Hedge funds keep safe distance

Several high-profile hedge funds have moved to sever ties with Bear Stearns since Friday's rescue, inflicting further damage on its once market-leading and lucrative prime brokerage business.

Prime brokerage involves providing trading, lending and other services to high-paying hedge fund clients. Alongside Goldman Sachs and Morgan Stanley, Bear had long been considered one of the US's top three prime brokerage outfits.

People in the hedge fund industry said funds including Davidson Kempner Partners and Fir Tree Partners had moved to cut their links with Bear on Friday, adding to the steady exodus of funds since last summer when worries first surfaced about the exposure of Bear Stearns to the US credit crunch.

The two named hedge funds did not respond yesterday to calls seeking comment. A spokesman for Bear said he could not comment about specific funds. "We have been picking up a number of clients from Bear. Hedge funds are moving substantial amounts of money away from them," a senior executive from a rival investment bank said.

One hedge fund manager whose firm does not use Bear as a prime broker said hedge funds should have seen the trouble at Bear coming. "A number of hedge funds are scrambling to take their business elsewhere. It is way too late now. They should have done this a long time ago, it goes to show their risk-management systems were not good enough".

Prime brokerage and the mortgage business are seen as the most attractive parts of Bear Stearns for any potential buyer. But the departure of so many funds means any buyer would be motivated by interest in the infrastructure and human resources of Bear rather than its once extensive roster of hedge fund clients.

Bear's decline in prime brokerage began about three years ago and was accelerated by its mortgage-related troubles, including the collapse of two hedge funds run by the bank's asset management division.

Almost all prime brokers have recently been making adjustments to their credit extension processes in recent times, and most hedge funds are trying to reduce their exposure to a blow-up at any one investment bank.

Robert Sloan, founder of S3 Partners, a US hedge fund advisory company, and a former head of prime brokerage at Credit Suisse, said the situation at Bear Stearns could usher in a new era in financing. "Recently, prime brokerage, though around for a long time, has become a cornerstone business for Wall Street. These events demonstrate that financing is a cornerstone to hedge fund's capital structure and is the pressure point that all managers and investors should address."

One leading hedge fund manager questioned whether the prime brokerage business as a whole could survive in its present form given the situation at Bear and the dependence of hedge funds on financing from unstable sources.

"I think we might need to consider a system that is fundamentally different from prime brokerage. Maybe it is the clients; large pools of money such as endowments and pension funds that should be providing the liquidity and stepping into the breach. We need to rethink the financing model."