2012 has been the year of the deal for the hedge funds-of-funds industry as players seek bigger partners with strong defined contribution and retail investor distribution networks to help them find new sources of inflows.
Five of the 25 largest hedge funds-of-funds managers — Fauchier Partners LLP, FRM Holdings Ltd., K2 Advisors LLC, Prisma Capital Partners LP and The Rock Creek Group LP, managing an aggregate $37.9 billion for some of the world's most prestigious institutional investors — have changed their ownership structure this year or will in the first quarter of 2013.
Their motivation is primarily financial, sources said.
Outflows continue as institutional investors become more comfortable investing directly in hedge funds. And pressure on fees from the remaining institutional clients and prospects is intense, prompting hedge funds-of-funds managers to look for richer fees from defined contribution and retail investors in liquid hedge fund mutual funds, observers noted.
Large multiasset-class money managers have come to the rescue, courting institutional-quality hedge funds-of-funds firms to fill a gap in their investment lineup, sources said.
“Hedge funds of funds are a good solution for traditional money managers that need to add alternative investment capabilities,” said Franklin H. Kettle, managing director of boutique investment bank Colchester Partners LLC, Boston.
“In the current environment, every chief investment officer has the same damn problem — achieving a 7.75% annual return. With low-yielding bond portfolios and wildly volatile equity strategies, companies like Franklin Templeton and others absolutely have to be able to offer hedge funds or be prepared to watch an awful lot of money walk out the door,” said the banker.
Gaining access to Wells Fargo Asset Management's large global distribution network was one reason Rock Creek Group, which lacks a dedicated marketing force, agreed to a deal in mid-December to sell a 35% stake to Wells Fargo Asset Management, San Francisco, said Afsaneh Mashayeki Beschloss, Washington-based Rock Creek's CEO and chief investment officer.
Terms of the deal were not disclosed, but Wells Fargo has an option to increase its ownership to a majority stake in Rock Creek over time, said Michael J. Niedermeyer, WFAM's CEO. “What's driving this (deal) is that we have a product gap. Few firms of our size are without this capability. This is a pretty straightforward deal to meet client demand.”
WFAM manages $450 billion, about 70% of which is for institutional investors. Rock Creek Group manages $7 billion in commingled and separate hedge funds-of-funds accounts as well as in customized funds-of-funds strategies.
Unlike Wells Fargo's minority stake, acquirers in the other four prominent hedge funds-of-funds deals of 2012 took or will take majority or 100% stakes.
Legg Mason (LM) Inc. (LM), Baltimore, for example, will acquire London-based Fauchier Partners from BNP Paribas Investment Partners in the first quarter of 2013 and combine it with its New York-based subsidiary The Permal Group to create a $24 billion hedge funds-of-funds money management unit. Terms of the deal were not disclosed.
In the case of Fauchier, sources said one of Permal Group's motivations was more to obtain a solid institutional hedge funds-of-funds manager to boost its market share and credibility than to gain defined contribution and retail investor access. Still, a new global distribution partnership between Permal and Paris-based BNP Paribas Investment Partners also will distribute Permal Group's hedge funds-of-funds strategies through the French firm's wealth management business.
Fauchier Partners manages 95% of its $6 billion under management for U.K., European, Asian and Australian institutional investors, while 50% of the $18 billion Permal Group manages is from institutional investors, mostly North American.
Other major hedge funds-of-funds deals this year were:
- Franklin Templeton (BEN) Investments (BEN), San Mateo, Calif., purchased a 69% majority stake in K2 Advisors from TA Associates Management LP in November and will acquire the remainder of K2's equity ownership over several years. K2 Advisors' $9.3 billion hedge funds-of-funds business fills a product gap for FTI and it will continue to operate under its own name from its Stamford, Conn., headquarters.
- Man Group PLC bought FRM Holdings Ltd. in July and combined its own $11 billion of hedge funds-of-funds assets with FRM's $8 billion of assets in a unit that operates under the FRM name. Both firms are based in London.
- Kohlberg Kravis Roberts & Co. LP acquired 100% of Prisma Capital Partners in October. As part of the deal, AEGON Group sold its undisclosed minority stake in Prisma to KKR and will remain an investor in Prisma's hedge funds of funds.
With these five deals, just six of the 25 largest companies on Pensions & Investments' hedge funds-of-funds list continue to operate primarily as stand-alone firms without a large parent company or controlling external investor: Aetos Alternatives Management LLC, Arden Asset Management LLC, EnTrust Capital, Grosvenor Capital Management LP, Morgan Creek Capital Management LLC and Pacific Alternative Asset Management Co.
Interest in grabbing all or part of these large hedge funds-of-funds firms plus another top institutional player, Crestline Investments Inc., likely will continue to be high, sources said, because they are among the last desirable companies without a big partner.
“A number of high-quality hedge funds-of-funds managers have experienced redemptions since 2008, but outflows have stabilized, making them attractive acquisitions. And for any large acquirer, the key to the success of a deal is to get one of the credible, institutional hedge funds-of-funds managers, not a firm that is struggling,” Colchester Partners' Mr. Kettle said.
Crestline's founding partner and chief investment officer, Douglas K. Bratton, stressed the 100% employee-owned firm has a history of being an opportunistic acquirer itself rather than the target of a larger firm. Crestline so far has taken on three smaller hedge funds-of-funds. The most recent deal was the May 2012 acquisition of some of the investment contracts for Lyster Watson & Co.'s $300 million hedge funds-of-funds business, which it was closing down.
“We get shown everything, because everyone knows we are willing to take a look at hedge funds-of-funds companies that have a similar client base, culture and investment process,” Mr. Bratton said.
Crestline Investments manages $7.2 billion mostly for institutions.
Private equity manager Hellman & Friedman LLC acquired a passive 30% stake in Chicago-based Grosvenor Capital Management in 2007, but Michael J. Sacks, Grosvenor's CEO, said there has been no talk yet of finding a new buyer for the stake.
“We're a pretty successful institutional manager, but one of our priorities is to create distribution capabilities in defined contribution and retail investor channels,” through a variety of possible partnership structures, Mr. Sacks said.
The “mainstreaming of alternatives” is “inevitable,” Mr. Sacks stressed.
“Every sophisticated institutional investor uses alternatives as does every sovereign wealth fund and every wealth management program. It makes no sense that defined contribution plan participants that have to fend for themselves for their retirement don't have access to the same investment tools that the smart money crowd does,” said Mr. Sacks.
Bloomberg contributed to this story.
This article originally appeared in the December 24, 2012 print issue as, "2012 was a year of deals for big funds of funds".