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Full house at the hedge fund hotel

Date: Monday, March 26, 2007
Author: Phil Davis, Financial Times

The days when hedge funds were launched and run from the spare bedroom are, by widespread agreement, over. The initial costs of obtaining regulatory approval and employing lawyers and accountants are burdensome enough. But the demands of institutional investors, which now dominate flows to hedge funds, mean new managers are forced to rent smart offices, hire expensive administrators and invest in a sophisticated IT infrastructure replete with risk management and reporting tools.

The cost, allied to the difficulty in raising initial funds, means the one-man band has largely been squeezed out. "The number of funds being launched today compared with five years ago is about the same," says Patric de Gentile-Williams, chief executive of PCE Investors. "But in 2002 it was a two-man band in a back-room. Today those launching funds are Gartmore, Henderson and GLG. Small entrepreneurial teams are being squeezed out and that's regrettable."

Mr de Gentile-Williams decided in 2003 that bad news for entrepreneurs represented a business opportunity for him. Having worked in options for 20 years at Morgan Grenfell, James Capel, CSFB and Indosuez, he had seen at first hand how the 800 independent Liffe traders were left without a place of work when open outcry ended in 1997.

"Schneider Trading Associates built infrastructure that permitted proprietary trading for many of them. It occurred to me the same could be done for hedge funds," he says. Backed by Schneider Group, Mr de Gentile-Williams set up PCE Investors, which is now located in London's West End.

The idea was that hedge fund managers could set up at PCE and trade assets from day one. PCE shoulders most of the set-up costs, which can otherwise rise to 1m ($2m, 1.5m), and provides IT support and resident experts to answer initial investment, legal and marketing queries. "The managers can spend time managing the money and talking to investors," says Mr de Gentile-Williams. Most hedge fund managers own their own infrastructure and spend 51 per cent of their time managing that."

The time to launch is also greatly reduced, so niche strategies can be rolled out before competitors discover and profit from them. "It can often be a year from idea to launch," says Mr de Gentile-Williams, adding that regulatory approvals take most of this time. "We already have the regulatory approvals and the infrastructure in place, so we can do it in six weeks." But in reality, marketing efforts mean the launch can take considerably longer.

PCE is on hand to offer ongoing advice on issues that new managers struggle with, such as portfolio valuations, contracts with clients, investor credibility and fund structuring. It also offers marketing advice to eight out of the 12 hedge fund teams that are resident in its offices.

The cosseted managers are also allowed to keep all of their equity, which would not be the case if they were part of an investment bank or a fund manager. But they do become employees of PCE, and PCE demands 10 per cent of their gross revenues in return for the services provided.

Hedge fund managers appear content with their side of the deal. A total of 200 approach PCE every year and, from a standing start in January 2004, the hedge fund hotel is now full. The 16 funds, whose assets range from $3m to $300m, run a total of $900m.

PCE is looking for new premises to expand its franchise. But it does not welcome all comers. It is careful about who it lets in and demanding in how they have to work.

"They need to have an investment thesis we understand and will add significant value to investors," says Mr de Gentile-Williams. "It is not just about spectacular headline numbers."

Once a hedge fund takes PCE office space, it is watched carefully for evidence of style drift and any other aberrations. Mr de Gentile-Williams says the separation of asset management from the administrative control and oversight gives comfort to investors. "How good is the control environment at a hedge fund where the managers are responsible for the risk director's bonus?" asks Mr de Gentile-Williams.

PCE's intense oversight of the funds is also crucial to its own business model. After all, by removing most of the hedge funds' start-up and ongoing costs it is taking a significant financial risk. "The costs mean that we don't make money until a fund reaches about $100m," says Mr de Gentile-Williams. Four funds to date have closed down while another has been sold.

The business model is not yet proven. PCE has yet to make a profit, although Mr de Gentile-Williams says this year will be the turning point. And then there is the issue of competition. So far, there is no direct competitor because the obvious candidates, the prime brokers, have balked at backing new funds while providing broking and distribution services to them. But PCE does have to compete with investment banks and traditional fund management firms to attract good hedge fund managers. "We are in a race for talent, so nearly everyone is a competitor," says Mr de Gentile-Williams.

Despite the lack of profits, Mr de Gentile-Williams is determined to expand the concept in London and then in Hong Kong, Dubai and Sydney. He also sees a potential opportunity in the US.

"If the US reintroduces the tough SEC rules, new hedge funds will have to jump through hoops to set up. That's when our model starts to look attractive to them."