From the December 2006 issue of Investment Advisor • Subscribe!

Morgan Stanley's Appetite for Hedge Funds

In early November, Morgan Stanley announced its third investment in, or acquisition of, a major hedge fund in a matter of three days. On October 30, Morgan Stanley acquired a reported minority stake (about 20%) in Avenue Capital Group for $280 million. Then on October 31, the brokerage firm fully acquired FrontPoint Partners, a $5.5 billion hedge fund manager, for what is believed to be $400 million. On November 1, Morgan Stanley acquired a 19% stake in Landsdowne Partners, a $12 billion hedge fund manager, for about $300 million.

Why gobble up so many hedge funds in such a short period of time? Matt Nelson, a senior analyst in the Investment Management practice at TowerGroup, says in a release announcing the Morgan Stanley purchases that they are "further evidence of a rapid convergence occurring between traditional asset managers and alternative managers." Within five years, he said, TowerGroup predicts that the walls separating traditional and alternative investment management will no longer exist. Nelson pointed out that Morgan Stanley's acquisition binge--"though far more aggressive"--mirrors the activities of JPMorgan and Lehman Brothers, which have also acquired stakes in large hedge funds over the few past years. These big firms are making such moves, he says, because of "pricing pressure on traditional products and the revenue opportunity from alternative investments."

TowerGroup predicted this year a 15% compound annual growth rate in hedge fund assets through 2008, Nelson notes, with assets expected to top $2 trillion. Nelson now believes that this estimate may be too conservative. He says factors such as the recent Pension Protection Act--which allows hedge fund managers to take more money from pension funds--"the continued infusion of capital from traditional managers, and the launch of new retail products may accelerate asset flows into hedge funds and result in a higher growth trajectory."

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