Reverse Repos

Under a methodology developed by the U.S. Securities and Exchange Commission, these reverse repurchase agreements are counted as assets, even though the related short positions help offset risk. As a result, fixed-income arbitrage can cause regulatory assets under management to balloon. The measure differs from net assets under management, the industry standard.

At Millennium, the firm’s regulatory assets under management soared 67 percent last year to $198.2 billion from $119 billion, while its net assets under management increased about 25 percent to $16.9 billion, according to filings. BlueCrest’s regulatory assets jumped 50 percent to $95.4 billion last year, while its net assets under management rose 15 percent to $35.3 billion, filings show.

Firms such as Millennium guide traders to shorter-term strategies traditionally dominated by big banks, which cut corporate-bond holdings 76 percent since the 2007 peak, to $56 billion on March 27, Federal Reserve data show.

Volcker Rule

Fixed-income arbitrage strategies are benefiting from “a relative lack of competition from large banks,” Aetos Capital LLC, which invests in hedge funds, said in an April 8 SEC filing. The New York-based firm said its Aetos Capital Multi- Strategy Arbitrage Fund LLC had a 9.2 percent return for the 12 months ended Jan. 31.

One reason for the retreat is the 2010 Dodd-Frank Act’s Volcker rule, which seeks to curb so-called proprietary trading, or betting with a lender’s own money.

As primary dealers, most large banks made markets in government and corporate bonds and also carried inventories of securities. The market-making function gave them insight into trading patterns by institutional customers, allowing them to spot and sometimes capitalize on anomalies in the pricing of bonds. Banks also formed proprietary-trading desks that used their own capital to make similar wagers. Because pricing discrepancies were often small, the firms used leverage, or borrowed money, to generate higher profits, expanding the size of their balance sheets in the process.

Proprietary Trading

“These large players provided the grease to allow the fixed-income markets to work,” said Brad Hintz, a former Morgan Stanley executive who now works as a bank analyst at Sanford C. Bernstein & Co. in New York. “The price of them doing that was they were taking risk.”

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