Why Wall Street Banks Are Breaking Up With Hedge Funds

The official story line behind Wall Street firms selling off hedge funds is that the moves are driven by the Volcker Rule, which severely limited the level of investments banks can make in hedge funds and private equity funds.

But the truth is more complex. The romance between banks and hedge funds—which had led to expensive buyouts for banks and big paydays for many former bankers who had become hedge fund moguls—soured long before the Volcker Rule, which has yet to take effect. Even if the rule wasn’t in the pipeline, many top executives at the banks now look on the acquisitions of hedge funds as mistakes or perhaps even scams.

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When we broke the news that Morgan Stanley was selling off FrontPoint, we noted that FrontPoint was founded by former Morgan Stanley executives. In short, it was a deal between closely related, long-term insiders.

The same could be said of many of the acquisitions of hedge funds by banks during the boom years. In case after case, the hedge fund managers were brought back into the bank and given important management positions.

We can just about squint our eyes and see those “acquisitions” as merely huge signing bonuses for the founders of the funds. If the payouts were disclosed as bonuses, they may have prompted more scrutiny and perhaps shareholder outrage. But since they were characterized as acquisitions of important and valuable assets, they largely escaped the attention of the pitchforkers.

Did any of these deals work out? Certainly Citigroup's acquisition of Vikram Pandit's Old Lane did not. It was closed less than a year after Citigroup purchased it. The FrontPoint deal lasted much longer but insiders say it never performed as well as hoped.

The failed romance between banks and hedge funds seems to have permanently soured many top Wall Street executives on similar acquisitions.

“The Volcker Rule is largely beside the point. Hedge funds are best when owned by the principals. I can’t see these deals ever coming back,” a top Wall Streeter told us over lunch in an executive dining room overlooking Midtown’s skyline.

The waiter came to take the orders. He asked for a salad appetizer, and then a second appetizer salad for the entrée. Wall Street’s appetite has certainly changed.