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May 8, 2006 7:17 pm

Stephen Schurr: Alternative investments keep evolving

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For Stuart Bohart, hedge funds have been an open book – literally – and the book is quite different from the doomsday scenario many pundits envision.

Mr Bohart served as global head of Morgan Stanley’s prime brokerage business until last week, when the investment bank tapped the 40-year-old to be head of alternative investments at Morgan Stanley Investment Management. They would have been hard pressed to find anyone with a more inside view of the industry.

And, from his vantage point, the industry is just getting started. “The notion of a hedge fund bubble is very much off base,” he says. “We are in the early stages of a major evolution in asset management and how people invest their money,” with hedge funds leading the movement toward more varied alter­native approaches to investing that are increasingly adopted by traditional asset managers. He says the industry will continue to grow as “we are seeing an explosion in interest from institutional investors”.

But he also notes that as hedge fund strategies increasingly move into the mainstream, the wall between hedge funds and mutual funds is breaking down. Traditional asset managers are increasingly adding hedge fund-like investments, such as “130/30” funds – the 130 representing a 130 per cent long position, using leverage, partially hedged by a 30 per cent short position.

“It is no longer hedge funds on one end and mutual funds on the other, it is about modern asset management,” he says. “For instance, Threadneedle is considered a traditional UK asset manager but it is home to some of the most alter­native approaches to modern investing. The winners will be the asset managers with evolving models.”

Given this outlook, the outlook for Morgan Stanley’s hedge fund business – not to mention its prime brokerage business – looks bright. Mr Bohart will now oversee Morgan’s efforts to build hedge funds internally, take strategic stakes in hedge funds externally and explore other alternative investment opportunities. Among the investment banks, Morgan Stanley has been slow to profit from managing hedge fund money, and Mr Bohart plans to change that.

Prime brokers – who provide services to hedge funds and other managers ranging from stock lending and leverage to advisory services and capital introduction – have a better window into the industry than just about anyone, including individual hedge funds themselves. They see everything hedge funds do, all the positions held and the leverage taken.

Because Morgan Stanley is the world’s largest prime broker – estimates of market share range from 30-40 per cent – Mr Bohart is familiar with big hedge fund companies in the US and the UK, and that should help drive investment in internal and external hedge funds.

Mr Bohart leaves the prime brokerage business at a time of intensifying competition, not only from rival Goldman Sachs but also from UBS, which is spending aggressively to position itself firmly in the top three. Citigroup is also bolstering its business and Deutsche Bank and Merrill Lynch are looking to gain market share.

Morgan Stanley reportedly spends more than $100m a year on technology to keep up with the demands of the hedge fund industry. Mr Bohart and Morgan have “broken down the silos” to make the prime brokerage division a global operation that can offer hedge funds services in every investment strategy they are likely to ever need, from emerging markets to structured products. “To succeed, we must become global and we must be multi-asset class, just as hedge funds have done.”

Building Morgan Stanley’s hedge funds business will not be easy for Mr Bohart, although he has earned a reputation as a fix-it man for his efforts to strengthen Morgan Stanley’s European prime brokerage business. A crucial factor in his favour: he has done time at top flight asset management shops, including $6.5bn US multi-strategy group FrontPoint Partners and Harvard Management Corporation, the asset management operation for the university’s $25bn endowment fund. “There’s no substitution for having been on the other side of the table.”

The Lincoln, Nebraska, native has never strayed far from Morgan Stanley. “In every day of my 17-year career, I have been either a client or an employee of Morgan Stanley.” After working in China and Japan in the late 1980s and early 1990s, he helped manage money at Cargill, Bankers Trust and Harvard Management, all Morgan clients. He joined Morgan Stanley in 1997, running money for the investment management business. In 1999, Morgan decided to put traders and portfolio managers in charge of the prime broker business, and so he jumped.

In 2002, he joined FrontPoint, co-founded by former Morgan chief financial officer Phil Duff, running a quantitative fund that focused on strategies to profit on volatility. “I didn’t talk to anyone, I spent all day looking at an options book,” Mr Bohart says. “You really had to care about the S&P 500 volatility curve; it wasn’t for me.”

He returned to Morgan the following year and from his perch he sees even more changes for Morgan and the hedge fund industry. Regarding Morgan: “The worst [of the key departures] are over. Morgan Stanley is shaking off the cobwebs and starting to gain real momentum.”

While talks with FrontPoint about an outright acquisition have fallen apart, he expects the bank will take a host of strategic stakes in big hedge funds in the US and the UK.

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