Big old-line firms flock to alternatives

Investments in alternatives by the nation's largest money managers have exploded.

Together, they managed at least $563 billion in hedge funds, hedge funds of funds, real estate, private equity, venture capital, structured finance and a variety of hybrid instruments as of June 30.

Some of the behemoth managers of traditional stock and bond strategies have had amazing success in just the last five years, sweeping into the kinds of esoteric investment strategies that once were the domain of smaller, specialty boutiques.

In the growth race, giant indexer Barclays Global Investors NA, San Francisco, leads the pack. BGI's alternative assets under management skyrocketed 4,873% in the five years ended June 30. BGI had a mere $246 million invested in hedge funds in June 1999. Five years later, that number grew to $12.2 billion in all alternatives, including $7.5 billion in hedge funds, $2.6 billion in equity real estate and $1.2 billion in structured products.

John Demaine, managing director and head of BGI's London-based alternatives investment group, said the driver was a "search for the most efficient way to deliver our alpha-generation capability."

Mr. Demaine said BGI's first clients for its alpha-generation strategies, delivered in the form of hedge funds, were hedge fund-of-funds managers and high-net-worth individuals. Now, about 80% of BGI's alternative assets come from institutional investors and 20% from hedge fund-of-funds managers and the high-net-worth sector.

Second after BGI was another indexing giant, State Street Global Advisors, Boston. SSgA's assets under management in alternatives jumped 1,937% in five years, to $15.5 billion as of June 30.

Other big winners: American Express Financial Advisors, Minneapolis, up 404%; INVESCO, Atlanta, 296%; and BlackRock Inc., New York, 216%.

The largest institutional manager of alternatives is Prudential Investment Management, Newark, N.J., which managed a whopping $83.3 billion in those asset classes. That's more than 17% of its $474 billion of assets under management. Citigroup Asset Management, New York, had $81.5 billion invested in alternatives as of June 30, up about 132% over the past five years. AIG Global Investment Group, New York, invested about 14% or $62 billion of its total assets of $431 billion, as of June 30. All three have extensive experience managing alternative investments for their parents' insurance general accounts.

"Alternatives are very important to us, first and foremost for managing part of our own balance sheet. It's becoming more important for external clients, as well," said Win J. Neuger, executive vice president and chief investment officer of American International Group Inc., New York, and chairman and chief executive officer of AIG Global Investment Group.

AIG portfolio managers made their first hedge fund investment in 1982, practically prehistory when it comes to hedge funds, and its first hedge fund-of-funds investment in 1988. It welcomed its first outside clients into its hedge fund strategy in 2000. In private equity and real estate, AIG was investing for decades before seeking external clients.

"A long track record is a very significant advantage," Mr. Neuger said. "Clients really like the fact that we are a major investor ourselves in all of these alternative asset classes right alongside them."

By contrast, Prudential doesn't offer private equity to outside clients any more, even though it "probably has more exposure to private markets than any other diversified financial services company," said Bernard Winograd, president. The reason: "Owner-operated firms tend to do better than institutionally sponsored companies," Mr. Winograd said.

Much of Pru's new client business is flowing to real estate and fixed-income market sectors such as collateralized debt obligations and private placements. That's because Prudential has deep experience "exploiting every sector of the fixed-income market" while managing the insurer's general account portfolio.

Two other managers with the built-in advantage of long-term experience in alternatives are GE Asset Management Inc., Stamford, Conn., and General Motors Asset Management, New York, the units that manage the bulk of their parents' pension funds.

GE Asset Management has been managing real estate for more than 40 years, private equity for 20-plus years and hedge funds since 1992, said Donald Torey, executive vice president and chief investment officer.

Another firm that has managed alternative assets since its early days is UBS Global Asset Management, Chicago. That's primarily because the firm developed strategies to implement the asset allocation models of predecessor company Brinson Partners, said Brian D. Singer, UBS'chief investment officer for the Americas.

As of June 30, UBS invested about 10%, or $49.4 billion, of its total assets of $476 billion in a mixture of alternatives.

In the past five years, UBS reorganized its asset management business and by 2002, created three separate units to manage real estate, hedge funds and funds of funds (known as its alternatives and quantitative unit) and private equity.

A very few large firms — mainly mutual fund companies — manage little or nothing in alternatives:

• Just 7% of the more than the $1 trillion Fidelity Investments, Boston, managed as of June 30 was invested in alternatives.

• At The Vanguard Group of Investment Cos., Malvern, Pa., only $4.8 billion of its $741 billion are in alternatives: a real estate investment trust indexed mutual fund.

• TIAA-CREF, New York, invested $11.5 billion, or 3%, of its $307 billion in real estate, private equity and venture capital but not hedge funds as of June 30.

And, neither Federated Investors Inc., Pittsburgh, nor Capital Guardian Trust Co./Capital Research & Management Co, both of Los Angeles, reported managing any alternative assets.

While American Express is by no means a lightweight in the alternatives area, with nearly $10 billion under management, Chief Investment Officer William F. "Ted" Truscott said the firm's focus is on "rebuilding our institutional business in traditional management strategies. … The rising importance of alternatives is clear to us, but it's not the be-all and end-all of our business. We're committed to their growth, but we're at the middle to left side of the alternatives (growth) spectrum."

The manager universe for this story was the 30 largest managers ranked by worldwide institutional assets under management as of Dec. 31, and listed in the May 31 issue of Pensions & Investments. Those firms were surveyed for details on their alternative assets under management.

Seven firms declined to provide alternatives data: Alliance Capital Management LP; Deutsche Asset Management; Goldman Sachs Asset Management; Merrill Lynch Investment Managers; Morgan Stanley Investment Management Inc.; Morgan Stanley Real Estate; and Pacific Investment Management Co.