The trend of investment banks taking a stake in high-profile hedge funds continued in March. Lehman Brothers announced that it would take a 20% holding in quant house DE Shaw, which has about $29 billion in assets under management. The investment bank already has investments in hedge funds GLG Partners, Ospraie Management and Marble Bar Management. In January, Lehman also took a 20% stake in emerging markets investment manager Spinnaker Capital.
According to an investment banker who advises hedge funds in M&A activity, an increasing number of managers are enquiring about interest from investment banks. "They are asking us, where is my Nomura?" he says, referring to Nomura’s acquisition of a 15% stake in hedge fund and private equity group Fortress at the end of 2006.
David Heaton, co-head of asset management in the investment banking business at Merrill Lynch in New York, says: "The Nomura investment in Fortress has intrigued many hedge funds, just as Putnam’s investment in TH Lee caught the interest of financial sponsors a few years back. While that investment did not lead to a myriad of partnerships, we expect to see a continued flow of minority investments in hedge funds by strategic partners."
Future investment
Heaton says he expects non-traditional forms of M&A activity, rather than outright majority acquisitions. "Future investment will likely take the form of past partnerships: minority interest, non-voting, and leveraging an investors’ proprietary capital base, product structuring and distribution capabilities with a hedge fund’s investment management acumen," he says.
The minority stake route has benefits for both sides of the deal. "For some investment banks and asset managers, it is too late to start building a credible alternative asset group internally, so growth into this area has to be done through acquisitions," says David Goldstein, partner at law firm White and Case in New York. "Buying stakes in hedge funds allows the banks to diversify their portfolios and their income streams. Hedge funds offer a steady income stream in the form of management fees. For hedge fund managers it is an opportunity to monetize their business. They are unlikely to miss the cashflow from the minority share that has been sold given the size of some of these managers. There is also some element of prestige that comes with having a large, well-respected investment bank participating in a fund."
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"Buying stakes in hedge funds allows the banks to diversify their portfolios and their income streams" David Goldstein, White and Case |
Goldstein expects more minority-stake transactions to take place but with more emphasis on cross-border participation rather than the simply US domestic deals that have so far dominated the news. In March, for example, Morgan Stanley announced that it intended to purchase a minority stake in Hong Kong-base Abax Global Capital. Abax is a start-up hedge fund investing in special situations in Asia, founded by former Citadel employees and the former head of Hong Kong and Greater China debt capital markets for Merrill Lynch.
"Cross-border stakes allow financial institutions to buy capacity, and enable banks access to new markets and investors," says Goldstein. "I really think you will see more US firms acquiring stakes overseas. You don’t need asset managers in 50 countries, just perhaps one in Asia, and two in Europe. It is not like buying regional banking networks but rather looking for a strategy in a particular region that is diversifying, counter-cyclical and that provides an investor base for cross-selling." He highlights the Middle East and Japan as a potential source for cross-border deals. "We have not seen many Middle Eastern financial institutions trying to get into the asset management business more broadly but there is a lot of money there and a need to deploy it," he says. "Middle Eastern institutions with a solid clientele would really be wanting to make a move like this. I would also expect greater interest from Japanese firms."