By Svea Herbst-Bayliss
NEW YORK (Reuters) - The race to buy hedge funds is picking up speed as traditional managers want a piece of these market darlings to keep clients happy and increase their own bottom line, hedge fund industry specialists said this week at the Reuters Hedge Fund and Private Equity Summit.
But whether performance can stay high is another question, said managers, who worried that incentive to deliver top returns could be muted by a big Wall Street investment.
"The reason we are seeing more consolidation in the hedge fund community is tied closely to the interest of institutional money going into hedge funds," said Richard Bookstaber, a well known manager who published "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation."
Bookstaber's FrontPoint Quantitative Fund was bought by Morgan Stanley last year. Before that Merrill Lynch and asset manager BlackRock Inc., which has sizable hedge fund offerings, linked up. JPMorgan Chase & Co. took a stake in Highbridge Capital Management and mutual fund firm Legg Mason bought Permal Group several years ago. Other deals are being considered, speakers said.
Last year pension funds' investments in the $2 trillion hedge fund industry jumped 69 percent to $50.5 billion, industry statistics show. And more funds, including Calpers, the biggest U.S. fund, plan to increase their hedge fund investments, several chief investment officers told Reuters in the last weeks.
While hedge funds are no longer delivering the outsized double-digit returns that made them famous in the 1990s, they are becoming more popular for their ability to keep a portfolio from losing too much ground. Hedge funds, unlike mutual funds, can use techniques like shorting securities, or betting that stock prices will fall.
But big pension funds often want assurances about oversight and risk management that can be better delivered by big banks, not small hedge funds. Linkups let hedge funds concentrate on trading and leave the running of the business to someone else.
"If you are a pension fund going into hedge funds, you'd feel more comfortable dealing with larger institutions. They have natural links already," Bookstaber said.
At the same time offering more hedge fund products is another way for big banks to keep clients happy as the hedge fund industry, once reserved for wealthy investors, becomes more appealing overall.
"The pattern of taking a minority stake in hedge funds is heavily driven by having products to sell to clients," said Steven Rattner, managing principal at the Quadrangle Group, a private equity group that also offers hedge funds. "It is a way to achieve access to product," he said, explaining that it is often easier to buy a fund than to build it from scratch.
At the same time, hedge funds' fee structures -- they add a performance fee that traditional managers don't charge -- can be very lucrative for a Wall Street bank's bottom line, all speakers agreed.
Many funds that have been approached by investment banks feel flattered, but some of the most successful also said it makes more sense to remain independent.
"It is always nice to have someone try to buy you," said Barry Rosenstein, who founded Jana Partners.
But he and other speakers warned that once a hedge fund is bought up, some of the managers' firepower may fade. "There is a is lot of peril in dealing with human beings who may not have as much incentive anymore," said Rosenstein.
Phillip Maisano , head of alternative investments at Mellon Asset Management who puts together portfolios of hedge funds, said: "I like hiring hedge fund managers but I don't want to own them. A lot of the business is based on individual talent and that can go away very quickly in a larger organization."
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