February 20, 2017 12:00 AM

Merger shows that contraction isn't going away

Scott Eells/Bloomberg

PAAMCO's Jane Buchan will be co-CEO of the merged entity.

The hedge funds-of-funds industry is contracting yet again with a merger of two big institutional players, a move that has some industry observers scratching their heads about the compatibility of the parties and wondering which firm will be next on the auction block.

Pacific Alternative Asset Management Co. LLC, Newport Beach, Calif., and KKR Prisma, New York, will combine in the second quarter to form a new hedge fund-of-funds firm, PAAMCO Prisma Holdings, with $20 billion of discretionary assets under management and $14 billion under advisement.

The new firm will be majority-owned by its employees and will operate independently from KKR & Co., New York. KKR acquired 100% of Prisma Capital Partners LP in 2012. KKR will retain a 39.9% stake in the new company.

Jane Buchan, PAAMCO's chief executive officer and co-founder, and Girish Reddy, a member of KKR, co-founder of KKR Prisma and head of KKR's hedge fund business, will become co-CEOs and co-chairpersons of the new firm.

The question of whether the PAAMCO-Prisma combination will thrive when past acquisitions and mergers in the industry have not is unlikely to deter hedge funds-of-funds executives looking for a lifeline.

“At the highest level, scale is of critical importance to hedge funds-of-funds managers,” said Jeffrey Levi, a principal at money manager adviser Casey Quirk, a practice of Deloitte Consulting LLP, Darien, Conn.

“Mergers are a way for companies to gain and share operational infrastructure, distribution networks and costs,” Mr. Levi said, stressing that he expects to see “a pretty big phase of consolidation” among hedge funds-of-funds managers and traditional money managers in the very near future.

“I think you'll see straight hedge funds-of-funds consolidation or shifting of capabilities by these managers to add more multiasset class capability, liability-driven investment, hedge fund alternative beta and outsourcing-like products,” said Mr. Levi.

As for the effectiveness of the PAAMCO-Prisma working relationship, industry observers as well as the co-CEOs of the new company stressed that the two firms are very different in their approach to investment strategy.

“We're going to keep the brands separate,” Ms. Buchan said in a joint interview with Mr. Reddy. “While we share similar intellectual cultures, our investment processes are quite different,” she added.

'Combine alpha engines'

Each firm will continue to manage investments in their offices on opposite coasts. “We will combine the alpha engines of each firm and redistribute it” in different ways, Mr. Reddy said, adding that the two investment teams will collaborate to develop new investment strategies such as alternative beta.

Multiple industry sources were not particularly optimistic about the new firm's prospects for success.

Mergers are “all about the narrative, why this collaboration will be additive to each firm. But this narrative doesn't make sense,'' said James C. McKee, senior vice president and director of hedge fund research, Callan Associates Inc., San Francisco, referring to the new firm's dual investment operations.

KKR's Scott Nuttall, global head of capital and asset management, stressed in an email that the deal is about gaining scale in the hedge funds-of-funds industry.

“This is about bringing together two strong players with complementary capabilities and products to become a top-five player in the liquid alternatives space. We are proud of the work done by our team at KKR Prisma and believe this is a transformative step that will benefit clients,” Mr. Nuttall said in an email.

“We have every confidence in our compatibility. It's what brought us together and provides the foundation of a great partnership,” Mr. Reddy said in an email.

If history is any indicator, odds are stacked against guaranteed success for merged and/or acquired hedge funds-of-funds managers.

The ranks of hedge funds-of-funds managers has been steadily shrinking since the financial crisis, according to analysis of Pensions & Investments' survey data collected from these firms in the eight years ended June 30, 2016.

AUM in hedge funds of funds as of June 30, 2016, declined 33.6% to $417.9 billion from $629.6 billion as of the same date in 2008, according to P&I survey data.

The number of hedge funds-of-funds firms that responded to P&I surveys dropped to 44 in 2016, with 29 firms reporting more than $1 billion in hedge funds-of-funds assets. In 2008, there were 71 firms, with 62 managing at least $1 billion.

Of those 62 firms reporting in the 2008 survey — conducted not long before financial turmoil struck global markets — only 29 also returned the 2016 questionnaire (P&I, Sept. 19).

Hedge funds-of-funds managers' long road back

Asset growth since the financial crisis; assets are in millions as of June 30, 2016.

Total

assets

Change

since

2008

SEI Investments	$6,906	271.9%	Large asset manager's HFoF business experienced the highest growth rate of all managers during the eight-year period. Asset growth has been unsteady, however, leaping 261% to a peak of $8.3 billion in 2013, then crashing 35% in 2014. Assets fell 17% in 2016.
Rock Creek Group	$11,600	132.0%	Independent HFoF specialist sold a 35% ownership stake to Wells Fargo in 2012, and another 30% stake in 2014. Assets remained on a steady upward path after the sales.
Blackstone Alternative Asset Mgmt.	$68,650	123.0%	Large asset manager unit has grown organically, with asset growth in every year except 2009.
KKR Prisma	$10,200	104.9%	Independent HFoF specialist was acquired by KKR in 2012. Assets recovered quickly after a decline to $4.1 billion in 2009. Assets have eclipsed $10 billion for the past three years, but did decline 6.8% in 2016 from its peak of $10.9 billion in 2014. Prisma will merge with PAAMCO in the second quarter of 2017.
Strategic Investment Group	$6,024	73.0%	Boutique multiasset outsourcing specialist's HFoF assets had grown yearly until 2016, when assets fell 6.1%.
Morgan Stanley Investment Mgmt.	$21,551	65.4%	Large asset manager unit set up a joint venture in 2005 with the pension investment team of Weyerhaeuser Co. to manage hedge funds of funds and took over the unit in 2005. Assets bounced between $10 billion and $14 billion, hitting a peak in 2016.
J.P. Morgan Asset Mgmt.	$17,130	60.0%	Large asset manager unit that has grown organically. Assets peaked at $19.8 billion in 2015, up 85% from 2008. Assets dropped 13% in 2016.
Aetos Capital	$10,270	53.5%	Independent HFoF specialist has had the backing of a family office for years and recovered well after assets fell to $4.7 billion in 2009. Assets have remained higher than $10 billion since 2013.
Evanston Capital	$4,972	49.8%	Independent HFoF specialist has had a backer for several years. Asset growth since 2008 has been on a steady increase until 2016, when assets declined 6.1%.
K2 Advisors	$9,162	23.7%	Independent HFoF specialist sold a 69% stake to Franklin Templeton Investments in 2012. K2 was one of a very few HFoF managers to produce slight asset growth in 2009. Assets peaked at $10.4 billion in 2011 but fell 13.5% in 2016.
Corbin Capital Partners	$4,243	8.7%	Independent HFoF specialist has had the backing of two hedge fund managers since inception. Assets had grown yearly until 2016, when they fell 15.6%.
Goldman Sachs Asset Mgmt.	$27,249	8.6%	Large asset manager unit has steadily rebuilt its assets since its 2009 low point, despite a 6.8% decrease in 2016.
Lighthouse Partners	$8,300	1.2%	Independent HFoF specialist has had a number of backers for years. Assets fell slightly — 3.4% — in 2016 from 2014's $8.6 billion peak.
Grosvenor Capital Mgmt.	$24,900	-1.8%	Independent asset manager with multiple backers during its history topped its 2008 assets in 2014 and 2015, but assets fell $2.5 billion, or 9%, in 2016.
Pacific Alternative Asset Mgmt.	$8,667	-20.6%	Independent HFoF specialist has had a backer since inception. Discretionary assets peaked at $10.9 billion in 2008 and have not recovered, down 26% from their peak to 2016. PAAMCO will merge with KKR Prisma in the second quarter of 2017.
BlackRock	$19,200	-21.5%	Large asset manager unit acquired Quellos Group in 2007, adding $20 billion of HFoF assets. Assets haven't regained 2008's $24.5 billion peak and fell 12% in 2016.
Mesirow Advanced Strategies	$11,604	-30.1%	Large asset manager unit has stayed in the middle of the HFoF pack, with assets holding steady between $12 billion and $14 billion in recent years. However, assets tumbled 18% in 2016.
Silver Creek Capital Mgmt.	$5,731	-37.0%	Independent HFoF specialist's assets peaked at $9.1 billion in 2008 and have not reached that level since. Asset nadir was $2 billion in 2013, but assets rose 185% to $5.7 billion in 2016.
Crestline Investors	$2,700	-37.9%	Independent HFoF specialist experienced steady growth in HFoF assets until 2016, when assets dropped 53% after the firm discontinued managing some strategies to concentrate more on credit funds.
Commonfund	$1,878	-38.4%	Large manager's HFoF business saw annual asset declines after 2012. Assets peaked in 2008 at $3.1 billion and hit their low in 2016.
UBS Hedge Fund Solutions	$34,254	-38.5%	Large asset manager unit has not made acquisitions and has yet to rebuild its assets to 2008 levels, but assets increased 46.7% since the firm's 2009 nadir of $23.4 billion.
EnTrustPermal1	$26,340	-45.1%	Legg Mason acquired Permal Group in 2005 and Fauchier Partners in 2013, and merged Permal and Fauchier into EnTrust Capital in 2016. The unit is still far from regaining the aggregate $48 billion its acquisitions managed in 2008.
Lyxor Asset Management	$7,300	-62.8%	Large asset manager unit's assets peaked at $19.6 billion in 2008 and have declined steadily every year since the financial crisis.
Aberdeen Asset Mgmt.2	$4,531	-63.8%	Large asset manager's $1 billion HFoF business was bolstered by the 2015 acquisition of Arden Asset Management. Arden managed a peak of $12.5 billion in 2008 but had dropped to $5.5 billion at the time of the acquisition. Aberdeen's combined HFoF assets fell 22% in 2016.
Larch Lane Advisors	$500	-66.2%	Independent HFoF manager specializing in seeding small hedge fund managers was acquired by Fiera Capital's U.S. subsidiary in 2016. Assets were $500 million at the time of acquisition, down from a peak of $1.5 billion in 2008.
Investcorp International3	$1,869	-72.3%	Large manager's HFoF business peaked at $6.3 billion in 2008. Post-crisis assets topped out at $3.7 billion in 2011. Even with the 2015 acquisition of SSARIS Advisors and its $800 million in HFoF assets, growth was essentially flat in 2015 and 2016.
Man Group4	$11,900	-80.5%	Part hedge fund, part hedge funds-of-funds manager, this large independent firm acquired FRM Holdings in 2012 and Pine Grove Asset Management in 2014. Aggregate assets of Man Group and its acquisitions were $61.9 billion in 2008.
BNY Mellon Asset Mgmt.	$2,929	-83.9%	Large asset manager unit acquired Ivy Asset Management in 2000 when Ivy's assets were $15 billion, and EACM Associates was acquired in 2004 with $4.5 billion. Assets peaked at $18.2 billion in 2008, but Ivy was hit with high investor redemptions after its association with Bernie Madoff became known. BNY Mellon shuttered Ivy in 2010 after the unit's assets dropped to $2.5 billion.
GAM Group	$3,165	-87.3%	Large asset manager unit has seen a precipitous 87.3% slide in HFoF assets from a peak of $24.9 billion. Assets have declined every year since the financial crisis.

Notes:

1 2008 assets are the sum of the HFoF assets of future acquisitions Permal Group, $35.481 billion; Fauchier Partners, $8.3 billion; and EnTrust Capital, $4.215 billion, all as of 6/30/08.

2 2008 assets are Arden Asset Management's HFoF assets as of 6/30/08.

3 2008 assets are the sum of future acquisition SSARIS, $448 million as of 6/30/07, and Investcorp, $6.298 billion as of 6/30/08.

4 2008 assets are sum of HFoF assets of future acquisitions FRM Holdings, $15.574 billion; Pine Grove Associates, $1 billion; and Man Group, $45.3 billion, all as of 6/30/08.

Source: Company information

Analysis of the 2016 data of the 29 $1 billion-plus firms that that responded to both P&I surveys:

Four acquired or took ownership stakes in a total of 11 hedge funds-of-funds managers over the eight-year span;
Six managers sold ownership stakes before 2008;
Five firms remained independent;
Ten firms, all units of large multiasset managers, stayed in the hedge funds-of-funds business without making acquisitions, although half experienced significant asset declines; and
Fourteen firms had positive asset growth, and 15 firms experienced declines over the eight-year period. (Some of the 29 surviving firms are in multiple categories.)

Of the 10 hedge funds-of-funds managers with double- or triple-digit growth of assets under management between 2008 and 2016, four firms are independent or units of large money managers that grew organically while the remaining six firms sold ownership stakes to other companies at some point in their history.

Among the 15 companies with double-digit AUM losses, five firms were acquirers; two were acquired or had a backer; two were independent; and 11 were units of large money managers, four of which were acquirers. (Some firms with AUM losses are in multiple categories.)

Active acquirers

A number of the hedge funds-of-funds managers near the bottom of P&I's AUM gain-and-loss chart have been active acquirers but had trouble holding on to the acquired assets.

Hedge funds-of-funds assets managed by BNY Mellon Investment Management, New York, for example, declined a precipitous 83.9% to $2.9 billion in 2016, from $18.2 billion in 2008.

BNY Mellon Investment Management acquired hedge funds-of-funds managers Ivy Asset Management, with $15 billion in AUM, in 2000, and EACM Associates Capital Markets in 2004, with $4.5 billion under management.

Ivy began to see high client redemptions in 2006 after losses from soured investments in Amaranth Advisors LLC and again after 2008 when its association with Bernard L. Madoff Investment Securities LLC became known. BNY Mellon shuttered Ivy in 2010 after assets declined to $2.5 billion (P&I, April 5, 2010).

Benjamin Tanner, a BNY Mellon Investment Management spokes-man, declined to comment.

London-based Man Group PLC also had a steep 80.4% decline in hedge funds-of-funds assets over the eight-year period, despite bolstering its AUM with the acquisition of FRM Holdings in 2012 and Pine Grove Asset Management LLC in 2014.

As of June 30, 2008, the combined AUM of Man Group ($45.3 billion), FRM ($15.6 billion) and Pine Grove ($1 billion) totaled $60.9 billion. Man Group hedge funds-of-funds AUM on June 30, 2016, was $11.9 billion.

A Man Group spokeswoman declined to comment.

Most active

Legg Mason Inc., Baltimore, has been one of the most active acquirers of hedge funds-of-funds firms, beginning in 2005 with Permal Group, which brought in $20.5 billion.

In 2013, the Fauchier Partners acquisition brought in $6 billion. In 2016, Legg Mason merged Permal with EnTrust Capital, which managed $12 billion at the time.

Assets of the three hedge funds-of-funds firms totaled $26.3 billion as of June 30, 2016, down 45.1% from $48 billion as of the same date in 2008.

Gregg S. Hymowitz, EnTrustPermal's chairman and CEO, said in an interview that while the firm's core commingled multistrategy hedge funds of funds have decreased since the financial crisis, its co-investment hedge funds of funds have attracted $6 billion during the eight-year period from institutional investors.

“When Legg Mason acquired Permal Group in 2005, it was primarily a firm with a European high-net worth investor base, which saw some nice growth until the financial crisis. After that, they did a nice job transitioning that business to an institutionally focused one,” added Joseph A. Sullivan, Legg Mason's CEO, in an email.