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Sound money

When former Tiger Management head trader David Saunders co-founded K2 Advisors in 1994, he set up shop in midtown Manhattan -- where else?

For an ambitious fund-of-funds manager, the heart of New York City seemed the obvious choice, close to the headquarters of big investment banks, near many other hedge funds and a short subway ride from Saunders' Upper East Side apartment. But over the next few years, Saunders began to wonder if he shouldn't move his 26-person firm someplace more hospitable to a small business.

The terrorist attacks of September 11, 2001, made up Saunders' mind. In the spring of 2002, he transplanted his family to Fairfield County, Connecticut, and his firm to Stamford, 35 miles away from ground zero. "I personally knew 30 to 40 people who passed away on that day," says Saunders. "You start thinking: 'Life is short. Do I need to be in Manhattan?'"

For more and more people in the hedge fund business, the answer is emphatically no. Thanks to technology, information-intensive financial firms can operate almost anywhere, and post-9/11 a non­New York location seems prudent to many financiers. Add the contraction of Wall Street, and it's no wonder the industry is seeing an exodus of one of its most profitable niches. By the time Saunders celebrated K2's first year in Connecticut, the firm had a one-person branch office in New York City and just over $1 billion in assets.

The siren song of suburbia -- and Fairfield County in particular -- has several motifs. Tax savings are a significant consideration: A professional making $10 million a year can save about half a million in local income taxes by working in Connecticut rather than New York. Williams Trading, a ten-person equity trading firm catering to hedge funds, moved from New York City to Stamford in December 2002. "The money we saved on taxes alone has paid for the move," confides president David (Tiger) Williams. "New York is an extraordinarily expensive place to run a small business."

Lifestyle is another draw -- and a big part of what allows Fairfield funds to attract talent. Living and working in Greenwich is "like finding two hours in your day," exults one manager, who shakes his head at the recollection of commuting to Wall Street. Adds a hedge fund trader, "There is no price tag" to be put on having your kids stop by your office after school so you can help with their homework before shooing them off to soccer practice.

The hedge fund diaspora has settled in a number of locales: Beverly Hills, California; Boca Raton, Florida; Fort Worth, Texas; Summit, New Jersey; even Sun Valley, Idaho. But no single area has been a greater Promised Land for hedge fund managers than Fairfield County and especially its business center, Greenwich. "Greenwich is about the most optimal location for this business," says Philip Duff, the former chief financial officer of Morgan Stanley who in November 2000 launched FrontPoint Partners in an office overlooking the white columns and red bricks of Greenwich's Town Hall. Today Duff manages and markets in-house hedge funds with combined assets of $1.3 billion, run by investment teams in five cities from Toronto to Dublin. "Critical mass exists here without having the downsides of the critical mass that exists in New York."

No fewer than 114 hedge funds now call Fairfield County home -- almost triple the number a decade ago, according to Rye, New York­based Tremont Advisers, which manages its own hedge funds and tracks others. "There's a lot of bright money up here," vouches Donough McDonough, a former Lehman Brothers convertible bond trader who founded hedge fund marketing firm Boomerang Capital in Rowayton, Connecticut, in 2001.

John Costas, chairman and CEO of investment bank UBS Warburg, which manages a $9.9 billion fund of funds for institutional clients, calls the hedge fund frenzy in Fairfield "the greatest show on earth that's outside New York City." Since the Swiss firm built its U.S. headquarters in Stamford in 1997, Costas has seen the area morph from a financial backwater into a formidable money center. "For us, it's exciting," he says. "We can visit a large number of institutional clients without getting on the train."

Local heavyweights include GE Asset Management, based in Stamford, which oversees $170 billion for institutional and retail investors (including $37 billion in General Electric Co. pension money). GEAM has $1.2 billion in hedge funds. Commonfund, based in Wilton, manages $28 billion for some 1,600 colleges, universities and other nonprofits, but it won't break out how much it has in alternative investments. In addition, two subsidiaries of global behemoth AIG, a New York­based insurance and financial services company, are located in Fairfield County. AIG Trading Group, in Greenwich, makes markets in global commodities and foreign exchange for a number of hedge funds. In Wilton, AIG Financial Products Corp. designs derivatives contracts for clients that include hedge funds.

Just 17 big Fairfield County­based hedge funds manage $65.7 billion in assets, according to the Institutional Investor ranking of the top 100 hedge funds (June 2003). That's more than 10 percent of the global industry total of $622 billion, making Fairfield County the No. 2 hedge fund center after New York, which accounts for 22.7 percent of the industry's assets.

To be sure, being in the 'burbs isn't all country clubs, Talbots stores and golden retrievers. In January 2003, Edward Lampert, who heads ESL Investments, was kidnapped from the underground parking garage of his Greenwich office building. He escaped unharmed, possibly by promising to pay ransom, and his bumbling captors were caught. (They used Lampert's credit card to order pizza.) The episode left local hedge fund managers on edge and even more determined to maintain their secretive ways, although Lampert has indicated no desire to move his $5 billion hedge fund back to the city. (Nor is he keeping a particularly low profile: He acquired a 49 percent interest in ailing retail chain Kmart Corp. after its bankruptcy reorganization in early May and became chairman of the company.)

High visibility may put individual managers' personal safety at risk, but scarier for Fairfield's hedge fund community as a whole is uncertainty about their industry's future growth. Although 2002 saw net inflows of $16 billion into hedge funds, and $7 billion worth of new assets followed in the first quarter of 2003, according to Tremont Advisers, many insiders think a slowdown is inevitable. "The frothiness of the hedge fund business has subsided," says Christopher Acito, a partner at Darien, Connecticut­based investment management consulting firm Casey, Quirk & Acito. "Raising money is more challenging than six to 12 months ago."

UBS Warburg's head of capital introductions, Joseph Pescatore, who helps find investors for his bank's hedge fund clients, predicts that "out of 6,000 to 8,000 hedge funds nationally, we will see 1,000 to 1,500 disappear" in the coming year. "It's already started," he says. "We've had several managers come to us who couldn't make a go of it." One local casualty: Stamford-based Lancer Partners, which filed for Chapter 11 bankruptcy protection in April. In the wake of such failures, the Securities and Exchange Commission is targeting hedge funds for stiffer regulation (see Institutional Investor, June 2003).

It may be that the calming influence of bucolic Connecticut offsets some of these stresses. FrontPoint's Duff, who had been chief administrative officer of Tiger Management as well as CFO of Morgan Stanley, considered starting his business in New York but chose his own town of residence, Greenwich, instead because he knew he could attract talent, save on taxes and avoid the hassle of New York. Duff is soon to be joined by fellow Tiger alumnus O. Andreas Halvorsen, who founded Viking Global Investors in 1999. Now based at 280 Park Avenue, Viking (with $3.5 billion in assets) recently signed a ten-year lease in Greenwich and plans to move its 40-person staff this fall.

Some of the best and brightest in the hedge fund universe have been in Connecticut for many years. In Greenwich there's Daniel Benton of Andor Capital Management, with $9.6 billion in assets; Paul Tudor Jones II of Tudor Investment Corp. ($6.9 billion); ESL's Lampert; Stephen Mandel of Lone Pine Capital ($5 billion); and Donald Sussman of Paloma Partners Management Co. ($2.1 billion). Ten minutes up the road in Stamford are Richard Chilton of Chilton Investment Co. ($5 billion) and Steven Cohen of SAC Capital ($3.8 billion). Half an hour away in wealthy former art colony Westport, whose citizens now collect paintings instead of creating them, is Arthur Samberg of Pequot Capital Management ($7 billion).

Westport, Greenwich, Darien and the other towns along Connecticut's Gold Coast -- the southwestern slice of the state, fronting on Long Island Sound -- have long beckoned Wall Streeters. But living in paradise was one thing and working there another. Only in recent decades have advances in information technology permitted the kind of real-time data flow that hedge fund managers need to be plugged into their increasingly global territory. Observes Alexander Ineichen, head of equity derivatives research for UBS Warburg in London and author of Absolute Returns, a book about the global hedge fund industry, "As a hedge fund manager, you can operate anywhere in the world as long as you have the right technology and infrastructure."

Back in 1970, when hedge funds numbered in the low hundreds and accounted for perhaps $1 billion in total assets, only a handful were based in Greenwich. One, Fairfield Partners, was started by Greenwich resident Barton Biggs, who recently left his post as Morgan Stanley's chief global strategist to launch a hedge fund in Manhattan's Rockefeller Center. (His new fund, Traxis Partners, will manage money for Morgan Stanley.) Pounded during the early 1970s recession and stock market retrenchment, the hedge fund industry didn't regain its feet for two decades.

But in the late 1980s and early 1990s, about a dozen influential hedge fund managers -- many of them residents of Fairfield County -- set up shop there. These included Jones, who moved Tudor Investment from New York City to a secluded campus near the Connecticut­New York border in 1996; Sussman, whose Paloma was one of the very first big hedge funds to migrate to Greenwich from Manhattan, in 1991; and health care investor Larry Feinberg, who shifted Oracle Partners from New York to Greenwich in the mid-1990s.

Former Salomon Brothers head bond trader John Meriwether did his bit to put Connecticut on the hedge fund map, albeit under a cloud. His Greenwich-based Long-Term Capital Management, formed in 1993 with his old bond arbitrage group at Solly, needed a $3.6 billion bailout in 1998 after making bad bets on interest rates. After settling up with his counterparties and investors, Meriwether started over with JWM Partners, also in Greenwich. And when his firm lost one of its mainstays, resident scholar Myron Scholes, of Black-Scholes and Nobel Prize fame, Scholes didn't go far; he joined Oak Hill Platinum Partners, founded by investor Robert Bass, just over the state line in Rye Brook, New York.

More and more resident fund managers are asking themselves why they should bother traipsing into the city and back every day. "All these wealthy guys live up here, and they don't want to commute," says one such wealthy guy. Another reformed city commuter brags that his drive to the office now involves "one stop sign and one traffic light."

For hedge fund managers, the concentration of high-net-worth people on the Sound can pay professional dividends. Jeffrey Matthews, who has run Ram Partners, a small long-short value hedge fund, from Greenwich for nine years, recalls that he once landed a client during a casual encounter in a coffee shop. "You go to where the money is," he says.

Many hedge fund managers insist that by living and working outside New York City, they're giving their kids a better childhood. If nothing else, they can invest in family dinners the time they save on commuting. Many suburbanites argue that Manhattan is not child-friendly. "A lot of Wall Street people are not comfortable raising their kids in the city," one fund manager flatly declares.

As Costas sees it, such sentiments help make UBS Warburg's Stamford location a positive for recruiting city dwellers: "To attract the best people, providing an alternative to New York City and Manhattan is a huge plus. People will come at a discount to other financial incentives, everything else being equal, for the lifestyle."

Lifestyle is a concept that's hard to quantify, but not so taxes. When it comes to letting hedge funds and hedge fund managers keep more of what they earn, Connecticut beats New York City hands down. People living and working in Manhattan pay 11.34 percent in state and local income taxes (recently boosted by Mayor Michael Bloomberg from 10.85 percent), while those living and working in Greenwich or anywhere else in Connecticut pay just 5 percent.

"For very highly compensated people, it's going to be a 5-point spread, unless you have a very unusual amount of deductions," says Edward Rodenbach, a principal at Greenwich-based law firm Cummings & Lockwood. (Income taxes are what count with hedge funds, since most are structured as partnerships and taxed on partners' income rather than on corporate profits.)

The Big Apple's cover charge amounts to serious money when levied on the kind of W-2s and K-1s common in the hedge fund world. Some of the Fairfield crowd pull down extraordinary incomes: According to II's 2003 list of top-earning hedge fund managers, Jones raked in $250 million in 2002, and Kenneth Tropin, head of Stamford-based Graham Capital Management, made $65 million.

Yet a major attraction of Fairfield County is that New York City is only a short train ride away. "You don't need to be in the middle of New York to do your business, but it's helpful being close," points out Casey Quirk's Acito. He himself mans the firm's satellite office in Manhattan and lives in the city, but his four partners run the main office in Greenwich and live in Fairfield County. Many hedge funds also maintain branch offices in the city.

Proximity to New York also means Fairfield hedge funds don't sacrifice access to potential investors from abroad. "European investors block out one day to come to Connecticut because there are so many funds up here," says Steven Suss, chief financial officer of Heirloom Capital Management, a Greenwich-based long-short hedge fund with $100 million in assets. "They can knock a lot off at one time, and they are coming to New York anyway."

Any image Manhattan-based hedge fund managers might entertain of their country cousins washing down lunch with gin and tonics and knocking off at 3:00 p.m. to go sailing is way off the mark. This is strictly a type-A, ten-hour workday crowd. Michael Castine, a former executive recruiter, remembers hosting a holiday lunch for Greenwich money managers. "After an hour or so, they were tapping their fingers to get back to their screens," he says. "They're thinking, 'I might be losing money.'" In April, Castine joined Dover Management, a Greenwich-based hedge fund set up by Merrill Lynch & Co. veteran Richard Fuscone.

To be sure, not everyone finds the case for Connecticut compelling. Manhattan remains the center of the financial cosmos, and some fund managers believe it still provides the most prestigious addresses. On top of that, Fairfield County's booming popularity has created traffic headaches, especially on its main artery, I-95. "It's a schlep to get to Connecticut, no matter what you say," declares Leon Metzger, Paloma Partners' vice chairman. (Metzger is a die-hard New Yorker who commutes to Greenwich.) In fact, he says, Paloma is exploring space alternatives in Westchester, where commercial rents are lower and New York State is kicking in subsidies for new businesses.

Castine, for one, admits to missing Manhattan's adrenaline rush. "There is a pulse in New York," he says. "Out here it's not the energy blast that you have in New York." But he seems to be in the minority among Connecticut loyalists. FrontPoint's Duff has no plans to repatriate to the city, despite his grumbles about what he calls an antiquated phone system in Greenwich run by monopoly provider Verizon. Once, he says, a truck backed into a telephone pole outside FrontPoint's office, shutting his entire trading system down for a split second until the backup communications network kicked in. Nevertheless, he is shopping for a bigger space in Greenwich or Stamford. His firm has already outgrown its quarters opposite Town Hall.