October 14, 2019

At Goldman Sachs, The Real Money May Be in Seeding Hedge Funds

Lloyd Blankfein, Goldman Sachs's CEO and risk management expert, has found seeding hedge funds a safe alternative to internal funds

Goldman Sachs’s approach to hedge funds is changing. Liz Rappaport reports in the The Wall Street Journal that the firm is shifting its focus from its internal Goldman Sachs Asset Management, or GSAM, hedge funds and towards investing in new start-ups. Everyone knows great-performing hedge funds reap tremendous profits for its principals and many investment banks got in on the action. Yet, after suffering losses internally using its own money, or proprietary trading, firms are looking elsewhere. And at Goldman Sachs, the real money may be in seeding hedge funds.

The New York securities firm has raised $600 million from clients such as pension funds, wealthy families and large institutions for a new fund. It plans investments in eight to 10 new hedge funds, to get them up and running, according to people familiar with the matter.

Investors will earn returns based on the hedge funds’ success, topped off with a percentage of the hedge-fund managers’ fees, said people familiar with the matter.

Typically, investors that seed new hedge funds take 15% to 25% of both types of fees that hedge-fund managers get, including the typical 2% fee investors must pay to join the fund and the 20% managers take out of their returns. It is unclear what percentage of fees Goldman’s fund is taking.

Goldman stands to gain fees on the total amount managed by the fund—and also from business the hedge funds will do with the bank’s trading unit.

In the run-up to the financial turmoil of 2008, Goldman and a number of its rivals, such as Morgan Stanley and J.P. Morgan Chase & Co., bought hedge funds or set up in-house hedge funds, lured by the high returns promised by those businesses. But when the crisis hit, many were left shouldering large losses, prompting the firms to reduce their exposure to hedge funds.

At Goldman, the Global Alpha Fund L.P.—a computer-driven trading fund that had grown to $12 billion in assets, including some of the firm’s own cash, and had generated double-digit annual returns just before the financial crisis—closed at the end of October after investors pulled their money and the fund suffered losses.

Internal hedge funds are indeed risky. Some point to the demise of two of Bear Stearns’s internal funds as the catalyst for their collapse. Indeed, author William Cohan likened the firm to a “house of cards”, with the business falling quickly as one unit got squeezed. A smart way of limiting risk and increasing returns is seed money – much like the role of venture capital for startup companies. Instead of risking its own money on a potential payoff, at Goldman Sachs, the real money may be in seeding hedge funds.

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