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In their nearly four years managing absolute-­return investments for the $140.6 billion New York State Common Retirement Fund, Peter Carey and his team completely rebuilt the third-­largest U.S. public pension plan’s hedge fund portfolio, moving from a strategy that depended on funds of hedge funds to a much more elaborate one that focuses on direct investing, portfolio construction and manager selection.

By last summer, Carey thought that other investors could benefit from the insights and expertise his group had developed overseeing the $4 billion absolute-­return port­folio, which was invested in 28 hedge funds. But New York Common is prohibited from managing outside money, so in November, Carey and his deputy, Robert Mazurek, announced that they had joined SkyBridge Capital II and would launch a new institutional business, ­SkyBridge Direct.

SkyBridge, No. 27 on the Fund of Funds 50 — ­Institutional Investor’s annual ranking of the world’s biggest multi­manager hedge fund firms, determined by assets under management as of January 3, 2011 — didn’t have a traditional fund of hedge funds until last spring, when it bought Citi Alternative Investment’s hedge fund business. SkyBridge is one of many multi­manager hedge fund firms seeking to diversify their capital bases and attract more institutional money. In doing so these firms are responding to the transformative trends dominating the fund-of-hedge-funds industry today and are working against the increasing tendency among institutional investors — like New York ­Common — to invest directly in a basket of hedge funds they create ­themselves.

“At New York Common we realized that we had basically built a fund of hedge funds in-house,” says Carey.

The firms constituting this year’s Fund of Funds 50 run a combined $525 billion, up 4.4 percent from the $503 billion that the 50 biggest firms managed when 2010 began but 40.1 percent less than the $877 billion they had as of mid-2008. The vast majority of the money is invested with the very largest firms. The five biggest managers collectively control 27.5 percent of the assets, as top-­ranked HSBC Alternative Investments Ltd and No. 2 ­Blackstone Alternative Asset Management each saw its assets under management jump by more than $6 billion last year.