1. Are Hedge Funds Shadow Banks?
Douglas Shaw
COO Fundamental Equity, BlackRock
April 2011

2. Yesterday’s risk dispersion is today’s shadow banking
What is a Shadow Bank?
Poorly defined:
SIVs
GSEs
Finance companies
Credit hedge funds
Securities lenders
Levered loan funds
Money market mutual funds…
Maturity and credit transformation
Yesterday’s risk dispersion is today’s shadow banking

3. Hedge Fund Industry 1990 – 2010
Source: HFR 2010 Report

4. Recent flows have favoured the larger funds
Source: HFR 2010 Report

5. Banks might be, but hedge funds are not too big to “fail”
Source: HFR 2010 Report
Hedge funds frequently “failed” – few people noticed!
No burden on taxpayers

6. Source of Hedge Fund Borrowings – September 2010
Source: FSA HFS
Source of funding means counterparties have much protection against hedge fund failure

7. Credit Transformation
Banks bundling mortgages, tranching & selling them
Especially the risky mortgages
Complex & Befuddling
investors
regulators
rating agencies
insurers
even banks themselves
Hedge funds were the early warning system
shorted into the bubble
presented to G7 Philadelphia 2007
“The Big Shorts”

8. Huge expansion of banks’ balance sheets heralded the financial crisis45 40 35 30 25 20 15 10
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q2 2002
Q4 2002
Q2 2003
Q4 2003
Q2 2004
Q4 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Q4 2008
Q2 2009
Q4 2009
Q2 2010
BoA
Citi
JPM GS ML MS
Huge expansion of banks’ balance sheets heralded the financial crisis
Source: Bloomberg

9. Hedge funds’ balance sheets are not on the same scale
The leverage indicator is estimated using a rolling (24-month window fixed effects) regression of hedge fund returns on a variety of market-based risk factors. It is the sum of the coefficients on these risk factors and is thus a measure of the aggregate sensitivity of hedge fund returns to movements in underlying prices.
‘All hedge funds’ includes market neutral (excluding equity hedged), directional, equity (including equity hedged), fixed income and fund-of-funds style families of active funds reporting to HFR database; weighted by assets under management in each style family.
Source: HFR, BIS calculations

10. Qualified Fund Footprint as a Percent of NAV
Source: FSA HFS
Hedge funds’ leverage not even on the same scale as banks’

11. Capital invested by hedge funds & prop. trading desks
1 Jan 2008
1 Jan 2009
1 Jan 2010
1 Jan 2011
Total Amount of Securities Owned by Hedge Funds
$5.7 trillion
$2.8 trillion
$3.2 trillion
$4.8 trillion
Total Amount of Securities Owned by Proprietary Capital*
$4.0tr
$0.4tr
$0.5tr
Total in Position
$9.7tr
$3.2tr
$3.7tr
$5.3tr
Hedge Funds
Hedge Funds
Proprietary Trading
Hedge Funds
Hedge Funds
Proprietary Trading
Proprietary Trading
Proprietary Trading
Source: Hedge Fund Research, Inc., Credit Suisse, BlackRock
* Proprietary Trading Desk Capital Base and Leverage, BlackRock Alternative Advisors estimates.

12. Maturity Transformation
Reliance on short duration repo markets converted risky long term assets to near cash
Money Market Funds drifted into longer maturity asset backed paper (and some were befuddled in so doing)
Valuation problems in BNP money funds heralded the financial crisis
Banks became highly levered and ran mismatches between
long dated assets that became illiquid &
short term funding that was withdrawn as confidence in ability to value assets evaporated causing further asset sales at depressed prices
Borrow short term – Lend long term

13. Maturity Transformation – Hedge Fund Style
Source: FSA HFS
Borrow (raise funds) longer term – but invest shorter term!

14. Hedge funds didn’t always get asset maturity right
When withdrawals were at the peak in winter 08/09
Some hedge funds could not close asset positions quicker than the investor redemptions to which they were responding
So some hedge funds restricted redemptions through
Gates
Sidepockets
Suspensions
As allowed by their prospectuses
Some clients were surprised and disappointed
But hedge funds did not exceed their powers (generally)

15. Credit Arbitrage Strategies
Source: HFR 2010 Report

16. Fixed Income & Asset Backed Strategies
Source: HFR 2010 Report
Tiny flows back to Credit and FI strategies, into the larger ones, already much more heavily scrutinised

17. To Conclude: Hedge Funds are not shadow banks
Significantly less levered
No credit transformation
though sought to profit from those who did
Some maturity transformation
not in the expected direction!
generally asset / shareholder mismatches well managed
No claim on the tax payers
Responding well to increased scrutiny
Regulators’ surveys
AIFMD

18. What’s next? Clamp down on “speculators” Financial Transaction Taxes
“It was obvious that one day Greece would have to face this kind of problems, and I knew that problems would arise because we - the French, the Germans, ECB President Trichet, the Commission and myself - had been discussing the perspectives of what was not at that time known as so-called Greek crisis……
…..The Greek crisis could have been avoided, but not starting last year, starting two or three decades ago”* Jean Claude Juncker, twice President of the Council of Europe, Luxembourg Prime Minister
Financial Transaction Taxes
Who’s the target?
Who gets the proceeds?
*Source: , quoting Le Monde

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