Victory Capital Management's acquisition of Austin Capital Management wasn't the only high-profile buyout of a fund of hedge funds in recent years, but it has proven to be among the more successful after some early struggles with customer retention.
Victory, an asset management arm of Cleveland's KeyCorp, bought the Texas firm in January 2006. The move has allowed KeyCorp to expand its business among institutional investors while providing crucial scale in assets and operations for its subsidiary.
Victory and Austin seem to have avoided the clash of cultures and dilution of returns that can undermine a union between a bank and an alternative asset manager.
Both Victoy and Austin have become more attractive to institutional clients since the deal. Dave Brown, senior managing director at Victory, said alternative investments are its largest area for growth. "We love the alternatives space. We think that's the future of our industry," he said. "There's always going to be a place for long-only, there's always going to be a place for typical asset management, but we see larger allocations to alternatives."
Austin's total assets under management in its four funds of funds have increased 67%, to more than $1.4 billion, since being acquired, and Victory's assets have risen 17.9%, to $64 billion. Chuck Riley, Austin's founder and senior managing director, said, "What has really changed is now we're getting a lot more exposure to the institutional world through Victory's institutional marketing people."
He said Austin became more attractive to institutional investors, including pension plans because most sizable institutional investors have a limit (typically 10%) on the percentage they can represent of a fund's overall assets.
"We're a firm that has been around a long time ... so we certainly weren't going anywhere," Mr. Riley said. "But the reality of the situation was that we were less than a billion-dollar fund of funds in an industry where the magic number is well north of $1 billion, and there were definitely some operational risks that went along with that.
"But once we were integrated into Victory, those concerns went away. Because now a very large institution could allocate to us and not be concerned about our business, because they knew we had Victory and KeyCorp backstopping us."
Though that backing is important, so was Austin autonomy, which it has maintained for the most part since the acquisition.
It is a unit of KeyCorp, as is Victory, but Austin's executives report to Victory CEO Bob Wagner.
Mr. Brown said, "They really run the business the way they ran it before, just with our oversight We're not telling them how to run their business. And if you look at Austin's investment performance, it has only gotten better."
Victory and Austin have introduced several products together, including insurance-dedicated funds, a portable alpha offering, and an Erisa-dedicated fund. Without Victory's capital and personnel, Mr. Riley said, these products "are things that we probably couldn't have done."
Over the past two years, several large investment managers and banking companies have entered the fund-of-funds field through acquisitions. This has made the large, independent fund of fund an endangered species.
Analysts said not all of these deals have gone smoothly because trying to shoehorn an entrepreneurial asset management firm into a large banking company can be difficult. And many investors are leery of such combinations
"As much as these guys say, 'Oh, we're going to continue as we've been, it's not a big change being owned by Bank X,' I think that's just wishful thinking," said a longtime fund-of-funds investor who refuses to allocate to funds owned by larger organizations. "Number one, they're going to be swamped with assets. Number two, instead of just reporting to the investors, they've got to report in two directions — downward to us, and upward to somebody in a city thousands of miles away. So, while people may say a merger or acquisition isn't going to change how they do business, it really does, whether they realize it or not."
Mr. Riley said he understands these concerns but believes the benefits far outweigh any pitfalls.
"Quite frankly, we did lose a few investors after the acquisition," he said. "They just felt that they liked us when we were a small boutique firm and they were fearful that returns were going to lag, and that we may not be as hungry as we had been before. I understand that concern. However, I think that, for other investors, the acquisition was a very positive event, because it gave us stability that we didn't have before."
He added: "We had seen other organizations go through those problems after they were acquired. I'll have to admit, when KeyCorp, through Victory Capital, first expressed an interest in us, we were not very excited about that possibility, because we didn't want to be owned by a bank. But after we met with Bob and Dave and heard their story and understood more about their organization and how they operated and what their goals were going forward, we understood that we really weren't going to be part of a bank. We were going to be part of a money management firm."
Richard X. Bove, an analyst with Punk, Ziegel & Co., said some client attrition can be dismissed, but retaining managers is more critical. "Banks cannot provide the same type of income to managers that a stand-alone hedge fund can. Manager retention will become more and more difficult the longer KeyCorp owns Victory," he said.
Tanya Styblo Beder, the chairman of the New York consultancy SBCC, said that achieving a balance between the scale of a banking company and the institutional appeal of investment management offerings is well worth the effort.
Alternative investments must be a core part of those offerings, and institutional investment in alternatives will only become more pronounced in the next couple of years, Ms. Styblo Beder said.
"In 2000, institutional investors were barely present in the hedge fund arena," she said. "This last year, they got to be 50% of the assets under management. That's pretty incredible. And, by 2010, they are forecasted to be 80% of the AUM. So, unless you have the ability to provide hedge fund and alternative products to that customer base, you're not going to be a player in the institutional arena. You've got to have a stake in the alternative asset management business."
It is not an easy task, Mr. Brown said. But he can lean on the experience he gained working in Nationwide Mutual Insurance Co.'s asset management operation when it bought Gartmore Investment Management, which had its own hedge fund operation, in 2000, and when Gartmore bought the fund-of-funds provider Riverview Investment Management in 2002.
"It's a balancing act," he said. "You have to have enough oversight and risk management and an infusion of technology, but not so much that you're going to smother them and impact how they do their business. We wanted a situation where a firm really needed us, and we needed them. We needed the manufacturing function of a hedge fund of funds; Austin needed the focus on distribution, and on taking their infrastructure and operations to the next level."
