A bigger slice of the multiasset pie

Hedge fund businesses are a lucrative source of fee revenue for large managers

Hedge fund and hedge funds-of-funds businesses are accounting for a more meaningful piece of the total assets managed by some of the largest multiasset money managers as well as their balance sheets.

“The message has finally sunk in: Big, traditional asset managers are not going to be able to survive without finding more lucrative sources of revenue,” said Daniel Celeghin, a partner at management consultant Casey, Quirk & Associates LLC, Darien, Conn.

The shift of giant, broadly diversified money management companies toward higher fee alternative investments — and away from low fee, increasingly commoditized passive and enhanced strategies and active long-only equity and fixed-income approaches — is picking up speed. At the end of September 2004, the last time Pensions & Investments analyzed the alternatives managed by big money managers, hedge fund and hedge funds-of-funds assets were significantly smaller for most companies (P&I, Oct. 18, 2004).

A review of P&I's ranking of the 50 largest money managers with significant U.S. investment businesses by their worldwide assets under management found that 30 companies managed hedge funds and funds of funds totaling an aggregate $300.9 billion. Thirteen managed in excess of $5 billion each in hedge funds and funds of funds and nine manage more than $11 billion each.

The top multiasset managers ranked by worldwide hedge fund and funds-of-funds assets managed as of June 30 were:

For a comparatively small money manager, hedge funds and funds of funds represented nearly 10% of Credit Suisse's $380.9 billion of worldwide assets under management as of June 30, the highest proportion in P&I's universe. That's a big jump from the 2.6% of assets CSAM managed in hedge funds and funds of funds at the end of September 2004. The total of CSAM's combined hedge funds and funds of funds grew 329% from $8.8 billion at the end of the third quarter of 2004.

Ranked by the percentage of total assets managed in hedge funds/funds of funds, the other top firms were:

1.2% at BlackRock

For a huge manager like New York-based BlackRock (BLK) — the largest firm in P&I's universe in terms of both worldwide and hedge funds/funds of funds assets at $3.56 trillion and $42.7 billion, respectively — hedge funds/funds of funds represented just 1.2% of the company's total as of June 30. That's up from a 0.91% slice of BlackRock's assets as of Sept. 30, 2004.

BlackRock's hedge fund/funds-of-funds growth since 2004 was fueled by a deliberate strategy to acquire existing managers, rather than build capability from scratch. During the eight-year span, BlackRock acquired Merrill Lynch Investment Managers in 2006 with $3.5 billion of hedge funds/funds of funds assets; Quellos Group LLC in 2007 with about $20 billion in hedge funds of funds; and Barclays Global Investors in 2009 with about $17 billion in hedge funds.

Prior to the acquisition spree, BlackRock managed about $6 billion in hedge funds and $1 billion in hedge funds of funds.

Other diversified money managers that bulked up their hedge fund capabilities via acquisition include Legg Mason (LM) Inc. (LM), whose acquisition of Permal Group in 2005 brought $20 billion in hedge funds of funds, and J.P. Morgan, which added about $12 billion in hedge fund assets through the 2004 acquisition of Highbridge Capital Management and Highbridge's 2010 acquisition of Gavea Investimentos.

J.P. Morgan's growth strategy in hedge funds has been to maintain “independent investment boutiques,” said Robert J. Klein, managing director and global head of hedge fund strategies, noting that both New York-based Highbridge Capital and Sao Paulo/Rio de Janiero-based Gavea control their own operations.

JPMAM, New York, had $28.8 billion in single and multistrategy hedge funds and $9.5 billion in hedge funds of funds as of June 30. The firm's assets in this area increased 379% since P&I's Sept. 2004 analysis.

JPMAM's hedge funds-of-funds business has been transformed to provide more customized hedge fund portfolios for clients than traditional commingled hedge fund strategies, Mr. Klein said. Many clients have moved to asking for more specialized and concentrated portfolios of hedge funds, focused on long/short equity, global macro or opportunistic funds, for example.

Financial motivation

The motivation for many companies is financial, regardless of what their institutional marketers may say, said Casey, Quirk's Mr. Celeghin.

“Though hedge funds may represent only a single-digit slice of a manager's total assets, they are a much bigger slice of the revenue pie because of the 2% management fee and 20% performance fee — give or take — that they can charge,” Mr. Celeghin said.

“For giant firms like BlackRock (BLK) and J.P. Morgan, the goal for additional inflows from existing clients or assets from new clients is not about getting that money into traditional asset classes. Instead, the goal is the upsale into higher revenue hedge funds and other alternative strategies,” he added.

Money managers themselves stress they are adding, honing or perfecting hedge funds as a tool essential for use in portfolio construction for clients.

Pacific Investment Management Co. for example, has launched just three hedge fund strategies — global macro, global credit long/short and multiasset volatility relative value — in the 10 years since the Newport Beach, Calif.-based firm first entered the hedge fund space, said Jennifer Bridwell, managing director and head of PIMCO's alternative products business.

“We don't want to have a huge number of hedge funds,” she added noting that each strategy was developed in response to client demand and investment needs.

“What we are looking for are strategies that are going to help us craft very sophisticated solutions for our clients. We have many clients who have invested significant amounts in a number of PIMCO strategies and they are relying on us to help them limit correlations, add diversification, decrease risk and limit their exposure to public equities,” she said.

Ms. Bridwell said PIMCO's investment team will only add new hedge funds when the market offers new opportunities or new tools that will generate alpha. For example, the global credit long/short fund was added in 2006 because “it finally was possible. Prior to that time, you couldn't short credit efficiently,” Ms. Bridwell added. The global macro fund was launched in 2002 and the volatility fund was added in 2007.

PIMCO's hedge fund assets totaled $7.6 billion as of June 30 and grew to $9.5 billion as of Nov. 30.

New York-based AllianceBernstein (AB) LP (AB) significantly beefed up its hedge fund and other alternative investment strategies after 2008 when it became clear the firm's institutional clients needed more uncorrelated sources of alpha, said Christopher Bricker, senior managing director and head of alternative strategies.

AllianceBernstein opted to hire teams of established hedge fund managers, rather than acquire whole firms. One team came from Caxton Associates LP to manage a U.S. long/short equity fund; SunAmerica Asset Management Corp.'s alternatives business, which included both hedge and private equity funds of funds teams, was added to assist clients with direct investments.

“This is a natural evolution for a big, active equity manager with a global research footprint. We are building relevant risk and return strategies to offer to clients, some of which have been with us for decades in traditional strategies,” Mr. Bricker said.

AllianceBernstein's hedge fund assets totaled $8 billion, about 2% of total worldwide assets, as of June 30, up 2,274% from $337 million as of Sept. 30, 2004.

This article originally appeared in the December 10, 2012 print issue as, "A bigger slice of the multiasset pie".