UBS blames Dillon Read closure on costs, not losses

NEW YORK, May 3 (Reuters) - UBS AG UBSN.VX is closing its Dillon Read Capital Management hedge fund unit just five months after opening its doors because the business plan proved prohibitively expensive and complicated, top bank executives said on Thursday.

It was an embarrassing about-face for the Swiss bank, which 18 months ago took steps to create a separate alternative investments and proprietary trading unit and launched its first fund with outside investor money in November.

The announcement to shut down the unit, and return the hedge fund’s money to investors, came as UBS announced that U.S. subprime loses in the first quarter hurt Dillon Read and lowered overall results for UBS.

Dillon Read’s two chief investment officers, Michael Hutchins and Ken Karl, left the bank, Dillon Read Chief Executive John Costas and UBS Asset Management CEO John Fraser told Reuters in an interview. Costas, who formerly ran UBS’s investment bank division, will become a senior adviser to the bank with unspecified responsibilities.

“Clearly we are disappointed,” Fraser said. “It didn’t work out as well as we expected.”

UBS raised some $1.2 billion for Dillon Read from institutions and wealthy people and launched the multi-strategy fund last November to trade alongside the bank’s proprietary trading operations, which has assets of about $3.5 billion.

Industry watchers said issues of co-managing internal and external money, while unusual, seemed surmountable.

“It is unusual to have external client money managed alongside prop money,” said Daniel Libby, senior portfolio manager at Select Asset Management, a Greenwich, Connecticut-based hedge fund group. “It just seems very ironic that they have come upon this as a problem at a time when they are suffering losses.”

UBS launched Dillon Read with some 250 employees from various bank proprietary trading operations in a bid to co-manage internal and outside money. But the combination of the two businesses was unique on Wall Street, and the model proved costly and unwieldy, bank officials said.

While Dillon Read lost about $124 million from trades in the U.S. subprime lending market in the first quarter, UBS said growing logistical and regulatory costs were the main reason for its closure.

The outside investor fund posted gains of 11 percent after fees in the first quarter, or an annualized return of 22 percent, the UBS executives noted.

“We faced an inordinate number of challenges,” including regulatory and logistical issues that delayed its launch by six months or so, Fraser said. “The business model was more expensive and more complex than we envisaged.”

The UBS executives said much of the subprime lending losses were confined to Dillon Read’s proprietary trading operations. But subprime losses were not the reason for the closure of the fund, which they expected to swell to $3 billion to $4 billion in coming years.

UBS will acquire the outside investor fund’s assets for cash, which will then be distributed to clients. The prop trading book also will be brought in house, where it began.

The executives said there likely would be job cuts as a result of the re-integration of Dillon Read’s assets and people, but declined to elaborate.

They said UBS remains committed to expanding its alternative investment offerings given the global demand for them.