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Great year anticipated for hedge fund startups

Date: Monday, January 20, 2014
Author: Christine Williamson, Pensions&Investments

Experience, available seed money, spinouts are among factors that could make for explosive 2014

2014 is shaping up to be one of the most active years for hedge fund launches since before the financial crisis.

That's due to a combination of factors, including:

  • experienced hedge fund teams planning to start their own firms;
  • ready seed money from larger alternative investment managers;
  • more spinouts of bank hedge fund and proprietary trading units to comply with Volcker rule requirements; and
  • institutional investors' increasing readiness to invest with managers holding shorter-than-normal track records.

Toward the end of 2013 and the beginning of 2014, senior hedge fund executives began to exit their old firms because implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act's Volcker rule on Dec. 10 lifted regulatory uncertainty in the U.S., said Jon Hansen, managing director and a hedge fund specialist at investment consultant Cambridge Associates LLC, Boston.

And the fact that many of the largest hedge fund managers have closed their funds to new investors and aren't currently hiring is also pushing talented managers to start their own firms, said Stephen L. Nesbitt, CEO of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif.

Mr. Nesbitt said the institutional investment industry is in “phase two, which means that many investors are looking for new hedge funds to invest in, since so many big funds are closed, and they need either ... to meet their asset allocation target or want to replace some of their managers.”

Lawyers, prime brokers and financial software and risk management system providers said they are already busy this year helping set up hedge fund firms. But like Cambridge's Mr. Hansen, all declined to name names.

One startup industry participants await is Aravt Global LLC, New York. The founder is Wui Yen Liow, former managing director and hedge fund sector head at Ziff Brothers Investments LLC, New York, a family office that is winding down its U.S. business.

Also hotly anticipated is a firm being created by Anand Desai, a long-tenured senior portfolio manager at Eton Park Capital Management LP, New York, who left in April with the intent of opening his own, as-yet-unnamed, hedge fund shop.

With such strong pedigrees from well-established investment firms, many believe both Messrs. Liow and Desai likely will start trading with assets of between $500 million to more than $1 billion. Neither has opened, and neither is registered with the SEC, and neither Mr. Liow nor Mr. Desai could be reached for comment.

Because of the long gap between launching a firm, raising assets and opening the hedge fund — usually at least a year — several firms that opened their doors in 2013 only recently started investing. Among them:

  • Three Bays Capital LP, Boston, which manages about $500 million and was founded by Matthew K. Sidman, managing partner and chief investment officer, formerly a veteran portfolio manager at Highfields Capital Management LP, Boston; and
  • Junto Capital Management LP, New York, with about $317 million, which is headed by CEO James C. Parsons, who was a senior portfolio manager at Viking Global Investors LP, Greenwich, Conn.

“In just the first two weeks of January, we've seen a surge of interest. You can expect to see a number of high-quality, big-name, big launches early this year,” said Steven B. Nadel, a partner and specialist hedge fund attorney at Seward & Kissel LLP, New York.

Dean C. Backer, managing director and global head of sales and capital introduction for New York-based Goldman Sachs & Co.'s global securities services unit, said: “I've never seen as robust an environment for hedge fund launches as we're moving into now. Well-established, experienced investment teams are staying intact and moving out on their own, bringing their institutional limited partners with them. New institutional investors will not wait the usual two to four years before investing in some of these new hedge funds.”

He added that Goldman Sachs' prime brokerage team anticipates eight to 10 hedge fund company launches starting with assets between $300 million and $1 billion in the first nine months of 2014.

Even though the environment is conducive to hedge fund startups, raising assets won't necessarily be easy, even from institutional investors. “It is still really hard for hedge funds to raise money,” said Tracy McHale Stuart, partner and CEO at Corbin Capital Partners LP, New York. “They do everything they can to reduce client fees and founders shares — which offer discounted management and performance fees for day-one investors — are very common now,” she said.

Corbin Capital manages $4 billion in hedge funds of funds, including a new emerging manager niche strategy.

But even discounted fees won't be enough to overcome a growing bifurcation among new firms: “Talent from blue-chip spinouts can raise around $500 million in the first round and (then there is) everyone else,” said one source.

The “most fertile hunting grounds are among the spinouts of experienced teams that worked at a hedge fund for a long time,” agreed Robert Kaplan, New York-based co-CIO of Permal Group. “These firms have to generate a critical mass right at inception or face serious problems.”

Permal manages $22.3 billion in hedge funds of funds.

Creating a successful new hedge fund firm requires far more than possession of an excellent investment strategy, sources said.

“The business operations of running a hedge fund firm have become substantially more complex. The days of being able to get a couple of hundred million under management, hanging out a shingle and expecting to get institutional money are gone,” said Basil C. Williams, co-CIO at Mariner Investment Group, Harrison, N.Y.

Mariner manages a total of $10 billion and offers a hedge fund incubation strategy, which means the firm is on every new hedge fund manager's must-meet list.

Mr. Williams said in the past 18 months, his team has looked at 450 hedge fund managers. Mariner officials met with executives of 225 firms once and 50 teams two or more times. Twenty finalist firms were subjected to extensive due diligence. Of the original 450 firms, four teams were selected to join Mariner's incubation program, and one firm is pending.

Competition in popular hedge fund investment strategies, such as U.S. long/short equity, is creating “structural headwinds for new managers,” said Theodore “Ted” Seides, president and CIO of hedge fund seeding firm Protégé Partners LLC, New York.

“It is very hard to raise money in a crowded strategy,” he said, but can be much easier for firms offering more capacity-constrained or esoteric investment approaches.