The competition for hedge fund dollars is heating up. In February, Boston-based State Street Corp. announced that it had agreed to pay $4.5 billion in stock for crosstown rival Investors Financial Services Corp. (IFIN), the parent company of Investors Bank & Trust. IBT is a leading pure-play provider of back-office services that include the administration of hedge fund assets, which was the key to the deal. IBT’s hedge fund assets will make State Street the largest hedge fund administrator, with more than $340 billion in hedge fund assets.
“The administration of hedge funds has been a major growth area for both State Street and IBT,” says Jay Hooley, State Street’s vice chairman. “And we expect this growth to continue -- particularly as global pension funds continue allocating a portion of their assets to alternative products to get exposure to top-performing investment strategies.”
The IBT deal is just the latest in a series of acquisitions by State Street aimed at making the company the leader among hedge fund administrators. In 2003 it bought New Yorkbased hedge fund administrator International Fund Services -- a leading provider of hedge fundbased accounting, administration and middle-office services. At the time, State Street had less than $35 billion in hedge fund assets under administration. International Fund Services’ hedge fund offerings, which include multicurrency accounting and global custody, helped State Street grow its hedge fund servicing stockpile -- primarily accounting and administration services -- to $185 billion. The IFIN deal will provide an additional $156 billion in hedge fund assets.
State Street’s buying spree reflects a larger trend in the sector. For hedge funds, consolidation among administrators is creating enhanced support for their operations, and demand for such services is higher than ever.
In fact, news of State Street’s latest acquisition came just two months after Bank of New York Co. announced its $16.5 billion purchase of Pittsburgh-based Mellon Financial Corp. -- part of its own push to capitalize on opportunities within the hedge fund arena. Mellon’s asset management business includes services ranging from institutional trust and custody to treasury services, as well as its DPM Mellon hedge fund administration business. Before the BoNY merger DPM Mellon serviced in excess of $40 billion in hedge fund assets -- bringing BoNY’s total hedge fund assets under management to roughly $1.1 billion as of January 2007.
Meanwhile, JPMorgan Chase & Co. is also stepping up its hedge fund focus and has acquired the alternatives businesses of U.K.-based investment funds group Threadneedle Investments and Greenwich, Connecticutbased Paloma Partners Management Co.
The recent burst of consolidation within the hedge fund administration business has been spurred by the rapid growth of hedge funds’ outsourcing activity. Alternative investments are one of the biggest drivers of custody services, requiring streamlined support systems that are compatible with electronic processing platforms. To meet demand, custody providers have stepped up development of their accounting and administration capabilities, specifically in alternative investments.
“The alternative space is clearly a continued area of growth,” says Rajen Shah, head of global custody at JPMorgan. “Our [institutional investor] clients want to find better margins, and the [new pension fund] regulations are helping them invest in alternatives in a much bigger way,” says Shah, who believes the market will continue to flourish.
That thinking is exactly what drove State Street’s management to pay a premium of $18.05 -- 38.4 percent above IFIN’s closing price on February 2, the day before the deal’s announcement. The deal marks the company’s largest expenditure since it shelled out roughly $1.5 billion for Deutsche Bank’s recordkeeping and securities lending business four years ago.
As larger institutions become more involved in hedge funds, custodians that have preexisting relationships with them are best positioned to cash in on the trend. In State Street’s case, Hooley believes the IBT acquisition will make its business particularly appealing to pension funds. “By adding the hedge business, we’re able to provide a very important and integrated service,” says Hooley.
