Traditional asset managers are adding hedge funds to their institutional product lines, while many that already run hedge funds are expanding their offerings. Newcomers to the asset class include:
* Driehaus Capital Management Inc., Chicago, which has begun marketing its first hedge fund;
* The Bank of New York Co. Inc., New York, which, in lieu of starting its own hedge funds, is acquiring manager of managers Ivy Asset Management to run hedge fund products for its clients, a capability it did not have; and
* MFS Investment Management and Putnam Investments Inc., both of Boston, which are quietly raising money for their first hedge funds, while Fidelity Investments, Boston, also looks at the asset class, according to industry sources.
Meanwhile, investment firms using hedge funds are trying to grow that business and add institutional clients. Examples include:
* Merrill Lynch Investment Managers, New York, which plans to develop two to three new hedge funds in the next six to nine months;
* DLJ Asset Management Group, New York, which expects to add two new funds of hedge funds for a total of seven funds of funds; and
* J.P. Morgan Investment Management Inc., New York, which is ramping up to expand its hedge fund business.
Bob Moyer, president of Driehaus, said that the firm's hedge fund -- the Small Cap Advantage Fund -- will invest in the same stocks its traditional small-cap portfolio uses. The hedge fund, however, will be able to leverage from 0% to 100% and short from 0% to 100%, although the bias will be long.
"It was a natural extension of who we are, since we're aggressive players," he said. "We are not core managers. Running hedge funds was something we wanted to do, but we didn't have time to get into them before. Now that we are near the maximum size for some of our products, it made sense to go into these."
Driehaus won't let the fund get much bigger than $100 million, Mr. Moyer said, adding that the firm probably will develop additional hedge funds from its other strategies.
At Bank of New York, Newton Merrill, executive vice president, said the Ivy acquisition was part of the bank's strategic plan to add products it didn't already offer. "We wanted to be able to offer hedge funds to our clients because there has been so much attention focused on them recently," he said.
Ivy's $2.4 billion in assets are two-thirds institutional, one-third high net worth. Ivy tracks 1,100 hedge funds and invests in 60 to 90 of them.
John Reilly, spokesman at MFS, said he couldn't comment on hedge funds at the firm. Putnam spokeswoman Laura McNamara said the firm is not marketing hedge funds now but is discussing offering them both at Putnam and at its TH Lee, Putnam Capital unit, a joint venture with Thomas H. Lee. Vince Loporchio, a Fidelity spokesman, said the company has no plans for hedge funds at this time.
Stephen Zimmerman, co-chief operating officer at Merrill Lynch, said the firm recently introduced an index arbitrage hedge fund that now has $25 million in assets. It also oversees $1.4 billion in a fund of hedge funds for Japanese corporate pension plans. Merrill expects to build on that strategy and market it first to European institutions and then to U.S. investors.
In addition, the firm has another $700 million in a market-neutral hedge fund, launched in August 1999 by a team of portfolio mangers known as Quantitative Advisers. That team moved to Merrill from New York-based Deutsche Bank last year. This fund uses five strategies: convertible arbitrage; risk arbitrage; statistical arbitrage; volatility arbitrage; and long-short, said Jamie Kase, managing director. Its investors are half institutional, half private clients. Unlike most of its competitors' offerings, Merrill's market-neutral fund is all managed internally and is based on rapid asset allocation decisions that can change daily if necessary.
Mr. Zimmerman said several other internally managed hedge funds are in development.
Institutions have been requesting more alternative products, he said, adding that he believes pension funds will increase their allocations to such strategies. The firm recently recommended to British pension plans that they allocate 10% of assets to alternatives, with 3% to 5% of that going to hedge funds and about the same amount to private equity, Mr. Zimmerman said.
DLJ, which got into hedge funds in 1994, now oversees more than $1 billion in funds of hedge funds, with about 25% of that coming from institutional investors, according to Tom Gimbel, managing director, hedge fund investments. In response to investor demand, this year the firm will increase the scope of its offerings, growing its manager-of-managers funds and building up its consulting client business.
"Institutions recognize the value of hedge fund management techniques and tools and realize that they often have a low correlation to other asset classes such as equities and fixed income," Mr. Gimbel said.
Investors' appetite for hedge funds also has been whetted by the announcement last year that the $172 billion California Public Employees' Retirement System, Sacramento, would invest in hedge funds, Mr. Gimbel said.
"They have been a catalyst for investor interest, as have the endowments of Yale and Harvard, because both of those endowments went into alternative investments early and had strong, positive results."
DLJ now runs five funds of hedge funds that invest in 35 funds. It expects to add two more funds of funds and invest in 15 more hedge funds. Each fund of funds has a different geographic, industrial or themed focus, Mr. Gimbel said, adding he couldn't provide more details due to legal restrictions.
The consulting part of the business involves building customized portfolios of hedge funds and overseeing them for clients that invest $50 million or more.
Anne Marie Gagnon, vice president of the hedge fund group at J.P. Morgan -- which has managed hedge fund investments for private clients for 10 years -- said there has been strong interest in the asset class both from institutions and high-net-worth clients because hedge funds offer ways of diversifying portfolios through strategies that are not correlated and that offer enhanced alpha.
In preparation for the ramp-up, the hedge fund group, which had been split between Geneva and New York, has in the past year moved most of its operations to New York and expanded its staff to 30.
"There is a changing landscape in the investment management business," Ms. Gagnon said. "Investors have been moving toward indexing and enhanced indexing, and gravitating towards alternatives such as private equity and hedge funds to give them diversification and enhanced risk-adjusted returns."