UBS's hedge fund woes Published: 3/5/2007 | Last Updated: 3/5/2007 13:45 London Time It was a bad idea from the start. Two years ago, when the world obsessed about hedge funds in the way it does about private equity today, UBS created Dillon Read Capital Management. Analysts and investors' eyebrows rose immediately. Firstly it seemed as though the Swiss bank was creating a plaything for John Costas, then its global head of investment banking who may, or may not, have been about to walk. Second, there were concerns about structure. DRCM managed the fixed income funds that used to be run in-house, alongside third party assets. The regulatory issues, particularly regarding conflicts of interest were obvious. Finally, the hoopla surrounding the whole venture â the glitzy offices and rumoured pay packages â was over-the-top. On Thursday UBS announced that DRCM would be closed down following a $123m trading loss in the first quarter of 2007, apparently related to sub-prime woes in the US. For UBS to pull the plug so quickly, as well as incurring a $300m restructuring charge, indicates that there must have been insurmountable problems and that initial fears were well founded. Many will baulk at the cost of this misadventure â probably in excess of $500m â not to mention the hit to credibility. But management should be applauded for admitting its mistake so quickly, and the one-off hit is worth less than one percent of UBS's market capitalisation. Much worse, is that improvements to the rest of UBS's business risk being overlooked. Excluding DRCM, fixed income revenues for the quarter were up 19 per cent year-on-year and new product areas are gaining traction. Wealth and asset management inflows were very strong, and costs are under control. Only Paine Webber in the US continues to disappoint. UBS is currently trading on a 2008 earnings multiple in line with its global peers, about 10.5 times. Given that 40 per cent of profits come from private banking, which should arguably trade closer to 15 times, there is clearly upside. But management needs to work harder to get the right story into the headlines.