Innovation and integration

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Though it has fewer clients than its major competitors, Barclays Capital’s prime brokerage unit has largely eclipsed its rivals when it comes to sophistication. Under the stewardship of Kevin Mirabile – who led the firm’s hedge funds-focused business until mid-2004 – Barclays became a pioneer in cross-product netting, over-the-counter derivatives clearing and securities lending.

Now, with his new firm, Saw Mill Management and Research, he’s focused on some of the thorniest problems that affect hedge funds. Mirabile says services that streamline operational and other non-investment aspects of funds’ businesses to boost returns are becoming important. “So I’m getting involved in the fledgling business of adding credit- and operational-related alpha to enhance managers’ returns,” he adds.

One of Mirabile’s first strategic moves was to invest in S3 Asset Management – an outsourced trading and portfolio financing desk for hedge funds (Risk January 2004, page 9). He became a partner in S3 in October 2004, and joins a staff roster that reads like a who’s who of prime brokerage. According to hedge fund managers Risk spoke to, S3’s service can help funds make cost savings of around 100 basis points – far from small change in a world of single-digit returns.

Mirabile believes there is chronic underinvestment in risk management and infrastructure for strategies where outsize returns are still the order of the day. He pinpoints distressed and high-yield debt, physical energy and capital structure arbitrage. He is also part of a joint venture to create a business model risk assessment database for hedge funds. Among other things, the database will help ascertain the existence of asset/liability mismatches among managers.

One of the big bugbears of the past two years is valuation – a fact not lost on Mirabile. Saw Mill will probably back a company involved in the independent valuation of less-liquid instruments by the end of the year. “Those in the prime position to provide marks – administrators and accountants – are increasingly ill equipped to handle product complexity,” he says.

Mirabile’s exit from the sell-side and subsequent launch of Saw Mill was a gradual transition. In his latter months in charge of the collateralised fund group (CFG) at Barclays in New York, he reduced his workload. Mirabile was spending some of his time guest lecturing at universities in the vicinity. He also worked on a joint strategy with Barclays Global Investors to create a platform to allocate to external hedge funds. Mauritz Schouten – appointed global co-head at the end of 2003 – assumed more of the day-to-day responsibility for running the CFG, which, alongside prime brokerage, encompasses US dollar and corporate credit repo, equity borrowing and hedging, and futures.

Barclays’ hedge funds group distinguished itself from its peers by its integrated structure and approach. Until around two years ago, other firms’ claims of integration were largely only justified at a more superficial level – a pale imitation of Barclays’ group. Chief executive Bob Diamond’s divisionless business model for Barclays Capital helped facilitate the structure. From risk netting through to financing, integration was the touchstone of the group’s success. “I recognised early on that this was how we would differentiate ourselves,” says Mirabile. “After all, back then Barclays didn’t have the depth of research and flow [business] in a lot of products,” he adds.

Areas where Mirabile’s group at Barclays was among the pioneers several years ago included interest rate swap and credit default swap (CDS) clearing arrangements. Among the funds Risk spoke to, Mirabile won most kudos for his group’s cross-product netting capabilities, which could encompass positions in convertible bonds, CDSs, bonds and equity derivatives. “There are probably only three firms that can do this today. Barclays has done it for several years,” he adds.

Sources familiar with the CFG say it generated revenues of around $1 billion during Mirabile’s six-year stint at the helm. Towards the end of his tenure, just over half CFG’s 75 prime brokerage clients were among the 100 top-performing funds with assets of $100 million or more.

Barclays board members demonstrated nerves of steel when they bought Daiwa Securities’ hedge funds business, just over six years ago. The transaction – which saw Mirabile and 53 of his staff switch employer – closed in 1998, just as the Long-Term Capital Management (LTCM) debacle shook the markets. The book Mirabile brought over included one of LTCM’s equity risk arbitrage exposures – $5 billion long, and the same in short positions.

But collateralisation ensured Barclays didn’t lose a penny on this huge exposure, and the questions asked at the time laid the groundwork for the CFG’s holistic view of risk. Six years later, the question Mirabile is asking himself is: how will tighter regulation and capacity constraints affect the hedge fund industry? To see how his answer evolves, just keep an eye on which firms Saw Mill ties up with next.

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