Boston Leads in Hedge Funds

SEC filings show Boston is a leader in hedge funds

By Ross Kerber, Boston Globe Staff April 21, 2006

New federal filings show that Massachusetts financial firms help manage more than $150 billion in hedge funds and other private investments, about 10 percent of the $1.5 trillion that the Securities and Exchange Commission estimates is held in private funds nationwide.

The filings, many available for the first time under new SEC rules that require hedge fund advisers and other managers of private funds to report data to the government, shed only a little light on this fast-growing, lucrative, and secretive corner of the world of money management.

While regulators couldn't provide figures showing where Massachusetts ranks compared to other states, the filings show that Boston is a major center of private investment.

''Boston has historically been one of the largest players in the hedge-fund industry, because the city has a tremendous pool of talented managers in the financial-services sector," said Richard A. Goldman, coleader of the hedge fund practice group at law firm Bingham McCutchen.

Scott Stewart, a Boston University finance professor, says hedge funds are a natural step for a local financial-services sector that began with insurance companies, then progressed to mutual funds and money-management. ''The hedge-fund business is a natural outgrowth of the firms that are here, and their people who leave to set up their own firms," he said.

Much of the money is tied to traditional financial-services companies including Bank of America, mutual-fund giant Fidelity Investments, and money-manager Wellington Management Co.

Private funds appeal to these firms because ''That's where the money is," said Lou Harvey, president of Dalbar Inc., a Boston market-research firm.

Compared to traditional mutual funds sold to the public, hedge funds and other types of private funds often are available only to wealthy clients and charge much higher management fees, frequently around 20 percent of profits. They're also more free to make risky bets such as short-selling stock.

The term ''hedge fund" isn't officially defined, but has come to refer to private investments made outside of some SEC public-disclosure rules. Other types of private funds can include those that take on debt to buy companies or private-equity firms that invest in assets like real estate.

The first hedge fund was created by New York manager A.W. Jones in 1949, who used a combination of short-selling and borrowing to protect, or hedge, against risks that individual stocks or the whole market would decline.

Many hedge funds have taken on much chancier strategies since then to capture higher returns. They exploded in popularity during the 1990s despite debacles like the near collapse of Long Term Capital Management in 1998. Since last year leaders of Connecticut hedge-fund operator Bayou Group have pleaded guilty to swindling $450 million from investors. Another hedge fund company, International Management Associates in Atlanta, has been closed amid complaints clients have lost millions of dollars.

Despite these cautionary tales, the hedge-fund industry worldwide has almost tripled to nearly $1.4 trillion in assets under management from $470 billion in 2000, according to research service Lipper Tass.

Locally, some of the biggest names in Boston investing have gotten into hedge funds: in February, news reports citing unidentified people said former Harvard endowment chief Jack Meyer had raised a record $6 billion for his new hedge fund firm, Convexity Capital Management LP. (A representative there said rules prevented the firm from commenting.)

Aiming to get a firmer handle on hedge funds' workings, the SEC put a rule into effect in February that requires private-fund advisers to disclose more information about themselves and the funds they work with. The rule still faces critics such as Republican SEC Commissioner Paul S. Atkins, who recent told a Boston University audience the disclosures do little to protect investors but burden both regulators and the industry. One weakness is the absence of a formal SEC definition of what is a hedge fund.

But the filings at least provide a window into how deeply some of Boston's most prominent firms have gotten into the private fund universe.

Altogether 115 Massachusetts companies or advisers have told regulators they help run private funds in some respect, as of Feb 28, according to data provided by the SEC. Its figures show Bank of America is the largest adviser of private fund assets registered in Massachusetts, with around $30.5 billion. (Bank of America says the total is now higher, more than $35 billion).

Money-manager Eaton Vance was second with $26.4 billion, followed by Wellington with $10 billion, and Adage Capital Management LP, run by former leaders of Harvard University's endowment, with $7.7 billion. Divisions of money-manager Grantham, Mayo, Van Otterloo & Co. were listed with a total of $19.8 billion.

Units of other major players like Massachusetts Mutual Financial Group and Pioneer Investments also appear. SEC officials caution the data may be out of date if companies have done more recent filings, or limited for other reasons such as overlapping accounts.

Of the more than 15 companies contacted for this article on the list, most either didn't respond to messages or said they couldn't comment because of SEC rules prohibiting them from advertising their products.

Others were more open. A Bank of America spokesman, Tom Gariepy, said the largest amount of its private-fund money, $31.5 billion run by its Columbia Management Advisors LLC unit, invests mainly in short-term bonds as part of the bank's money-market operations. Another unit, Banc of America Investment Advisors Inc., offers wealthy investors the chance to invest a combination of different hedge funds, an approach known as a ''fund of funds" strategy.

Filings show the Banc of America division solicits its clients to invest in private funds like one called ''BACAP Multi-Strategy Hedge Fund Ltd.," which requires a minimum investment of $500,000.

Eaton Vance spokeswoman Meg Pier said the $26.4 billion figure double-counts much of the money handled by the company's Boston Management and Research unit, whose total of private funds is $13.5 billion. Many of these funds are in turn pooled into one fund totaling $12.9 billion, which represents the majority of Boston Management and Research's assets, she said.

She called the funds ''pooled investment vehicles offered privately to high net worth investors and certain institutional investors." Compared to mutual funds, the private funds' advantages can include more flexible investments and better tax treatment, she said.

Private fund assets totaling $1.5 billion are associated with Fidelity units on the SEC's list. One unit, Geode Capital Management LP, helps run $646 million, according to filings. Fidelity spokeswoman Anne Crowley said the unit ''uses alternative investment strategies, including long-short management techniques."

A hedge-fund industry primer

Some terms for understanding the hedge-fund industry:

PRIVATE FUND -- Investment funds subject to less oversight. The federal Investment Company Act of 1940 regulates companies that offer investment products, such as mutual funds, to the public, but it exempted some funds from regulation, such as those with fewer than 100 investors, or if member investors had substantial money invested elsewhere.

HEDGE FUND -- Not defined by SEC regulations. In practice the term often refers to a private fund that isn't publicly marketed and in which the manager earns a ''performance fee," or a share of the fund's profits, often as much as 20 percent. By some estimates the industry now accounts for around $1.4 trillion among 8,000 funds.

FORM ADV -- To fight fraud, a new SEC rule adopted in 2004 ended exemptions and required many hedge-fund advisers and others to take steps such as filing data about themselves using the form ADV and to appoint a chief compliance officer.

ACCREDITED INVESTOR -- Under SEC rules, these include a person making more than $200,000 a year, or a couple making $300,000 a year, or a couple whose net worth exceeds $1 million. Many hedge funds and other private funds require investors to meet these minimums.

SOURCES: Securities and Exchange Commission, Lipper Tass

Ross Kerber can be reached at kerber@globe.com.