Conditions ripe for hedge fund seed investors

Date: Wednesday, May 7, 2008
Author: Laurence Fletcher, Reuters

Investors able to provide seed capital for hedge funds are set to enjoy the most favorable conditions in years due to an abundance of talented start-ups and a lack of competing capital.

At a time when volatile markets, poor returns and scarcity of capital might be expected to discourage hedge fund start-ups, some managers are setting up on their own.

Some of these are traders coming out of troubled investment banks, or out of larger hedge funds that have run into difficulties, who see excellent opportunities thrown up by market volatility as a result of the credit crisis.

However, attracting assets is hard in an industry that is favoring larger hedge funds for their perceived security and where the bar below which some investors will not look at a fund can be between $100 million and $1 billion.

Such a combination favors providers of seed capital.

"2008 throws up phenomenal opportunities in the seed space, I mean extraordinary opportunities, because investment banks are shedding people," said Christian Benigni, partner at First Avenue Partners, a merchant bank focusing on alternatives that helps seed start-ups.

Seed investors -- funds of funds, institutions or sovereign wealth funds -- provide start-up assets, usually tens of millions of dollars, to small funds eager to get up and running.

They aim to make their returns by negotiating a share of the fund's revenue over a certain period, a model favored by First Avenue. Other seeders, such as Thames River Capital, may take a stake in the fund firm too, allowing it to share in its profits. 

Whilst times are tough for start-ups -- "as tough as it's ever been," according to Anthony Simpson, manager director of asset manager Ramius -- hedge funds continue to spring up.

According to Hedge Fund Research, 1,152 funds were launched in 2007 and 563 liquidated. Whilst down from 1,518 launches and 717 liquidations in 2006, this may pick up as top traders from banks or larger funds start their own firms.

"From where we're sitting, there's no let-up in the number of start-ups," said Mark Brady, a partner at law firm Eversheds, who specializes in alternative investments.

One hedge fund executive, who declined to be named because he was close to the situation, said he was aware that the head of Asia proprietary trading at a large investment bank was preparing to leave with all his traders to set up a hedge fund.

"You've had big multi-strategy products where some of the strategies haven't worked and they've closed, but within it is a good team and it's become the case they've run a small amount of money. Sometimes they're looking for sources of capital and some have set up on their own," said Michael Warren, investment director at Thames River Capital.

"In the eyes of some of these hedge fund managers, these (market) opportunities are so interesting that they believe they should be approaching those with their own businesses, and not out of their old shops," said First Avenue's Benigni.

EAGERLY SOUGHT OUT

While seeding can often be a tough business, because the best hedge funds do not require assets, conditions suggest now is an opportune time to negotiate a deal. New seeding funds are being lined up to take advantage.

"It is a good time to consider seeding start-ups," said Eversheds' Brady.

"When the investment climate is less certain, there is a tendency for investment capital to follow a brand rather than merely performance, and this can make for tough going for a lot of the start-ups looking to raise money."

This month, Thames River Capital's $2.3 billion range of Warrior funds of hedge funds is making its first seed investment in two years.

It is putting $50 million into AlphaTran Capital, a hedge fund set up by a former TCI (The Children's Investment Fund) partner, among others because it sees opportunity in volatile markets.

Warren said seed investments account for 3 percent of the Warrior range but may rise to between 5 and 10 percent by the end of the year.

"In the last couple of years ... it's been easy to raise money -- there was lots of cash around and prime brokers were in good condition to provide capital," said Thames River's Warren.

"In the past six months, liquidity conditions have not just dried up, they've disappeared off the face of the earth. As a lender of capital, we're being eagerly sought out."

(Editing by David Hulmes)