Lehman in talks to buy out hedge fund pioneers in $1.5bn acquisition

Investment banks' fascination with speculative funds could signal top of the market.
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The Independent Online

A sure sign that an industry has matured is when the pioneers begin to sell up. Is that what's happening after a period of explosive growth to hedge funds? Earlier this week, Man Group, the quoted hedge fund group, reported a wobble in what until now had been a stellar growth performance, while yesterday it emerged that the partners of GLG are negotiating to sell their hedge fund back to Lehman Brothers in a deal that may be worth hundreds of millions of pounds each to the founding executives.

The managing directors Noam Gottesman, Pierre Lagrange and Philippe Jabre are in preliminary talks with their former employer to sell the fund, which industry sources value at between $1.5bn and $2bn. The move comes after JP Morgan Chase agreed to buy a majority stake in another large hedge fund earlier this week, reflecting the growing interest of Wall Street firms in hedge funds and other alternative investments.

"These are extremely preliminary talks," a person familiar with the discussions said, adding that it could be months before any deal is announced.

GLG Partners, based in London, has at least $10bn in assets under management. The hedge fund was set up within Lehman in 1995 by Mr Gottesmann, Mr Lagrange and Jonathan Green, who has since left. They bought the fund from the bank in 2000 but Lehman retained a 20 per cent stake. The trio previously worked at Goldman Sachs, where they managed money for wealthy individuals. Mr Gottesmann is thought to rent a house in Eaton Square, Belgravia, for £20,000 a week after selling his own house in Kensington for £20m.

Crispin Odey, of Odey Asset Management, said: "Some people say that the growth rate for hedge funds is slowing down and that now is a sensible time to sell."

Hedge funds, investment pools which have long catered to wealthy individuals and institutions, are becoming increasingly attractive to the big investment banks, looking for new ways of boosting earnings as income from mergers and acquisitions and initial public offerings stagnates. For their part, institutional investors such as pension funds, seeking better returns, are increasingly turning to hedge funds and other alternative investments. Hedge funds offer both high fees and the potential of big investment gains.

On Tuesday, JP Morgan, America's second-biggest bank, agreed to buy a majority stake in Highbridge Capital Management, which has $7bn in assets, in a deal thought to be worth about $1bn. Details were not disclosed, but a JP Morgan spokeswoman said the price was tied to future investment performance. While JP Morgan already has about $12bn of hedge fund assets, the deal reflects its desire to gain a larger foothold in what has been the fastest-growing area of the asset management world in the last few years. Other Wall Street firms including Goldman and Citigroup are also big players in the field.

Faced with mounting competition, hedge funds are also becoming keener to link up with larger banks to gain access to a wider pool of clients. The hedge fund industry is now worth between $800bn and $1tn, with the number of funds quadrupling to 7,000 in the past decade.

A Lehman deal with GLG would be "a good fit", an industry source said. "There will be a long-term increase in demand for good hedge funds." He added that the sector's poor performance this year was a market issue rather than an industry issue. "With choppy markets, it was relatively difficult for the average hedge fund to do well." In snapping up hedge funds, Wall Street firms show they are taking a long-term, strategic view, he said.

Fund performance has flattened over the last six months, leading some to believe the good times are over for hedge funds. Man Group, one of the world's biggest, enjoyed a spectacular run of growth in the past four years, with its shares soaring from £4 to £18.50 before sliding - closing at £11.89 yesterday. Man said this week that funds under management now total $39bn, little changed from $38.5bn at the end of March, with its biggest funds losing money. Its flagship AHL fund, with £10bn assets, tumbled 5.4 per cent in the first nine months of the year.

Man is now receiving most of its new money from institutional investors, rather than individuals who have traditionally accounted for the lion's share of its business. That is a general trend and explains why the big banks are increasingly drawn to hedge funds, people in the industry say. Whereas five years ago hedge funds received most of their money from wealthy individuals, a lot of institutional money is now flowing in, giving it capital that is more long-term and reliable. "The move by pension funds and others into hedge funds is not a short-term thing; it's a fundamental shift of assets into absolute return products," one hedge fund manager said.

By getting more involved in hedge funds, investment banks may also be better able to retain key staff. This week it emerged that Mehmet Dalman, the head of investment banking at Commerzbank, is finally leaving the German bank to set up a hedge fund after months of speculation. Mr Dalman had considered leaving during the summer but decided to stay after assurances that he could run a hedge fund business within Commerzbank.

Meanwhile, most people think the industry is overcrowded, with many hedge funds not sustainable businesses in the long run. "The number of players is going be whittled down," an analyst said, adding that at the moment "every man and his dog is trying to be a hedge fund manager". But she thought it was wrong to argue that the industry was close to its peak, saying there was a lot of growth left.

Many have commented on the dearth of talent in the industry. "There are lots of hedge funds but that doesn't mean that there are lots of great allocators of capital," Mr Odey said. He noted that hedge funds only have a limited size.

Hedge funds have suffered their worst returns since 2002, according to the CSFB/Tremont Hedge Fund Index. Funds have gained 2.75 per cent on average in the first eight months of the year, compared with 8.9 per cent in the same period last year. This suggests that while hedge funds are becoming more common, with the big investment banks getting involved, the number of players will decline but the industry is set to continue growing.