Neuberger’s Dyal Fund Blurs Line Between PE and Hedge Funds

The boundaries keep getting blurred between private equity funds and hedge funds, as one of the world’s largest money managers, Neuberger Berman, has raised most of its $1 billion target for its new Dyal Capital Partners private equity fund, which plans to take minority stakes in prominent hedge fund firms.

According to a person familiar with the fund, Dyal so far has raised more than $600 million toward its goal. Dyal began raising money in July 2010, and there is a good possibility that the fund will be able to close by the end of 2011, the person said.

A spokesman for Neuberger Berman, citing regulatory restrictions, declined to comment on Dyal or its fundraising efforts. Neuberger Berman manages $198 billion in assets, and the firm also oversees a $4 billion business in hedge fund of funds.

The team leading Dyal is made up of executives from now-bankrupt Lehman Brothers who had been responsible for managing the investment bank’s $2 billion in stakes of well-known hedge fund firms such as D.E. Shaw and Ospraie Management. Michael Rees, who was one of the executives responsible for Lehman’s hedge-fund stakes and who is now the chief operating officer of Neuberger Alternative Investments, is the lead partner in the Dyal venture. Neuberger Berman was a unit of Lehman Brothers until the investment bank’s bankruptcy in September 2008.

One other investment bank, Goldman Sachs, has established a private equity fund that focuses on owning stakes in hedge fund firms. Goldman’s $1 billion Petershill Fund, which is based in its London office, bought a stake last December in Mount Lucas, a Pennsylvania hedge fund with $1.8 billion under management. The fund also owns stakes in London-based Capula Investment Management and Trafalgar Asset Managers.

Once funded, Dyal plans to take minority stakes in about a dozen established hedge fund firms. According to the person familiar with its strategy, Dyal will target hedge funds with between $1 billion and $6 billion in assets under management. The fund’s aim, the source said, will be to have a relatively hand-off approach. The fund won’t seek control of hedge fund firms in which it owns stakes, nor will it seek to change a hedge fund’s investment processes. Instead, said the source, the aim would be for Dyal to be a strategic partner with its portfolio hedge funds.

So far, Dyal’s largest investors, according to the source, have been sovereign wealth funds, followed by public pensions and endowments.

As a private equity fund, Dyal’s structure is different than a hedge fund of funds. The benefit of a private equity fund devoted to investing in hedge fund firms, according to the source familiar with Dyal, is that returns should be more stable than a hedge fund of funds. In a hedge fund of funds, an investor commonly pays “2 and 20” in management fees and carried interest on the fund of fund’s underlying performance, plus an additional annual fee to the firm that is running the fund of funds. Thus, investor returns after fees are mostly determined by the investment performance of the portfolio hedge funds.

Since Dyal is a private equity fund, Dyal (and its investors) would receive its share of fees and carried interest from each of the portfolio firm’s own LPs. Since annual fees paid to hedge funds are fairly stable, so too would be the annual fee income that is passed on to Dyal’s investors.

The source familiar with Dyal says that besides having a goal of achieving 25 percent yields, the annual fees that flow to Dyal’s investors would make up nearly half of Dyal’s overall revenues, a fact that should add a degree of stability to the fund’s annual returns, especially compared to hedge funds of funds, whose returns depend more on the underlying hedge fund’s investment performance.