Knight Capital Group (NASDAQ: KCG) executes stock trades (ie, completes the buy or sell) for asset management companies such as mutual funds, hedge funds, and retail brokerages. NITE executes both U.S. and international trades in securities such as equities, futures, options, fixed income on both US and foreign exchanges. NITE profits from this line of business from both flat fees for its services and from investments NITE makes when it makes a market for a client.
The company's Asset Management division consists of a 51% stake in the Deephaven family of hedge funds . Deephaven Capital Management runs hedge funds for wealthy individuals, institutions, and fund of funds. These funds have different strategies and have the freedom to invest in any security. NITE earns money both from management fees that are collected on its assets under management and from the incentive fees which are charged when the funds outperform.
Knight Capital Group was created in January 2000 resulting from the Knight/Trimark Group, Inc. and Roundtable Partners, LLC. NITE is headquartered in Jersey City, NJ and employs 868 full-time employees with 10% in the United Kingdom and the remainder in the United States.
In 2009, NITE generated a net income of $117.1 million on revenues of $1.16 billion. This represents a 34.2% decrease in net income on a 23.8% increase in revenues from 2008, when the company earned $621.2 million on $938.9 million in revenue.
Knight Capital has three operating segments:
The current struggles of the financial markets will lead to negative consequences for all 3 of NITE's divisions. The Global Markets division has been hurt by reduced trading by broker dealers in the current markets . With reduced liquidity and volume, market making will also become a less profitable business.
Reduced returns for their investors leads to redemptions and further struggles for Deephaven's funds. As investors redeem, Deephaven has to sell off assets, which are usually their most liquid investments, leaving Deephaven with its most illiquid investments. Since the Corporate division has company investments in Deephaven's funds, this would lead to further losses for NITE.
Regional exchanges and broker-dealers have been joining together to provide their own alternative trading systems to compete with OTC and listed trading venues . Moreover, more broker-dealers are offering their own internal crossing networks . These moves are increasing the fragmentation in the market and making it more difficult to gain market share . Moreover, this has led to market makers charging explicit commissions for OTC securities and these commissions have also decreased due to the increased competition . Thus, the consolidation has raised the competition due to increasing the number of firms who can alone fulfill all the needs of their clients.
Since 1990, the number of hedge funds has risen from 610 to 10,096 . This is both good and bad for NITE. The Global Markets division benefits from an increase in hedge funds because it increases the number of potential buy side clients. The increase in potential clients has also attracted more companies which has decreased what NITE is able to charge for its services. Thus, it has presented a double edged sword where the increase in hedge funds has given it more potential clients but also increased the competition for said clients. However, this will also provide more competition for Deephaven to gain the investments dollars of hedge fund investors. Deephaven is somewhat shielded from some of this competition since it has been in existence much longer than the average hedge fund and has a track record of high returns .
The Global Markets division is in a competitive industry with ever changing technology and an increased international presence. Similar products as NITE's are being offered by exchanges, broker dealers, ECNs, alternative trading systems, and crossing networks. The NASDAQ market makers who are involved in the most program trading are Goldman Sachs, Merrill Lynch , and Morgan Stanley . Hedge funds, such as Renaissance and Citadel, have become increasingly involved in market making under the name of statistical arbitrage . This makes it difficult to fully understand the market breakdown since the market making of these billion dollar hedge funds are not accounted for in market share data. Direct Edge ECN, partially owned by NITE, is the fourth largest U.S. equities venue. Companies in this industry compete based on the types of services they offer clients, fees, and the speed of trade execution.
Deephaven competes with other asset management companies than run hedge funds. The companies Deephaven competes with run hedge funds with multi-strategy, credit, long-short equity, event driven, and volatility driven strategies . Due to the very private nature of the hedge fund business, it is very difficult to get the market share data for the industry. Also few hedge fund firms are publicly traded. Och Ziff Capital Management, GLG Partners, and Lazard are examples of asset management firms that are traded publicly. Investors in hedge funds do significant due diligence and examine many aspects of not only the strategies of the funds but also the past performance of funds run by the portfolio managers. Investors also examine the risk management systems of hedge funds to make sure that the fund has systems in place to protect against a blow up. Ultimately, the reputation of an asset management company is very influential in the decision making of the investor and can make all the difference.