UBS Hedge Fund Loss Ensnares Wuffli With Debacle Reprising LTCM
By Christine Harper and Jacob Greber
June 4 (Bloomberg) -- UBS AG Chief Executive Officer Peter Wuffli spared no expense when he agreed two years ago to let John Costas, the top-ranking American at Switzerland's largest bank, start an internal hedge fund.
Wuffli gave Costas $3.5 billion, 80 top traders and 40 support staff for the Dillon Read Capital Management LLC venture. Costas hired another 130 people and leased space in London, Singapore, Tokyo, Connecticut and Manhattan, where his corner office on the 22nd floor has a view of St. Patrick's Cathedral. By the time he was done, Dillon Read's 250 employees received bonuses averaging $1 million a year, or almost three times the comparable payout at Goldman Sachs Group Inc.
Shareholders had no idea Dillon Read was anything but a success until May 3, when UBS suddenly pulled the plug. Although the unit made money for its first six quarters, Costas failed to raise capital fast enough after investors balked at his group's fees. Wuffli lost patience when Dillon Read stuck UBS with 150 million Swiss francs ($122 million) of first-quarter losses.
As Costas expanded Dillon Read, shares of UBS slipped behind Zurich-based rival Credit Suisse Group and profit fell for the first time in four years. Now, as Wuffli spends $300 million to shut down Dillon Read, the fallout threatens to approach the damage from Long-Term Capital Management LP, the hedge fund whose 1998 collapse cost UBS $700 million and paved the way for its takeover by Swiss Bank Corp.
``It's reputation that's the issue,'' said Dieter Buchholz, who helps oversee $107 billion, including UBS shares, at AIG Private Bank Ltd. ``The feeling here in Zurich is that it wasn't executed well.''
Keeping Traders
Wuffli, 49, declined to comment on Dillon Read beyond his statement last month that the project ``did not meet our expectations.'' Costas, who remains an adviser to UBS, said in an interview May 30 that he wants to run a ``big business'' and would stay if ``maybe the bank has a great project that shows up.''
UBS, whose 3.1 trillion francs in client assets make it the world's biggest money manager for the wealthy, promoted Dillon Read as a way to satisfy demand for alternatives to stocks and bonds. In practice, Costas used the venture as a carrot to keep traders, including Michael Hutchins and Kenneth Karl, from joining hedge funds, according to one person directly involved in the planning.
Karl, 48, declined to comment when reached at home. Hutchins, 51, didn't respond to a message left at his home.
Costas, 50, stepped down as head of the bank's securities division in June 2005 to start Dillon Read with traders led by Hutchins and $3.5 billion in investments. About $2 billion was in fixed-income markets, with the remainder bet on real estate and mortgages.
$1 Billion a Year
The proprietary trading group that went to Dillon Read was established in the late 1990s and produced an average of almost $1 billion a year in revenue for UBS, Costas said. Because the bank couldn't afford to give up such a cash cow, it struck an agreement with Costas: The securities division would continue to record Dillon Read's trading gains as its own and pay set fees as if the venture were outside the bank.
``They were trying to have their cake and eat it, trying to create a hedge fund and trying to keep the revenues in their investment bank,'' said Christopher Wheeler, an analyst at Bear Stearns Cos. in London.
While Costas gushed about the ``unstoppable trend'' of hedge funds and the opportunity they offered UBS, Wuffli saw the venture in more practical terms. He said it would ``extend the talent life cycle of some of our very successful traders and investment bankers.''
Phase of Transparency
Wuffli, an ex-reporter at Zurich's Neue Zuercher Zeitung and former McKinsey & Co. consultant, had first-hand experience with the risks of hedge fund investing. In 1998, three months after Swiss Bank's takeover of UBS, Chairman Mathis Cabiallavetta resigned over the losses from Long-Term Capital. CEO Marcel Ospel pledged to focus on traditional services such as investment banking and asset management.
To restore confidence in UBS, Ospel turned to Chief Financial Officer Wuffli, whose father resigned as president of Credit Suisse's executive board in 1977 amid losses at the bank's branch in Chiasso, Switzerland. Wuffli was promoted to president of UBS in 2001 and became CEO in 2003. Ospel, 57, is chairman.
``UBS went through a phase of commendable transparency from about 2000 onwards,'' said Derek Chambers, an analyst at Standard & Poor's Equity Research in London who rates UBS stock a ``hold.'' ``They seemed to get all their risk judgments right because they were chastened by what happened in the late 90s.''
Taking Risks
Costas, a former bond trader, was accustomed to taking risks. UBS hired the New Jersey native from Credit Suisse in 1996 to run U.S. fixed income and derivatives and within a year he was named global head. In 2001, Ospel picked Costas to challenge Goldman as chief of UBS Investment Bank, the securities unit derived from the former Dillon Read & Co., a Wall Street firm that Swiss Bank acquired in 1997, as well as Kidder Peabody & Co., S.G. Warburg & Co. and parts of PaineWebber Group Inc.
UBS revived the historic Dillon Read name for its new hedge fund and envisioned attracting as much as $15 billion in capital from institutions and individuals over a five-year period, according to the person familiar with the plans. While the bank would bear the start-up costs for Dillon Read, client fees eventually would pay for most expenses.
For all its wealth-management expertise, UBS failed to anticipate the pitfalls it would soon encounter.
Hedge Fund Pitfalls
The bank initially wanted to sell stakes in its existing trades and estimated that setting up the necessary channels would take no more than six months. Costas said he learned belatedly of regulatory requirements that made his plan infeasible. As a result, Dillon Read had to establish a new fund and install systems to prevent conflicts of interest between the UBS account and money managed for clients.
One investor who met with Costas and his deputies said it was clear Dillon Read's staff lacked hedge fund experience. The group was oblivious to the advantages they had as proprietary traders, including the ability to draw on the bank's capital when market declines made assets cheap, according to the investor, who declined to be identified because he now works for a hedge fund and isn't authorized to comment.
Fees posed another obstacle. While UBS paid Dillon Read 3 percent of assets and 35 percent of trading profits, prospective clients found the charges excessive. Most hedge funds levy a 2 percent management fee and pocket 20 percent of investment gains.
Cool Reception
The reception was so cool that within six weeks of starting the fundraising drive in 2006, Costas offered to manage the assets for nothing in exchange for a 40 percent performance fee. UBS remained subject to the original terms.
``I had never run a fund before,'' Costas said. ``We started out at 3 and 35, and we got some resistance.''
It wasn't until November, 16 months after forming Dillon Read, that Costas's team was able to start making trades for the second fund. Dillon Read Financial Products, as the vehicle was dubbed, drew $1.2 billion from 29 investors. That included $30 million to $40 million from UBS and more than $100 million from investment funds the bank managed for clients, Costas said.
While Dillon Read was working on putting more funds together, including one to invest in real estate and another to specialize in equities, it was slow going. Each new investment pool had to be walled off to ensure it wasn't influenced by decisions made for the UBS account, dimming Dillon Read's chances of raising $15 billion in five years.
Fundraising Constraints
``Where we should have gone quicker was getting out that second and third fund into the marketplace,'' Costas said. ``One of the things that we weren't successful at, given the constraints we were dealing with, was trying to roll out product quick enough.''
Meantime, UBS reported in October that third-quarter profit fell 21 percent, missing analysts' estimates and sending the bank's shares to their biggest decline in 2 1/2 years. Dillon Read, where trading revenue fell and expenses rose, was partly to blame for the shortfall.
UBS management began an internal review of Dillon Read, focusing on the slow pace of fundraising. With a staff of 250, Dillon Read was almost as large as Pequot Capital Management Inc., Arthur Samberg's $7.5 billion hedge fund, with only 60 percent as much assets under management.
Shareholders weren't told that Dillon Read was a concern or that Karl, one of the deputies Costas brought with him from UBS, quit in early March after bonuses had been paid out.
Final Straw
The final straw came later in March, when Dillon Read joined the list of investors burned by bets on the U.S. mortgage market. The UBS account hemorrhaged as defaults surged on so- called subprime home loans to people with poor credit histories or high debt burdens, forcing Dillon Read to mark down the value of its mortgage bonds. The losses more than obliterated the account's trading profits for January and February.
Costas said he immediately phoned John Fraser, chairman and CEO of UBS Global Asset Management, to report what happened, hopeful that UBS would tolerate a single month of losses after so many years of successful trading. Instead, Costas said UBS gave him two options: return the bank's capital and stay in business managing the fund for outside investors; or let UBS take over its account at Dillon Read and cash out clients with their gains intact. He chose the latter.
``If this other plan doesn't work I have to liquidate that portfolio,'' Costas said. ``Funds don't take well to liquidation.''
Winding up Dillon Read
Wuffli relieved Costas of responsibility for Dillon Read on May 3 and put Suneel Kamlani, chief of staff at UBS Investment Bank, in charge of the winding up the project by the third quarter. Huw Jenkins, who succeeded Costas as head of the securities division in 2005, told Dillon Read's employees the previous night that some might be rehired by UBS.
Hutchins left, and by last week Dillon Read had fired its team of about 20 equities traders.
Costas said he's bewildered that UBS shut Dillon Read after it made money for the bank every month until March. He said Dillon Read had the potential to grow into a firm as big as Fortress Investment Group LLC, the New York-based manager of hedge funds and private equity that went public in February and now has a market value of $11.2 billion.
``You know, between the loss, between the pace at which we were growing, I can't speculate on what was driving it,'' Costas said. ``Those traders made money every damn quarter for eight years.''
Wall Street's Dilemma
UBS's missteps underscore the dilemma of trying to compete with hedge funds for the best talent. No securities firm has gone as far to keep an entire trading desk intact. Even New York-based Goldman, the world's most profitable investment bank, let superstars such as Eric Mindich, Dinakar Singh and Hyder Ahmad leave for the lure of hedge-fund riches.
As UBS employees, Dillon Read's top moneymakers probably took home 8 percent to 12 percent of the trading profits they generated for the bank, said Gary Goldstein, a veteran Wall Street recruiter and CEO of the Whitney Group in New York. Working for a hedge fund, they stood to keep as much as 45 percent, he estimates.
Shutting down Dillon Read will require about $200 million in personnel costs, including severance pay and retention bonuses, Fraser said last month.
UBS shareholders have less to show for Wuffli's experiment.
``People used to have a default reflex that if you wanted a safe investment bank you went for UBS,'' said Chambers, the Standard & Poor's analyst. ``Perhaps people are questioning that.''
By Christine Harper and Jacob Greber
June 4 (Bloomberg) -- UBS AG Chief Executive Officer Peter Wuffli spared no expense when he agreed two years ago to let John Costas, the top-ranking American at Switzerland's largest bank, start an internal hedge fund.
Wuffli gave Costas $3.5 billion, 80 top traders and 40 support staff for the Dillon Read Capital Management LLC venture. Costas hired another 130 people and leased space in London, Singapore, Tokyo, Connecticut and Manhattan, where his corner office on the 22nd floor has a view of St. Patrick's Cathedral. By the time he was done, Dillon Read's 250 employees received bonuses averaging $1 million a year, or almost three times the comparable payout at Goldman Sachs Group Inc.
Shareholders had no idea Dillon Read was anything but a success until May 3, when UBS suddenly pulled the plug. Although the unit made money for its first six quarters, Costas failed to raise capital fast enough after investors balked at his group's fees. Wuffli lost patience when Dillon Read stuck UBS with 150 million Swiss francs ($122 million) of first-quarter losses.
As Costas expanded Dillon Read, shares of UBS slipped behind Zurich-based rival Credit Suisse Group and profit fell for the first time in four years. Now, as Wuffli spends $300 million to shut down Dillon Read, the fallout threatens to approach the damage from Long-Term Capital Management LP, the hedge fund whose 1998 collapse cost UBS $700 million and paved the way for its takeover by Swiss Bank Corp.
``It's reputation that's the issue,'' said Dieter Buchholz, who helps oversee $107 billion, including UBS shares, at AIG Private Bank Ltd. ``The feeling here in Zurich is that it wasn't executed well.''
Keeping Traders
Wuffli, 49, declined to comment on Dillon Read beyond his statement last month that the project ``did not meet our expectations.'' Costas, who remains an adviser to UBS, said in an interview May 30 that he wants to run a ``big business'' and would stay if ``maybe the bank has a great project that shows up.''
UBS, whose 3.1 trillion francs in client assets make it the world's biggest money manager for the wealthy, promoted Dillon Read as a way to satisfy demand for alternatives to stocks and bonds. In practice, Costas used the venture as a carrot to keep traders, including Michael Hutchins and Kenneth Karl, from joining hedge funds, according to one person directly involved in the planning.
Karl, 48, declined to comment when reached at home. Hutchins, 51, didn't respond to a message left at his home.
Costas, 50, stepped down as head of the bank's securities division in June 2005 to start Dillon Read with traders led by Hutchins and $3.5 billion in investments. About $2 billion was in fixed-income markets, with the remainder bet on real estate and mortgages.
$1 Billion a Year
The proprietary trading group that went to Dillon Read was established in the late 1990s and produced an average of almost $1 billion a year in revenue for UBS, Costas said. Because the bank couldn't afford to give up such a cash cow, it struck an agreement with Costas: The securities division would continue to record Dillon Read's trading gains as its own and pay set fees as if the venture were outside the bank.
``They were trying to have their cake and eat it, trying to create a hedge fund and trying to keep the revenues in their investment bank,'' said Christopher Wheeler, an analyst at Bear Stearns Cos. in London.
While Costas gushed about the ``unstoppable trend'' of hedge funds and the opportunity they offered UBS, Wuffli saw the venture in more practical terms. He said it would ``extend the talent life cycle of some of our very successful traders and investment bankers.''
Phase of Transparency
Wuffli, an ex-reporter at Zurich's Neue Zuercher Zeitung and former McKinsey & Co. consultant, had first-hand experience with the risks of hedge fund investing. In 1998, three months after Swiss Bank's takeover of UBS, Chairman Mathis Cabiallavetta resigned over the losses from Long-Term Capital. CEO Marcel Ospel pledged to focus on traditional services such as investment banking and asset management.
To restore confidence in UBS, Ospel turned to Chief Financial Officer Wuffli, whose father resigned as president of Credit Suisse's executive board in 1977 amid losses at the bank's branch in Chiasso, Switzerland. Wuffli was promoted to president of UBS in 2001 and became CEO in 2003. Ospel, 57, is chairman.
``UBS went through a phase of commendable transparency from about 2000 onwards,'' said Derek Chambers, an analyst at Standard & Poor's Equity Research in London who rates UBS stock a ``hold.'' ``They seemed to get all their risk judgments right because they were chastened by what happened in the late 90s.''
Taking Risks
Costas, a former bond trader, was accustomed to taking risks. UBS hired the New Jersey native from Credit Suisse in 1996 to run U.S. fixed income and derivatives and within a year he was named global head. In 2001, Ospel picked Costas to challenge Goldman as chief of UBS Investment Bank, the securities unit derived from the former Dillon Read & Co., a Wall Street firm that Swiss Bank acquired in 1997, as well as Kidder Peabody & Co., S.G. Warburg & Co. and parts of PaineWebber Group Inc.
UBS revived the historic Dillon Read name for its new hedge fund and envisioned attracting as much as $15 billion in capital from institutions and individuals over a five-year period, according to the person familiar with the plans. While the bank would bear the start-up costs for Dillon Read, client fees eventually would pay for most expenses.
For all its wealth-management expertise, UBS failed to anticipate the pitfalls it would soon encounter.
Hedge Fund Pitfalls
The bank initially wanted to sell stakes in its existing trades and estimated that setting up the necessary channels would take no more than six months. Costas said he learned belatedly of regulatory requirements that made his plan infeasible. As a result, Dillon Read had to establish a new fund and install systems to prevent conflicts of interest between the UBS account and money managed for clients.
One investor who met with Costas and his deputies said it was clear Dillon Read's staff lacked hedge fund experience. The group was oblivious to the advantages they had as proprietary traders, including the ability to draw on the bank's capital when market declines made assets cheap, according to the investor, who declined to be identified because he now works for a hedge fund and isn't authorized to comment.
Fees posed another obstacle. While UBS paid Dillon Read 3 percent of assets and 35 percent of trading profits, prospective clients found the charges excessive. Most hedge funds levy a 2 percent management fee and pocket 20 percent of investment gains.
Cool Reception
The reception was so cool that within six weeks of starting the fundraising drive in 2006, Costas offered to manage the assets for nothing in exchange for a 40 percent performance fee. UBS remained subject to the original terms.
``I had never run a fund before,'' Costas said. ``We started out at 3 and 35, and we got some resistance.''
It wasn't until November, 16 months after forming Dillon Read, that Costas's team was able to start making trades for the second fund. Dillon Read Financial Products, as the vehicle was dubbed, drew $1.2 billion from 29 investors. That included $30 million to $40 million from UBS and more than $100 million from investment funds the bank managed for clients, Costas said.
While Dillon Read was working on putting more funds together, including one to invest in real estate and another to specialize in equities, it was slow going. Each new investment pool had to be walled off to ensure it wasn't influenced by decisions made for the UBS account, dimming Dillon Read's chances of raising $15 billion in five years.
Fundraising Constraints
``Where we should have gone quicker was getting out that second and third fund into the marketplace,'' Costas said. ``One of the things that we weren't successful at, given the constraints we were dealing with, was trying to roll out product quick enough.''
Meantime, UBS reported in October that third-quarter profit fell 21 percent, missing analysts' estimates and sending the bank's shares to their biggest decline in 2 1/2 years. Dillon Read, where trading revenue fell and expenses rose, was partly to blame for the shortfall.
UBS management began an internal review of Dillon Read, focusing on the slow pace of fundraising. With a staff of 250, Dillon Read was almost as large as Pequot Capital Management Inc., Arthur Samberg's $7.5 billion hedge fund, with only 60 percent as much assets under management.
Shareholders weren't told that Dillon Read was a concern or that Karl, one of the deputies Costas brought with him from UBS, quit in early March after bonuses had been paid out.
Final Straw
The final straw came later in March, when Dillon Read joined the list of investors burned by bets on the U.S. mortgage market. The UBS account hemorrhaged as defaults surged on so- called subprime home loans to people with poor credit histories or high debt burdens, forcing Dillon Read to mark down the value of its mortgage bonds. The losses more than obliterated the account's trading profits for January and February.
Costas said he immediately phoned John Fraser, chairman and CEO of UBS Global Asset Management, to report what happened, hopeful that UBS would tolerate a single month of losses after so many years of successful trading. Instead, Costas said UBS gave him two options: return the bank's capital and stay in business managing the fund for outside investors; or let UBS take over its account at Dillon Read and cash out clients with their gains intact. He chose the latter.
``If this other plan doesn't work I have to liquidate that portfolio,'' Costas said. ``Funds don't take well to liquidation.''
Winding up Dillon Read
Wuffli relieved Costas of responsibility for Dillon Read on May 3 and put Suneel Kamlani, chief of staff at UBS Investment Bank, in charge of the winding up the project by the third quarter. Huw Jenkins, who succeeded Costas as head of the securities division in 2005, told Dillon Read's employees the previous night that some might be rehired by UBS.
Hutchins left, and by last week Dillon Read had fired its team of about 20 equities traders.
Costas said he's bewildered that UBS shut Dillon Read after it made money for the bank every month until March. He said Dillon Read had the potential to grow into a firm as big as Fortress Investment Group LLC, the New York-based manager of hedge funds and private equity that went public in February and now has a market value of $11.2 billion.
``You know, between the loss, between the pace at which we were growing, I can't speculate on what was driving it,'' Costas said. ``Those traders made money every damn quarter for eight years.''
Wall Street's Dilemma
UBS's missteps underscore the dilemma of trying to compete with hedge funds for the best talent. No securities firm has gone as far to keep an entire trading desk intact. Even New York-based Goldman, the world's most profitable investment bank, let superstars such as Eric Mindich, Dinakar Singh and Hyder Ahmad leave for the lure of hedge-fund riches.
As UBS employees, Dillon Read's top moneymakers probably took home 8 percent to 12 percent of the trading profits they generated for the bank, said Gary Goldstein, a veteran Wall Street recruiter and CEO of the Whitney Group in New York. Working for a hedge fund, they stood to keep as much as 45 percent, he estimates.
Shutting down Dillon Read will require about $200 million in personnel costs, including severance pay and retention bonuses, Fraser said last month.
UBS shareholders have less to show for Wuffli's experiment.
``People used to have a default reflex that if you wanted a safe investment bank you went for UBS,'' said Chambers, the Standard & Poor's analyst. ``Perhaps people are questioning that.''
**Original Source = Bloomberg.com**
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