Inside D.E. Shaw's special relationship with Blackstone, which shines a light on the power the hedge fund industry's largest investors have

Sources say $50 billion quant D.E. Shaw's preferential treatment of its biggest investor, private equity giant Blackstone, leads to the fund getting special access to internal and one-off funds, as well as reduced fees.The relationship between the two is reflective of a growing industry reality that hedge funds — even industry titans like D.E. Shaw — are becoming much more responsive to, and dependent on, their biggest investors. Every hedge fund — even the biggest firms run by celebrity investors — is most concerned about one thing: Keeping its biggest investor happy. For $50 billion quant fund D.E. Shaw, that means giving its biggest investor — private equity giant Blackstone —preferential treatment, according to several sources inside the manager. Blackstone is the largest hedge fund investor in the world, with more than $78 billion invested in hedge funds as of the end of 2018, so it pulls weight across the hedge fund world. And it's unclear exactly what percentage of D.E. Shaw's assets are owned by Blackstone, since the private equity giant has invested across multiple products.But Blackstone's preferential treatment at D.E. Shaw, ahead of other large consultants and institutions, has raised eyebrows at the firm, sources day. A source inside D.E. Shaw said there was a huge difference between even how it treated Blackstone compared to Goldman Sachs, which several insiders view as the firm's second-most important investor.“It's like Blackstone is number one (in importance), Goldman is number five with no one in between, and everyone else is way, way below that,” one source said. The special treatment includes creating a special fund with reduced fees just for Blackstone and offering access to several other exclusive funds, such as a product known as Asymptote that D.E. Shaw insiders have referred to as the firm's version of Renaissance Technologies' famed Medallion fund. “They gave Blackstone a look at anything special they do,” another source inside D.E. Shaw said. “They always got the first look.”The window into D.E. Shaw's treatment of its biggest investor shows the leverage the hedge fund industry's largest investors have — and how they are using it. With thousands of hedge funds out there and poor performance plaguing the entire industry's reputation, large investors have put their size to work to get more customized products from managers while demanding lower fees.“You've seen the maturation of the business push hedge funds and alternative investment managers to segment their investors,” said Jonathan Doolan, principal at Deloitte's Casey Quirk, speaking about hedge funds in general.Every investor “always wants a little bit more” from a hedge fund, Doolan said, but “they understand the pecking order.” Don Steinbrugge, CEO of hedge fund consultancy AgeCroft Partners, said hedge funds will often tier their investors by the amount of assets invested, and service them accordingly.“The largest clients might be serviced by the head of the firm, and the smallest will meet with IR,” he said. While many investors have to travel to the hedge fund to meet, for the biggest investors, portfolio managers will go to them, he said. A representative for Blackstone declined to comment. A representative for D.E. Shaw declined to comment about specific investors or fees.See more: Hedge funds went from a niche market to a $3 trillion titan, but became a victim of their own success thanks to their biggest investorsAsymptote, which filings say is made up of roughly 70% internal assets and launched in 2012, has a minimum outside investment of $1 million, and sources say Blackstone is consistently the only outside investor in it. Marketing and investor relations staff, sources say, were once told not to bring up the fund with other investors.A source familiar with the firm's thinking said that when the firm launched the fund, all investors were notified in a conference call and by writing, and that various external investors have been in the fund. The source said the fund is currently at capacity and closed to new investors. The exclusivity of the fund is obvious in its size, strategy and investor base — it's the smallest product the firm has by assets, the source said, and it's quant strategy is different than the quant strategies offered in the firm's larger funds. A majority of investments by D.E. Shaw employees are made in funds other than Asymptote, and the majority of its quant strategies are conducted outside of that fund, the source added. The performance of Asymptote is unknown, but several sources say the fund is “some of the best stuff at D.E. Shaw.” Current and former employees at D.E. Shaw say even most employees at the hedge fund are not able to invest in the fund.In funds with other investors, Blackstone pays the same fees as everyone else, sources say. However, D.E. Shaw created one fund specifically for the private equity giant in 2010, known as Composite Graphic, which is a version of the firm's popular Composite strategy without the most illiquid investments in the fund's portfolio.It gave its largest investor a discount — not a massive one — but other investors say they weren't aware that D.E. Shaw was willing to lower the 2.5% management fee and 25% performance fee that it charges for the overall fund for Blackstone. It was also internally significant, sources say, because “dozens” of other investors have asked for fee discounts or specialty funds — and been rebuked by D.E. Shaw. All investors are aware of the Composite Graphite fund and were told about it when it was created, one of the sources said.However, a June 2011 public due diligence report by consultant Cliffwater for the Rhode Island Employees' Retirement System plan lists out all the different funds offered by D.E. Shaw — including another fund that had been started in 2010 — except for Composite Graphite. Sources say the firm had never made a fund for a single investor like Composite Graphite before it did for Blackstone. See more: Investors are asking hedge funds to move to a '0-and-30' fee model, and it's putting pressure on a big chunk of the industryThe Rhode Island pension plan declined to comment. Cliffwater did not return requests for comment. Blackstone was one of the few investors given access to a special opportunity fund in 2013 that focused on energy and oil stocks. Sources inside the firm say that every investor was told about the fund, but a majority of investors were not able to actual invest in it. The fund ended up generating annualized returns, net-of-fees, of roughly 12% from 2013 to 2016, when it was liquidated, sources say. It was also reportedly the first investor in Arcesium, the back-office company D.E. Shaw spun off in 2015.Sign up here for our weekly newsletter Wall Street Insider, a behind-the-scenes look at the stories dominating banking, business, and big deals.