A record number of hedge fund firms come to market

Date: Monday, November 15, 2010
Author: Harriet Agnew and Elizabeth Pfeuti, Financial News

UK hedge fund management companies are being formed at the fastest rate since the financial crisis. More were launched in the third quarter of this year than in any other quarter since before Lehman Brothers collapsed in September 2008.

Twenty-eight new hedge fund firms registered with the UK’s Financial Services Authority in the three months to the end of September, bringing the total so far this year to 65, already topping the 60 that registered during the whole of last year, according to corporate finance firm Imas Corporate Advisors.

Dominic Freemantle, head of European capital introductions at Morgan Stanley, said: “There’s a backlog of people that couldn’t launch during the crisis. Two years of pent-up demand is coming out now that there is more stability in the investor base. It was a disaster in 2008.

“No one was setting up in 2009 because the capital-raising environment was too unstable. In 2010 things have shored up a bit.”

Stephen Burke, group director at IMS Consulting, which helps firms get FSA authorisation, said: “Nearly all of those businesses would have been planned in the latter stages of 2009 and begun fundraising early in 2010. There was the combination of strong markets, improving fundraising opportunities and more investor demand.”

The big rise this quarter comes from a rapid increase in the number of applications that were lodged with the FSA in the first three months of this year. FSA authorisation takes an average of six months.

The increase in the number of new hedge fund management firms has come as money returns to hedge funds. Following two consecutive years of net outflows, net inflows resumed this year, according to data provider Hedge Fund Research.

In the third quarter, a net $19bn was allocated to hedge funds, the largest quarterly capital inflow since the fourth quarter of 2007, said HFR. Fund performance fell 19% on average in 2008, gained 20% in 2009, and this year the average hedge fund is up over 7%, according to HFR.

Of the 28 new firms, 16 were founded by former staff of large hedge fund management companies, such as CQS, Odey Asset Management and Cheyne Capital. This continues the trend of “second-generation” managers – those who have trained at a larger rival, established a track record and decided to set up on their own.

Olly Laughton-Scott, managing partner at Imas, said: “The future stars of the industry are not always content to wait for dead men’s shoes at larger firms as they may see increasing opportunities and want to exploit them.”

Leon Diamond, chief investment officer of Mansard Capital, which began trading less than two months ago, formed the new company with several former colleagues from commodities house Castlestone Management and staff from Brevan Howard.

Diamond said: “There were 17 funds at Castlestone, all with a different focus. At Mansard we want to focus purely on absolute returns – we see opportunities in the market in the differences of economic environment and want to be able to go after them.”

He has invested 70% of his own investable wealth in the firm’s global macro fund.

The pace of growth of new firms coming to market is set to increase further as the Volcker rule takes effect. This rule will force banks to scale back their proprietary trading desks, which some have already started, driving many to set up their own hedge fund.

Patric de Gentile-Williams, chief operating officer at FRM Capital Advisors, which provides start-up capital for hedge funds, said: “The wave of prop traders has become something of a tsunami. I expect that to go on for a while.”

Morgan Stanley’s Freemantle said the launch environment was likely to be dominated by second-generation hedge fund managers and former prop traders. “There’ll be a handful of big ones and a tail of small ones.”

He said the typical size was currently $25m to $75m, with fewer in the $100m-plus range than before the crisis.