June 26 (Bloomberg) -- BlackRock Inc., the largest publicly traded U.S. mutual-fund company, agreed to buy the investment unit of Quellos Group LLC for as much as $1.7 billion, more than doubling its hedge-fund assets.

BlackRock, which oversees about $1.15 trillion, will pay $562 million in cash and $188 million in stock for the division, which invests clients' money with other fund managers. Closely held Quellos's owners will get additional payments of as much as $970 million over the next 3 1/2 years depending on its fee growth, New York-based BlackRock said today in a statement.

BlackRock Chief Executive Officer Laurence Fink is buying Quellos after completing the acquisition of Merrill Lynch & Co.'s fund unit for about $9.7 billion in September. That deal helped the firm triple earnings in the first quarter, though its shares have trailed rivals such as Franklin Resources Inc. and T. Rowe Price Group Inc. this year.

``This adds another dynamic to BlackRock's world,'' Geoffrey Bobroff, an independent money-management consultant in East Greenwich, Rhode Island, said in an interview today. ``Larger players have much more leverage to gain access to top fund managers and negotiate terms.''

Seattle-based Quellos, an adviser and money manager for the wealthy, closed its tax-planning unit after it was targeted by client lawsuits and federal investigations over tax shelters. The remaining investment unit has farmed out more than $20 billion to hedge-fund and private-equity managers, both fast- growing parts of the investment industry.

`One-Stop Shop'

Funds of hedge funds gathered almost $50 billion in new assets last year, a fivefold increase from 2005, according to data compiled by Hedge Fund Research in Chicago.

Private-equity funds of funds gathered $31 billion in 2006, or 19 percent more than a year earlier, according to London- based research firm Private Equity Intelligence Ltd.

The acquisition, which BlackRock expects will close by October, will give the company $25.4 billion in funds of funds. It also directly manages $7 billion of hedge funds. BlackRock will be the ninth-largest manager of hedge funds of funds. Zurich-based UBS AG is the largest, with more than $43 billion.

``This gets them into hedge funds in a more substantial way,'' Rachel Barnard, an analyst with Morningstar Inc. in Chicago, said in an interview. ``This makes sense with Larry Fink's strategy of becoming a one-stop shop for clients.''

BlackRock's shares rose $1.77, or 1.2 percent, to $156.30 at 4:16 p.m. in New York Stock Exchange composite trading. The shares have advanced 2.9 percent this year, compared with the 9.6 percent increase in the Standard and Poor's Supercomposite Asset Management & Custody Banks Index.

Greenstein Departs

The company will rename its funds-of-funds business BlackRock Alternative Advisors. More than three-fourth of its assets will be in hedge funds, with the remainder in private equity. Funds of funds invest with many managers to diversify risk and provide more predictable returns.

Quellos CEO Jeffrey Greenstein will retire from his post after the completion of the transaction. He will remain as an adviser to help with the transition, BlackRock said.

Bryan White, chief investment officer at Quellos, will become global head of BlackRock Alternative Advisors.

``With the global capital markets changing so rapidly, we had to do something beyond organic growth,'' Fink said today in an interview. ``Alternatives are becoming such a core part of client portfolios that pretty soon, we're not going to call them alternatives any more.''

BlackRock Fees

BlackRock had net deposits of $340 million into its hedge and private-equity funds of funds during the first quarter. Fees from its hedge-fund, private-equity and real estate products surged to $70 million in the first quarter, a 78 percent increase from the previous year. Such funds accounted for 8 percent of BlackRock's investment fees in the first quarter.

Quellos has been investigated for tax-advisory activities that it has discontinued and that aren't part of the acquisition. BlackRock won't assume any potential liabilities of that business, it said in the statement.

The Senate Permanent Subcommittee of Investigations in August described Quellos as a maker and seller of abusive tax shelters, the New York Times reported. The Internal Revenue Service is conducting an audit of the firm that may result in civil penalties or a criminal referral to the Justice Department for more investigation, the Times said on Aug. 9.

Quellos denied the allegations, saying the tax-shelter work was legal as well as separate from its main business, the Times reported.

BlackRock was advised in the transaction by Citigroup Inc. and law firm Skadden, Arps, Slate, Meagher & Flom LLC. Quellos was advised by and the law firm Paul Weiss Rifkind Wharton & Garrison LLP.

To contact the reporters on this story: Andrei Postelnicu in London at apostelnicu@bloomberg.net; Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net.

Last Updated: June 26, 2007 16:37 EDT