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The sale last week of Société Générale's UK-based asset management division to the listed hedge fund group GLG is a story of our times.
First it tells us how even the biggest and most well-regarded hedge fund groups are working to become mainstream. SocGen has $8 billion (£5 billion) of assets to GLG's $17 billion, so it is a significant deal for the firm and underlines its belief that hedge funds can no longer exist on the promise of excess returns alone.
They need the regular income that comes from simply having assets under management, whether they perform or not. It underlines too how the business is polarising again between passive funds, which track the market at low cost, and active managers, who purport to beat the market but charge for it.
The second fascinating thing is the price. In a bull market, retail fund management groups can change hands for 5% of the value of funds under management, so a bull-market price for SocGen would have been $400 million.
Last week's price was $10 million, which is virtually giving it away. It does not bode well for the selling price of New Star, currently also on the block after running foul of its bankers last month.
The third point is that SocGen's UK business was a serious disappointment. The French bank is hugely successful as an asset manager in other markets, where it has £280 billion under management, and when it launched here just under 10 years ago it expected to do a lot better than it in fact did. Somehow, the business never quite caught the imagination of the independent financial advisers. Creating a successful retail fund management group is as much about hype and marketing as it is about the ability to manage money.
The final point is the people involved. The impression has been given subsequently that Nicola Horlick set up SocGen's UK business. In fact, it was done by Keith Percy and, at a time when the Bernard Madoff scandal is in the news, it is ironic that he was only on the market 10 years ago because he had been caught out while in charge at Morgan Grenfell Asset Management.
It was on his watch that its star fund manager, Peter Young, cracked up, got careless with the funds, heard voices, and was ultimately declared unfit to stand trial when he turned up in a dress and insisted on being called Elisabeth.
Luckily Deutsche Bank, Morgan Grenfell's parent, did the honourable thing and paid across millions of pounds to make good client losses - though it was under no obligation to do so. This was a great relief to the regulator, which would have been seriously embarrassed if a similar-size fraud had occurred at an independent fund management house that did not have a parent with deep pockets standing behind it.
Though Percy was a long way distant from the wrongdoing and pretty well blameless, the regulator made him the fall guy anyway "to encourage the others". He fought long and hard to maintain his innocence but ultimately, when his legal costs had almost destroyed him, he was forced for the sake of his family to abandon his defence and do a deal.
SocGen marked his return to the City. He subsequently employed Horlick, who had come to media prominence when she flamboyantly objected to Deutsche's effort to reassert control over the fund management business she was by then managing, following Percy's enforced resignation. But the Percy-Horlick combination was not a great success and she subsequently left.
So the sale of SocGen, though a small deal, really does signify the end of a very big City story.
Why the banks can't come clean
It is widely believed that for the banking crisis to be properly turned round, the banks have to come clean about their bad debts. The fact that they have not done so is often interpreted as an unwillingness to face reality.
But there is another reason. Many of these mortgage-backed securities are so complex that they are almost impossible to value.
American investor Warren Buffett saw this coming months ago, and explained why it was that purchasers of the credit derivatives could have no understanding of what they were buying.
A mortgage-backed security is a pool of several thousand mortgages and the starting block for a CDO, and its prospectus would run to about 300 pages, he said. This pool would be divided into perhaps 30 tranches, and one of these would be combined with a similar tranche from 50 other mortgage pools to create one CDO. To understand what is in that CDO the investor now has 50 prospectuses of 300 pages to read - 15,000 pages. The further derivative, the CDO squared, repeated the trick using CDOs as the building block and took tranches from 50 CDOs to create one CDO squared. To understand a CDO squared the investor had to read 750,000 pages.
There were also a few products called CDO cubed. The underlying prospectuses for these would be 37.5 million pages.
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"It is widely believed that for the banking crisis to be properly turned round, the banks have to come clean about their bad debts. The fact that they have not done so is often interpreted as an unwillingness to face reality. But there is another reason. Many of these mortgage-backed securities are so complex that they are almost impossible to value............. To understand a CDO squared the investor had to read 750,000 pages. There were also a few products called CDO cubed. The underlying prospectuses for these would be 37.5 million pages."
Why were auditors signing off accounts when they couldn't possibly have the time to audit them effectively?
- Nick Gulliford, Taunton UK, 25/01/2009 11:24
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