State Street Shrinks Hedge Fund Operations With Sale Of SSARIS Advisors To Management

In a move that is likely motivated by the increased pressure on banks to limit their exposure to hedge funds, State Street (NYSE:STT) has reached an agreement to sell its hedge fund unit SSARIS Advisors to the unit’s senior management. ^[1] SSARIS specializes in hedge funds as well as hedge fund of funds, and provides hedge fund advisory services to clients. ^[2] The unit managed around $1.4 billion in client assets through six funds at the end of 2013. The deal, financial terms of which were not disclosed, is expected to close in less than three months.

SSARIS represents a very small part of the $2.4 trillion in assets managed by State Street at the end of Q3 2014. But the proposed management buyout is significant as it marks an important step by the global custodian to fall in line with the Dodd-Frank Act that limits a financial institution’s total exposure to a hedge fund at 3% of its total tier 1 capital.

The move does not affect our $78 price estimate for State Street’s stock, which is slightly ahead of the current market price.

See our full analysis for State Street

State Street is the second largest custody bank in the world after BNY Mellon (NYSE:BK), and is also one of the largest asset managers in the world with a strong position in the global ETF market. A glance at the chart above shows that State Street’s primary source of value comes from its services as a custodian, with the asset management roles contributing to less than 15% of its total estimated value – almost the same value generated by the bank’s trading and financing operations. But our analysis also indicates that among all funds managed by State Street’s asset management arm, the alternative investment options are the biggest source of value – contributing to almost 5% of the total share value. This can be attributed to 2 important factors: the popularity of its SPDR Gold Fund and the significantly higher fees generated by its alternative investment funds (around 0.25% of the asset base) compared to ETFs (0.08% of the asset base), active fixed-income funds (0.05% of the asset base) and even active equity funds (0.15% of the asset base).

State Street’s alternative investment funds include real estate investment trusts, currency and commodities funds as well as hedge fund investment offerings. The share of these funds in State Street’s total asset management portfolio can be better understood by the fact that the $124 billion in assets they manage represents just over 5% of the total $2.4 trillion asset base. And SSARIS, with its $1.4 billion in hedge fund and hedge fund of funds assets, is just over 1% of the alternative investment arm.

Already a very small part of State Street’s business model, the hedge fund unit fell out of favor with the bank due to the fact that several large U.S.-based pension funds have decided to discontinue the use of hedge funds. ^[3] The availability of cheaper investment options that promise investment strategies similar to hedge funds, and more importantly, the Dodd-Frank Act’s limits on banks’ involvement with hedge funds, only hastened State Street’s exit from the business.

You can see how a reduction in assets under management for State Street’s alternative investment funds affects the bank’s share value by making changes to the chart below.

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1. State Street to Sell Hedge Fund Business in Management Buyout, Bloomberg, Nov 17 2014 [↩]
2. SSARIS Website [↩]
3. Hedge Funds Lose Calpers, and More, The New York Times, Sept 22 2014 [↩]