Goldman’s small internal hedge fund

By Felix Salmon
January 8, 2013

When JP Morgan’s London Whale blew up, one part of the collateral damage was the publication of a detailed Volcker Rule. The Whale was gambling JP Morgan’s money, and wasn’t doing so on behalf of clients — yet somehow his actions were Volcker-compliant. And when the blow-up revealed the absurdity of that particular loophole, the rule went back to the SEC for further refinement.

So we still don’t know exactly what will and what won’t be allowed under Volcker, if and when it ever comes into force. We do know, however, that Citigroup is selling off its internal hedge fund, Citi Capital Advisors. If by “selling off” you mean “giving away“: it’s spinning the fund out as an independent entity, to be owned 75% by its current employees. Citi will retain a Volcker-compliant 25% stake, and slowly reduce the $2.5 billion of its own money it has invested in the entity so that the managers can “diversify the client base away from Citi and to build a stand-alone firm”.

It’s incredibly difficult to value a hedge fund, especially a relatively small one without a long track record. The high-water point for such transactions was probably Citi’s acquisition of Vikram Pandit’s fund, Old Lane, in 2007. Old Lane managed $4.5 billion, and was sold for $800 million, but even then the markets appreciated that the buy was more of an “acqui-hire” of Pandit than a fair price for a young and volatile business.

A few years later, Citi was on the ropes and selling rather than buying; that’s when it unloaded its fund-of-funds, Citi Alternative Investments, to Skybridge Capital. Skybridge paid almost nothing up-front for the business, but agreed to remit a large chunk of the group’s management fees back to Citi for the first three years.

Bloomberg managed to find one consultant who valued Citi Capital Advisors, which manages about $3.4 billion, at $100 million. I, for one, wouldn’t buy in at that valuation: less than $1 billion of the assets under management constitute real money, as opposed to simply being a place where Citi parks a small chunk of its balance sheet. And as the Citi funds diminish, the chances of Citi Capital Advisors becoming a profitable standalone entity have to be pretty slim.

Which brings me to Multi-Strategy Investing, a small group of a dozen people within Goldman Sachs, who between them manage about $1 billion. As Max Abelson shows, MSI is unabashedly an internal hedge fund, concentrating on medium-term trades lasting a few months. (The idea is that if positions are held for longer than 60 days, that makes them Volcker-compliant.)

Abelson finds a lot of illustrious alumni of the MSI group; maybe the bank is keeping it on just for nostalgia’s sake. Because I can’t for the life of me see the point of it. Goldman Sachs has a trillion-dollar balance sheet; the $1 billion it has invested in MSI is basically a rounding error. And by the time you’ve shelled out annual bonuses to a dozen high-flying Goldman Sachs professionals, the contribution of MSI to Goldman’s annual profits has to be downright minuscule. (Let’s say the group generates alpha of 5%, or $50 million per year: that doesn’t go very far, split 12 ways at Goldman Sachs.)

Clearly, with a mere $1 billion under management, MSI doesn’t present Goldman with much in the way of tail risk. But by the same token, this really doesn’t seem like a particularly attractive business for Goldman to be in. As Abelson says, Goldman’s own CEO is adamant that the bank doesn’t make money trading for its own account: everything it does has to be for clients. Under that principle, MSI shouldn’t exist. And the profits from the group simply can’t be big enough to make it worth the regulatory and reputational bother.

Goldman should take a leaf out of Citi’s book, here, and spin MSI off as a standalone operation, if necessary retaining a 25% stake. If its principals can make a go of it, attracting real money from outside investors, great. If they can’t, no harm done. Alternatively, Goldman could just shut down MSI entirely, and put its valuable employees to work helping the bank’s clients, and making money that way. Either way, there doesn’t seem to be any point to keeping this small fund going as is.

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While I can’t comment on MSI directly having never laid eyes on the group before this blog post I can say that banks would serve society and their customers well if they could do some very risky things.

Dig back into the Citigroup “Philbro” issue… I might be spelling that wrong from memory. Basically some guy there saw a massive opportunity to buy literally boatloads of oil at spot rent and insure supertankers to hold it all and sell it forward earning Citi hundreds of millions of dollars. Some called it speculation of the worst kind, worst still because it was done by an FDIC insured bank.

Pretty valuable though… it sent a price signal to the market that the market could respond to. Refiners, airlines, trucking and train companies all got to lock in oil and get cost clarity. Tanker companies were happy to have their boats leased. Who got hurt? Since most of the trade was hedged the minute the oil was bought there really was not very much risk. There was an is an economic interest in smoothing out swings in oil prices.

I don’t see why big banks can’t play in that or any other space if they can be regulated and well capitalized. Totally different ballgame but look at Beal bank. They basically loan to own buying up everyone elses failed deals. It’s litterally a FDIC insured private equity fund… it works though and I think they are the best capitalized bank in the country (because the regulators demand it.)

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