funds and performance returns for asset managers. But at the same time regulators will increasingly focus on these “shadow banking” activities, demanding hedge funds and asset managers to up their game managing market, credit and operational risk. This is all good but also means hedge funds and asset managers will need to continue to upgrade operations and systems in order to satisfy client and regulatory transparency demands. As one business shrinks another’s grows. For more on shrinking balance sheets see Oliver Wyman’s The Wholesale and Investment Banking Report.