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Lehman Brothers Buys Stake in Hedge Fund D.E. Shaw (Update4)

Date: Tuesday, March 13, 2007
Author: Yalman Onaran and Jenny Strasburg, Bloomberg

 March 13 (Bloomberg) -- Lehman Brothers Holdings Inc. bought 20 percent of D.E. Shaw & Co., the fourth-largest hedge- fund company, to gain a larger foothold in the fastest-growing part of the asset-management industry.

D.E. Shaw, led by David Shaw, a 55-year-old former Columbia University computer-science professor, oversees $29 billion for institutions and wealthy individuals with more than $1 million to invest. The price of the stake wasn't disclosed, though the New York-based firms said in a statement today it would be tied to D.E. Shaw's performance.

Securities firms including Morgan Stanley, banks and insurers are buying hedge funds to win more business from clients who pay fees averaging 2 percent of assets and 20 percent of investment profits. The loosely regulated investment pools, which can bet on falling as well as rising market prices, attracted a record $126.5 billion in 2006, according to data compiled by Chicago-based Hedge Fund Research Inc.

``These shops will constantly deepen and broaden their products because they can't stand still,'' said Bruce Foerster, president of South Beach Capital Markets, a Miami-based financial advisory firm, and a former Lehman executive. ``Lehman's proprietary trading isn't its strength, so I'm not surprised they're trying to buy into management firms like this.''

George Walker

Lehman, the fourth-biggest U.S. securities firm, agreed in January to buy one fifth of Spinnaker Capital Group, a London- based hedge fund investing in emerging markets. It has stakes in three other hedge funds: Ospraie Management LP, Marble Bar Asset Management and GLG Partners LP.

Last year, the company hired George Walker, a second cousin of President George W. Bush, from Goldman Sachs Group Inc. to head its investment-management unit.

Lehman manages $225 billion, including $9 billion in alternative-investment assets such as hedge funds. That doesn't include money at the firms in which it has minority stakes. Last year, the firm generated $1.4 billion in revenue from asset management, or 8 percent of total revenue.

Shares of Lehman fell $4.55, or 5.9 percent, to $72 at 4:01 p.m. in New York Stock Exchange composite trading. All 88 financial stocks in the Standard & Poor's 500 Index fell on concern a home lending crisis is spreading across the economy.

D.E. Shaw, founded in 1988, uses computer programs to find discrepancies in prices among securities. It also invests in distressed debt and makes bets on broad economic trends using stocks, bonds, currencies and commodities.

Industry Growth

Shaw, the firm's founder and chairman, earned $340 million in 2005, which ranked him ninth among the most highly paid hedge-fund managers, according to Institutional Investor's Alpha magazine. Shaw said in an interview in March 2006 that he was spending most of his time on scientific research and was no longer directly involved in the day-to-day running of the firm.

D.E. Shaw manages about $27 billion in hedge funds and $2 billion in traditional institutional investments, spokesman Trey Beck said. Lehman bought a minority stake in both asset management entities, he said.

Hedge funds are private partnerships that allow managers to share substantially in the profits they earn for clients. Fund assets worldwide have more than doubled in five years to $1.4 trillion, according to Hedge Fund Research.

Since June, Morgan Stanley has invested in hedge funds including Oxhead Capital Management LLC, Avenue Capital Group, FrontPoint Partners LLC, Lansdowne Partners LP and Brookville Capital Management. Morgan Stanley Chief Executive Officer John Mack told investors in November 2005 that he needed to expand in ``alternative investments'' to meet a goal of doubling profit in five years.

Returns Suffer

Investment returns will decline because of the volume of money pouring into hedge funds, David Shaw said in last year's interview during a conference at Stanford University.

``There's an enormous amount of capital now chasing a smaller amount of investment opportunities, so it's made it easier for people to go into business but harder to make a profit once you're there,'' Shaw said in the interview.

D.E. Shaw doesn't publicly disclose investment returns. Hedge funds worldwide advanced an average of 12.9 percent last year, compared with 9.3 percent in 2005, according to Hedge Fund Research. The Standard & Poor's 500 Index, a benchmark for large U.S. stocks, gained 15.8 percent including reinvested dividends in 2006.

JPMorgan Chase & Co. overtook Goldman Sachs Group Inc. last year as the largest U.S. hedge-fund manager, according to survey released earlier this month by Absolute Return magazine. New York-based JPMorgan managed $34 billion as of Dec. 31, including $20 billion at Highbridge Capital Management LLC, which it acquired in 2004. Goldman, based in New York, had $32.5 billion in hedge funds, while Bridgewater Associates Inc. of Westport, Connecticut, had $30.2 billion.

To contact the reporters on this story: Yalman Onaran in New York at yonaran@bloomberg.net ; Jenny Strasburg in New York at jstrasburg@bloomberg.net