In the summer of 2001, Barton Biggs captured the attention of hedge fund managers when he announced to the world that their industry was in the midst of a bubble. Morgan Stanley's chief market strategist at the time, Biggs likened investments flowing into hedge funds, which then managed a collective $500 billion, to a gold rush and warned that sizable blowups were imminent.
A few years later, when Jes Staley, CEO of JPMorgan Asset Management, persuaded his bosses at JPMorgan Chase & Co. to buy a majority stake in hedge fund firm Highbridge Capital Management, it looked like Biggs might have been right. When the deal was announced in September 2004, assets under management in Highbridge's multistrategy hedge funds totaled just $7 billion, which many market participants thought hardly justified the $1.3 billion that JPMorgan reportedly was paying for the New Yorkbased firm. The biggest beneficiaries, they said, would be Highbridge co-founders Glenn Dubin and Henry Swieca. When analysts' predictions of a flurry of copycat acquisitions didn't immediately materialize, there was even speculation that Dubin and Swieca would end up buying back their firm.
That was then.
Now, JPMorgan is perched atop the hedge fund mountain with $33 billion in hedge fund assets, $15.7 billion of it managed by Highbridge, and there is little doubt about the merits of the deal. Last year JPMorgan saw its single-manager assets soar 70 percent, up from $19.5 billion at the end of 2005, growth Staley largely credits to the maturation of the relationship between JPMorgan's private banking business and Highbridge. Overall, hedge funds controlled an estimated $1.46 trillion in assets as of year-end 2006, according to Chicago-based Hedge Fund Research.
"The growth in the hedge fund market is for real," says Staley, explaining that institutionalization is driving the top firms to get even bigger. "This is not a bubble."
The firms that make up the 2007 Hedge Fund 100, the sixth annual ranking of the world's biggest hedge fund managers of Alpha, our sister publication, would certainly agree. Together, they managed a cool $1 trillion in hedge fund assets as of December 31, 2006 -- up from the $720 billion managed by the 100 firms on the list a year ago. The 39 percent rise in assets marks the biggest annual increase since we began tracking single-manager funds. And the firms in the Hedge Fund 100 have never been so dominant. They control 69 percent of the hedge fund industry's assets, up from 65 percent a year ago.
The amount of money managed by the individual firms on the list is also staggering. The top three -- JPMorgan, Goldman Sachs Asset Management and Bridgewater Associates -- each have at least $30 billion under management. By comparison, a year ago Goldman and Bridgewater were the only firms to break the $20 billion barrier. But the wealth this year isn't just going to the very top; 38 firms manage at least $10 billion, up from 19 in the previous ranking.
The success of New York based Goldman is especially telling. Unlike JPMorgan, whose asset growth got a boost from a 24.7 percent net return in its flagship Highbridge Capital Corp. fund, Goldman's hedge fund products generally turned in less than stellar performances. The firm's $12.5 billion Global Alpha fund, which was up 39.9 percent net in 2005, fell 6 percent last year. Nonetheless, Goldman's single-manager hedge fund assets grew $11.5 billion, to $32.5 billion, demonstrating the impact of the marketing reach and brand power of a top securities firm.
Westport, Connecticutbased Bridgewater, which drops from No. 2 to No. 3 this year, also shows the benefits that a broader business approach brings. The firm, which manages $130 billion in traditional assets, grew its hedge funds by more than $9 billion in 2006, to $30.2 billion, as many of its existing clients moved money from long-only accounts into its Pure Alpha Strategy. Although Pure Alpha was up less than 4 percent each of the past two years, the low-risk fund is popular among more conservative institutions for its noncorrelated returns.
The industry's biggest players are bulking up for a reason: They are after more permanent capital and the security it can provide. Having a steadier capital base makes it easier for firms to keep top-notch fund managers and to avoid the potential problem of liquidating positions to meet ill-timed investor redemptions.
"Permanency of capital is the Holy Grail for hedge funds," says Stuart Davies, global head of investments for Jericho, New Yorkbased Ivy Asset Management Corp., which manages $16.6 billion in funds of hedge funds. "It enables managers not only to withstand a storm but, more importantly, to take advantage of the huge opportunities that become available when one hits."
The quest for permanent capital has spurred deal activity, with hedge fund firms like London's Lansdowne Partners and New Yorkbased Avenue Capital Group and D.E. Shaw Group selling minority stakes to major investment banks. In March, Lehman Brothers purchased 20 percent of D.E. Shaw, No. 4 on the list, with $27.3 billion in assets. Last October, Morgan Stanley paid roughly $300 million each to Lansdowne (No. 14) and Avenue Capital (No. 32) for 19 percent stakes.
Teaming up is proving beneficial for hedge funds and Wall Street. For securities firms and banks, hedge funds are attractive because of the hefty fees they can generate. Hedge funds are drawn to Wall Street by its deep pockets, brand recognition and marketing strength.
"You've got someone else who is saying, 'We believe this is someone who is best in class,'" explains Avenue Capital co-founder Marc Lasry, whose firm had $10.6 billion in assets at the end of 2006. Lasry is using the money he received from Morgan Stanley to grow his business, investing it alongside the assets of institutional investors as he launches new products.
Hedge fund firms are also turning to the public markets to raise capital. In February, Fortress Investment Group (No. 33) became the first U.S. hedge fund to go public, raising $634 million in its initial public offering. As of year-end 2006, Fortress had $10.5 billion under management, up from $7.6 billion a year earlier. Because the market so readily embraced Fortress's IPO -- the stock closed its first day of trading at $31 a share, 68 percent above its $18.50 offering price -- investors are waiting for other firms to follow suit. One U.S. firm said to be readying itself for an IPO is Greenwich, Connecticutbased AQR Capital Management (No. 45). AQR had $8.9 billion at the end of 2006, up from $7.9 billion last year, when it ranked No. 32.
U.S. hedge fund firms are late to the IPO game. London-based Man Investments, No. 9 in this year's ranking, has been public since 1994. With $18.8 billion under management, Man is the world's biggest listed hedge fund firm. Nonetheless, it falls a notch from last year, when it was No. 8, with $12.7 billion. Another London firm, RAB Capital, went public in 2004 and is a new addition to this year's ranking -- though it barely makes the list with $4.9 billion.
In 2006, Citadel Investment Group was rumored to be considering an IPO, but the Chicago-based firm ended up taking a different approach to tapping the public market. In December, Citadel -- No. 18 this year, with $13.4 billion -- became the first U.S. hedge fund to issue investment-grade debt when it sold $500 million in five-year bonds.
Large capital pools and ties to securities firms don't guarantee success. Last month Swiss banking giant UBS announced it would pull the plug on its U.S.-based Dillon Read Capital Management hedge fund business after the group lost $124 million on investments in the U.S. subprime mortgage market. The bank's Chicago-based Alternative and Quantitative Investments group ranks No. 71 this year, with $6.2 billion.
Size wasn't enough to save Amaranth Advisors. Highly concentrated bets on natural gas led to more than $6 billion in losses and the Greenwich-based firm's ultimate demise. Amaranth ranked No. 39 last year, with $7.3 billion.
The growth of the hedge fund industry is an increasingly global affair. Of the firms in the 2007 Hedge Fund 100, 23 are based outside the U.S., up from 20 in last year's ranking. JPMorgan Asset Management's Staley believes that globalization is still in its infancy. "The major firms are going to be much more active internationally," he says. JPMorgan is making a hedge fund push into China through its locally branded business arm, Hong Kongbased JF Asset Management.
In an industry where the actions of the biggest firms are closely watched and mimicked, those of Barton Biggs are promising. In January 2003, Biggs gave up his post as chief market strategist at Morgan Stanley to launch Traxis Partners, a New Yorkbased firm that manages $1.4 billion for Morgan Stanley Investment Management, No. 53, with $7.7 billion in hedge fund assets.