Institutional Investor's Alpha Magazine - May 2008 - (Page 14)

Small Fry A s giants like Citigroup, State Street Corp. and Bank of New York Mellon gobble up small fund-administration service providers, niche players are circling the wagons in hopes that they can compete by specializing. One of the newest is ISIS Fund Services, a tiny Bermuda-based ﬁrm formed last fall by a breakaway team of Citigroup alternative-investment specialists led by Ede Conyers, the founder and general UPDATE Back from the Dead or those who run afoul of the financial markets, second chances can be surprisingly easy to come by. Take the case of Jeff Larson, the head of formerly high-ﬂ ying Sowood Capital Management. Last July, Larson, a seasoned fund manager with years of solid gains, made headlines when his $ 3 billion, Boston-based hedge fund lost more than half its value in a matter of days after its highly leveraged investment strategy went awry. As we reported in March, the blowup came as a shock to Larson’s investors, who had grown accustomed to the steadiness of his performance (Sowood had returned an annual 10 percent, on average, for three consecutive years). In retrospect, Sowood was seen by some as one of the ﬁrst funds affected by the brewing credit meltdown. Af ter returning what he could to investors (which included high-proﬁ le endowments like Harvard Management Co., Larson’s former employer, which lost some $ 35 0 million of its $ 5 0 0 million investment in the collapse), Larson sold the remainder of Sowood’s portfolio at a deep discount to opportunistic Citadel Investment Group of Chicago. He issued a terse apology and headed for t he ex i t . Though he was just 49, Larson’s career in high finance seemed to have abruptly ended. Not so fast. Larson, who has yet to comment publicly on the circumstances surrounding Sowood’s demise, is get ting back in the game through a new fund that will mirror its marketneutral approach, according to those close to him. The as-yet-unnamed fund F will have a much smaller capital base — $250 million to $500 million, according to people familiar with the plan — and will avoid the structured-credit positions that contributed to Sowood’s unraveling. One could also assume that Larson will steer clear of overleveraging (near the end of Sowood’s existence, he had borrowed at least ten times the fund’s cash on hand). Getting investors to forget a devastating recent past can’t be easy, yet time and again displaced managers have done just that, with varying degrees of success. The most frequently cited case is that of John Meriwether, former head of Long-Term Capital Management, which blew up infamously in 1998. Meriwether founded Greenwich, Connecticut–based JWM Partners in 1999. The ﬁ rm has struggled this year but still manages $1.4 billion. Robert Bruner, dean of the University of Virginia’s Darden Graduate School of Business Administration and author of The Panic of 1907: Lessons Learned from the Market’s Perfect Storm, thinks that seeking redemption comes naturally to fallen fund managers. “To quote Thomas Edison, most of life’s failures are people who didn’t realize how close they were to success when they gave up,” says Bruner. He notes that managers like Larson still ﬁ rmly believe in the underlying fundamentals of their long-term strategies. Besides, as histor y shows, the market has a short memory. “The point is, investors prefer to look at the longterm track record,” Bruner says, “and in Larson’s case, that would certainly be a plus.” — Dave Simons manager of Forum Fund Services, also based in Bermuda, which was acquired by Citi in December 2003. ISIS has about $2.5 billion in assets under administration; by comparison, some rivals have hundreds of billions. Citco Group and State Street, the largest competitors, have in excess of $400 billion apiece in single-manager hedge fund assets under administration. Such companies offer services that include domestic and offshore accounting, portfolio valuation and corporate governance and compliance. Small fry like ISIS are battling the odds. Hedge fund administration is a business in which scale increasingly drives business, though ISIS executives say they see steady demand for smaller, customized solutions. “Larger administrators and investment banks that participate in the hedge fund administration space are focused on two primary criteria: proﬁtability and assets under administration,” says Jason Bibb, a managing director at ISIS who argues that his ﬁrm’s boutique quality gives it an appeal big competitors lack. Bibb says bigger players have in some instances raised their minimum account size threshold per client to $500 million. But as he notes, nearly two thirds of hedge funds have less than $100 million in assets — fertile ground for niche ﬁ rms. Additionally, large administrators sometimes divest themselves of smaller, less-proﬁtable clients, providing fresh prospects for midsize and smaller providers, Bibb says. In a report last fall on fund administrators, Aite Group, a Boston-based research and advisory ﬁrm, says the newcomers shouldn’t be taken lightly in the trend toward consolidation. “The acquiring ﬁrm could easily be one of the independent or spin-off administrators,” says Denise Valentine, a senior analyst at Aite. Big competitors dismiss the upstarts, however. “I don’t think there are any serious competitors who don’t have scale,” says Andrew Smith, head of North American securities and fund services at Citigroup. Alan Greene, head of State Street’s U.S. mutual-fund-servicing business, agrees. “It costs a fair amount to get these developments built,” he says. “If you have a large asset base, you have some pretty important unit-cost advantages.” Locales like Bermuda, the Cayman Islands and the Channel Islands of Guernsey and Jersey have figured prominently in the growth of offshore administration ﬁ rms. There is approximately $2 trillion in alternative assets in offshore funds, according to a survey this year by the International Custody & Fund Administration, which tracks the securities back-ofﬁce industry, compared with $655 billion in onshore U.S. funds. ISIS’ Bibb suggests that tax considerations aren’t the only explanation for the prevalence of offshore funds. “For one thing, there is a concentration of expertise [offshore].” Bibb says ISIS made the right call and that small-ﬁrm ﬂexibility will be enough to help such outﬁts fend off the big boys. “There will always be a place in the market for all types of administrators,” he says. — Dave Simons 14 • INSTITUTIONAL INVESTOR’S ALPHA • MAY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - May 2008

Institutional Investor's Alpha Magazine - May 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Send in the Clones The Good Guys: Outside the Box Cover Story: Welcome to Oz Interview: The Tipping Point Regulation: When Sentinels Go Astray Strategies: Taking Credit Research Center: The Hedge Fund 100 Book Excerpt: Shoot the Messenger Alpha Bytes: VaR Enough? Unhedged: Commentary: Not Your Father's Activist

Institutional Investor's Alpha Magazine - May 2008

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