Beyond the Hedge Fund Shakeout

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asp?capId=4841764'>Bridgewater Associates, and JPMorgan Asset Management.

Skillful Navigators

Those firms have been particularly adept at navigating through the subprime crisis and have less tarnished reputations. They stand to gain the most in coming years. Case in point: JPMorgan took a majority stake in Highbridge Capital Management in December, 2004, when the company had $7 billion in assets. Highbridge had the money-management talent and teamed up with JPMorgan to gain access to its massive sales force and distribution platform, along with connections to high-net-worth clients and institutions. Last year, Highbridge nearly doubled its capital, to $27.8 billion, from 2006, a fourfold increase in assets from when JPMorgan took its original stake. It is a model that other banks want to replicate. Indeed, Citigroup began to build a similar in-house multimanager platform about 18 months ago with 62 teams of money managers who can invest all over the world in any instrument at a moment's notice.

"Big banks have fabulous penetration of the institutional market, be it large endowments or pension funds," says Christopher Davis, president of the Money Management Institute, the trade association representing the investment advisory industry. "Plus, they may not have the ability to analyze the startups. It's a risky proposition defending why they are allocating money to something that's been operational for less than six months."

Oversight and risk-management demands by institutions investing at the big banks will certainly change. And as the big get bigger, performance will undoubtedly suffer, say some observers. A brand name that has deep pockets often offers security, but that comes at a cost, says Charles Gradante, principal of the Hennessee Group, a hedge fund consulting firm in New York. Big banks will dominate the market and are "more likely to pay out limited partners if there's a blowup, but in most cases very talented people do not want to work for a bureaucracy, unless they are very highly compensated," he says. Still, there may be extra motivation for them to team up with big banks in the short term for survival. Before the recent market rout, many hedge fund founders, such as those at Citadel Investment Group in Chicago and Blackstone Group (BX) in New York, floated public bonds and equity as a way to monetize their firm's assets. That avenue is closed for now. "The IPO is the preferred way to get your money out and still be a player in the industry," says Gradante. Adds Margaret Gilbert, managing director of Greenwich Alternative Investments, a research and advisory firm to institutional investors: "Big isn't always better, but there's no doubt that the name recognition and the power of their own distribution definitely attracts assets. Everyone knows who Goldman is."

Hedge fund investors say as much. They are bracing for more hedge fund consolidation, and their worries about who will succeed will be the big banks' gain. B. Lane Carrick, chairman and CEO of Sovereign Wealth Management in Memphis manages about $500 million for 175 high-net-worth clients. He runs a fund-of-funds that invests in a couple hundred managers, but he tends to allocate more assets in big shops. "It doesn't mean there won't be a blowup," he says. "But by owning large institutional funds we tend to eliminate the business risk."

Der Hovanesian is Banking editor for BusinessWeek in New York.