Single-Manager Platforms: Opportunities and Challenges

I've spent a lot of time thinking about single-manager platforms, their optimal structure and operation. I ran a big one while at Deutsche Bank called DB Advisors. Goldman Sachs recently announced the building of a similar platform in its asset management division. Most Wall Street firms have some kind of single-manager platform as I define it, and these operations are frequently characterized by:

• Legal, operating and risk management environments that are separate from the broker-dealer;

• Teams that are initially seeded with proprietary capital, but after establishing strong track records often are marketed and attract client capital as well;

• Managers who are paid better than position traders in broker-dealer Sales & Trading operations, but not as well as external hedge fund managers;

• Managers who are often either quant-driven or socially challenged, and either lack the desire or ability to run an independent hedge fund operation on their own;

• Teams that are paid off of a percentage of net profits (realized and unrealized gains less direct and indirect costs of running the business) on an annual basis and begin each year at -0-, meaning they generally don't get the benefit of compounding capital over time;  and

• Top talent from the broker-dealer clamoring to get in, sometimes causing tension between the best broker-dealer traders and senior management.

These groups can be fantastically profitable ways of deploying firm trading capital while creating valuable third-party product for distribution. This is the good news. The bad news is that these businesses are hard to run and, by their nature, are subject to massive volatility due to internal and external factors. Consider these three real-world scenarios:

1. Say that one day you wake up and your top performing manager has grown some personality and wants to leave. Well, what do you do?
2. Imagine that the market gets crushed (as it did in August) and that hedge fund returns across most strategies are poor. This results in huge mark-to-market losses for the firm and potentially a whole lot of pissed off asset management clients. Then what?
3. What about the very real possibility of some marquee traders in S&T getting angry about their comp because they are getting 10-12% of net on smaller capital amounts than their pals on the single-manager platform getting 15% on both proprietary and client capital. How do you preserve firm talent without either cherry-picking top S&T talent and putting them on the platform or paying them off the curve relative to the colleagues with whom they sit, collaborate and trade?

There are no easy answers to any of these questions, but they are questions that need to be considered if a firm is to be successful in building and operating a successful single-manager platform. Given these headaches, is it worth it? Quite simply, the answer is yes subject to a few important caveats:

Management needs the right mind-set when establishing these businesses. This means:

• Setting aside a pool of risk capital upon which it is willing to accept hedge fund-like levels of volatility in stressed environments. Because the worst thing you can do is set up a business, communicate a vision, a mission and a risk tolerance, and get cold feet right when your traders and clients need you to suck it up, keep cool and stay in the game.

• Establishing a strong, holistic risk management culture. A firm running one of these platforms will have a lot of prop capital at risk and position-level detail across all of its books. This information needs to be aggregated, analyzed and disseminated in an accurate, fluid manner, and used for managerial decision-making when viewed in context with the firm's aggregate risk position.

• Accepting the fact that successful teams will eventually want to leave and providing a mechanism for creating a win-win between firm and team. This could mean the firm getting an option on a share of the newly-established GP, guaranteed capacity, reduced fees, continued prime brokerage business, etc. In exchange, a team will get to keep its name, its audited track record, and receive assistance in moving parts of its book to other prime brokers and in setting up the new business.

• Creating open communication and understanding among business leaders in the single-manager operation and S&T. This will be required to handle situations where top traders want to move from the broker-dealer to the single-manager operation. This will inevitably come up and create discomfort among all parties, and this situation needs to be anticipated with rules of engagement defined beforehand to guard against fractious, destructive behaviors.

There are so many interconnected factors to be considered when building and operating a single-manager platform that a book could be written on the topic. But I have hopefully provided an interested party with a primer on the key issues that need to be considered.