(Bloomberg) — When Blackstone Inc. recruited Ivy League endowment manager Joe Dowling to make its lumbering hedge fund division more competitive last year, it took pains to minimize any appearance of drama.
Within a year, Dowling’s co-head atop the unit left. So, too, have other senior staff, by choice or pushed out, as Dowling made big hires. Clients including pensions noticed all the turnover, and some have raised questions.
What’s afoot is an effort by a new generation of Blackstone leaders to overhaul an $80 billion corner of the firm that has long operated in the shadows of its gargantuan private equity and real estate operations. The division known as BAAM — for Blackstone Alternative Asset Management — ranks as the world’s biggest hedge fund investor, yet its performance hasn’t measured up for the firm’s leaders.
Clients pulled money in each of the past three years. With other parts of Blackstone swelling, the unit’s assets under management made up just 9% of the firm’s total in the first quarter, down from about 22% a decade ago.
“This should be a much larger business than where it is today,” Blackstone President Jon Gray said in an interview.
Gray has enlisted Dowling, 58, to jolt returns, an assignment that looks all the more formidable amid this year’s market slump, with the S&P 500 clocking its worst first-half loss since 1970.
Yet BAAM’s biggest business — creating packages of hedge funds for clients — is so far defying that trend. It eked out a 1.3% gain, its biggest outperformance of markets since the 1990s, according to people with knowledge of the matter. And since the start of 2021, around the time that Dowling arrived, the division has notched an 8.6% net gain, beating both the S&P’s 3% total return as well as benchmarks tracking hedge funds, which are underwater.
With the spotlight on Dowling, the next test will be whether the team he’s building can continue the streak through turbulent markets. If he succeeds, it will bolster the clout of a new generation of Blackstone leaders.
This account is based on conversations with more than 20 current and former employees, investors and others close to the New York-based firm, many of whom asked not to be identified discussing confidential information.
In Dowling, Gray saw an unconventional money manager who transformed Brown University’s underdog endowment into the top performer in the Ivy League by the time he stepped down about two years ago. He’s a sports enthusiast with a fondness for self-improvement books. At Brown, Dowling gained a reputation for his unusually aggressive approach to going beyond the numbers when vetting outside managers, getting to know their families and personal lives.
At Blackstone, he’s reshaping a business that’s more than 10 times larger. Its mainstay is assembling portfolios of hedge funds, but it also seeds new hedge funds, buys stakes in private equity firms, runs a mutual fund and invests in deals alongside other money managers.
He’s trying to do it amid treacherous markets that have humbled once-high-flying firms including Tiger Global Management, D1 Capital Partners and Melvin Capital Management — all three of which held money from BAAM.
This year’s swings may provide opportunities for hedge funds, and “could be an incredible investment environment for BAAM,” Gray said.
‘Not Satisfied’
The hedge-fund unit wasn’t originally designed to serve customers. Blackstone established it in 1990 to manage executives’ money. But as clients clamored for access, the firm relented, letting in pensions, endowments, family offices and wealthy individuals. For years, the division kept amassing assets and pulling in fees under former Lehman Brothers co-Chief Executive Officer Tom Hill, the wheeler and dealer-turned-billionaire who’s credited with inspiring the look of Gordon Gekko in the movie “Wall Street.”
Despite that image, BAAM’s executives tended to shun the sort of high-profile transactions that regularly drew headlines about Blackstone’s other divisions. Executives viewed their main offering as a replacement for bonds, where steady gains are prized above sizzling returns — a throwback to the original meaning of “hedge” fund.
Hill stepped back from running the business in early 2018 and John McCormick assumed his duties. Gray, 52, succeeded Tony James as president weeks later, taking a more hands-on approach to BAAM. He encouraged the division to be less hidebound, more active and ramp up direct investing. He also pushed it to adopt Blackstone’s embrace of “megathemes,” such as life sciences and technology, to capitalize on fast-growing parts of the economy, as well as favored sectors such as housing and travel.
When searching for a new investment chief a few years later, Gray told potential candidates that BAAM wasn’t growing as quickly as expected and needed to take better advantage of the firm’s intellectual capital.
After reading a newspaper article on Dowling’s unconventional approach to picking hedge funds at Brown, the pair met at a restaurant on Manhattan’s Upper East Side two years ago. The candidate, once co-captain of Harvard’s squash team, struck a different tone from his short-time co-head, McCormick, a former McKinsey consultant with a dry sense of humor.
“This is someone who is clearly not satisfied with the status quo,” Gray recalled.
Since arriving at Blackstone, Dowling’s competitive streak has become well known around the office. He has compared sleep statistics collected from his smart ring with David Blitzer, the firm’s head of tactical opportunities, to see who rests better at night.
Dowling is also known for his enthusiasm for sports analogies. Investing, he said in an interview, is like scoring points.
“You are going to miss some shots,” he said. “But you are going to hopefully make more shots than you miss and win the game at the end of the day.”
Shifting Bets
Dowling is taking a lot more shots. He added dozens of outside hedge funds to the firms’ roster, reducing concentration. He placed money, for example, with Atreides Management, a “crossover” investor in public and private markets, and Islet Management, a small firm known for block trading, an area of finance that has come under regulatory scrutiny. He also ramped up co-investing with other Blackstone units, dialed down various portfolios’ credit exposure and layered on more equities.
Some of BAAM’s bets haven’t panned out. Equity hedge funds that gained last year are down in 2022. And growth equity, which makes up about 8% of Blackstone’s portfolios of hedge funds, has fallen particularly hard in this year’s tech selloff.
BAAM invested in Gabe Plotkin’s Melvin Capital after that hedge fund was crushed by a short squeeze during the meme-stock mania of early 2021. In May, with losses continuing to mount, Plotkin opted to close the firm — and Blackstone executives fielded investor questions about lessons learned.
Horizon, a new Blackstone-run crossover fund that bets on public and private growth companies, was down about 17% as of April, fueled in part by declines in China-based firms JD Logistics Inc. and Didi Global Inc., the ride-hailing giant under scrutiny by Beijing.
The fund was meant to initiate a push into growth products. But Blackstone, concerned about lofty valuations, didn’t make new private investments from July to December last year, and it has deployed just half of the $2 billion committed so far. Investors expect the firm to use the rest of that dry powder to take advantage of the market swoon and recoup losses.
Conceding they came into growth at the top of the market, executives told Horizon investors in recent months they will wait until private company valuations reset before they get comfortable investing more there. Going forward, Blackstone will continue to pursue opportunities in China, but be mindful it needs to be compensated for regulatory risk.
Gray and CEO Steve Schwarzman, 75, have both put money in Horizon.
Employee Exits
Since January, Gray and Dowling have made BAAM a part of Blackstone’s Monday meetings with the company’s most senior management — a ritual featuring debate and pointed questions from the top. Schwarzman, whose golden rule is “don’t lose money,” is present to keep tabs, and every other week Dowling moderates a brisk conversation about BAAM. The division’s employees and those in supporting roles — about 400 people — can tune in. Most do.
“That’s transparency,” Dowling said. “They can see what Steve’s asking, what Jon’s asking.”
In the same spirit, he recently moved the desks of the team that seeds hedge funds to encourage communication, and he’s convened internal roundtables.
It has been a rocky adjustment for some staff.
A third of BAAM’s roughly dozen partners left since the start of last year, and so have personnel, taking advantage of an era of job openings across Wall Street. Some departing staffers were encouraged to go. Others disagreed with the direction of the unit, the focus on thematic investing or the frequency of meetings with senior management. Some questioned whether Blackstone had strayed too much from its view of hedge fund of funds as a replacement for bonds.
The view inside the C-suite hasn’t changed, people familiar with the matter said.
The most high-profile exit came in late 2021, when Dowling’s co-head, McCormick, a 17-year-veteran at Blackstone who helped grow fee streams and products at BAAM, shocked associates by saying he wanted to focus on teaching and do something more entrepreneurial. Other departures included Min Htoo, head of special situations investing, and Michael Pierog, who led hedge fund seeding.
R.V. Kuhns & Associates, a pension adviser, recommended vigilance.
“RVK would not be surprised to see additional turnover within BAAM over the next several quarters as individuals who may have been loyal to prior leadership or who feel marginalized by new leadership seek out other opportunities,” the consultant wrote in a note to clients.
In June, the City of Norwalk Municipal Employees’ Pension Board grilled Blackstone about whether to expect more turnover. Afterward, the pension decided it wasn’t comfortable with the changes and asked to redeem $20 million from an equity hedge fund strategy.
New Playbook
Meanwhile, Dowling has been recruiting. Since his arrival, BAAM has added 20% more investment professionals. The division’s headcount is now higher than ever.
He installed David Ben-Ur as investment chief for the group’s hedge fund of funds. Ben-Ur brought over his team from CAM Capital, as well as the firm’s client, Bruce Kovner’s family office. Ben-Ur has been dialing up macro, commodities and quant hedge funds, strategies seen as less reliant on markets rising.
Atish Nigam, tapped from David Tepper’s Appaloosa Management, now leads the special situations business and has been cutting back on risk.
Gray said BAAM’s performance speaks for the unit’s ability to deliver steady returns through up or down markets.
The stress of the job and the changes aren’t for everyone, Dowling said. “That goes with a high-performance culture.”
The most important goal, he said, is to achieve a high-quality return. “If you handle that, everything else takes care of itself.”
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