The regulation, called the Volcker rule, puts a cap on the amount of capital that Morgan Stanley can pledge to the new fund. That means senior executives at Morgan Stanley Infrastructure Partners will have to make do with a smaller share of the fund's profits, the sources said.

While the majority of the executives have so far accepted the new reality and Morgan Stanley is in talks to increase the fund managers' share of profits, a few have left the bank, the sources said, declining to be identified because they were not authorized to speak publicly on the matter.

Over the past year, at least four key executives who oversaw infrastructure fund investments in the Americas, Europe and Asia have left or are in the process of leaving the Wall Street firm, the sources said.

The most recent departures were Adil Rahmathulla, an executive director for investments in the Americas, and Gautam Bhandari, a managing director and head of Morgan Stanley Infrastructure in Asia, the sources said.

Morgan Stanley spokesman Matt Burkhard declined to comment and would not make executives available for comment.

Morgan Stanley's problems underscore the disadvantage banks have when competing with independent alternative asset managers such as Blackstone Group LP and Carlyle Group LP. They also highlight the constraints facing U.S. investment banks wishing to hold on to traditionally strong but capital-intensive businesses, particularly private equity assets that, by nature, are usually tied up for several years.

Infrastructure funds invest in assets such as roads, airports, power grids and electricity transmission networks. They offer investors low-risk returns with a long-investment horizon. But being private equity-type assets, they are much less liquid than traditional stocks and bonds.

The future of such businesses at banks like Morgan Stanley and Goldman Sachs Group Inc has been in question since the Volcker rule passed in 2010. The rule, which was mandated by the 2010 Dodd-Frank Act and named for former Federal Reserve Chairman Paul Volcker, is expected to be finalized by the end of this year.

Morgan Stanley's current $4 billion infrastructure fund, launched in 2008, is part of the bank's merchant banking business, which in turn is housed inside its investment management division.

The infrastructure fund has about 40 employees, with roughly 10 in senior investment roles, sources said.

Investment banks are already having a hard time convincing investors that they are the right custodians of alternative assets. Goldman Sachs was not as successful in its second infrastructure fund endeavor, slashing its fundraising target in half in the middle of its marketing process and ending up raising $3.1 billion.

Banks have been approaching the regulatory hurdle with different strategies. Bank of America Corp, HSBC Holdings PLC and Credit Suisse Group AG have each outlined plans to exit some private-equity businesses. Deutsche Bank AG had planned to do sell some of its alternative asset businesses as well, but reversed course in a strategic overhaul last week.

VOLCKER CHANGES

Under the Volcker rule, Morgan Stanley will have to cap investments in new private equity funds at 3 percent, far below the 10 percent investment it contributed to its existing infrastructure fund.

Fund managers have decided to increase their personal commitment to the new fund, targeting about 1 percent of its capital compared to 0.5 percent of capital of the 2008 fund, according to one of the sources.

Some executives want the firm to do more to compensate fund managers for losing out on profits as a result of Morgan Stanley's smaller commitment, with one of them even calling for a spin out of the infrastructure business, the sources said.

Morgan Stanley has been offering to share more of the carried interest - its slice of investment profits - with the fund managers. Fund managers currently get 60 percent of the carried interest, up from an initial level of 50 percent, one source said. They are negotiating a further increase for the new fund, the source added.

To be sure, a lower contribution from Morgan Stanley into the new infrastructure fund may not affect investor sentiment and the amount of money the bank is able to eventually raise.

For example, Global Infrastructure Partners (GIP), an independent firm, is putting less than 1 percent of its own money into its latest $8.25 billion infrastructure fund, according to a person familiar with the matter.

GIP did not respond to a request for comment.

DEPARTURES

But the promise of higher pay elsewhere has played a role in at least some Morgan Stanley fund executives looking for opportunities outside the bank, the sources said. Independent firms, such as GIP and Alinda Capital Partners, do not have a bank owner they have to share profits with.

Of the recent departures, Rahmathulla is on "gardening leave" - or the notice period when he is still on payroll - considering opportunities at other independent funds, sources said.

Bhandari is still at Morgan Stanley but recently informed limited partners of his intention to leave and may eventually launch his own fund, sources said.

Morgan Stanley is speaking to him about the possibility of launching an emerging markets-focused fund off its infrastructure platform, one of the sources added.

Other executives who have left the fund in the past year include Sadek Wahba, the former chief investment officer who left the fund in late 2011; and Vincent Policard, who oversaw some investments in Europe and quit Morgan Stanley in August 2011. Private equity firm KKR & Co announced in February that it had hired him.

Wahba and Policard could not be reached for comment.

After Wahba left, Morgan Stanley named three co-heads of the business - Markus Hottenrott, who is also chief investment officer; Anne Valentine Andrews, who is also chief operating officer; and Jim Wilmott, who is also head of Europe.

John Veech, a managing director, oversees investments in the Americas division where Rahmathulla worked.

(Reporting By Lauren Tara LaCapra and Greg Roumeliotis in New York; Editing by Paritosh Bansal and Ryan Woo)

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