Institutional Investor's Alpha Magazine - November 2008 - (Page 38)

Hedge Fund Seeding Louis Bacon runs out of London and New York. Coffey appears to have reached a realization that has swept the industry. “People now accept the fact that it has gotten harder to start a hedge fund,” explains Chris Acito, chief hedge fund operating ofﬁcer at Investcorp, a $17 billion asset management ﬁrm headquartered in Bahrain. In an abrupt turnaround from a time when accepting seed money carried a certain disrepute, almost 100 percent of hedge fund start-ups now are seed deals, up from only 10 to 15 percent just a few years ago. Stars like Coffey — who spent four years running a GLG emergingmarkets fund that delivered annual returns of 50 to 100 percent — can take easy cover in an established fund like Bacon’s. Others have few options beyond seeders. With the average hedge fund down about 20 percent through October, according to Chicago-based Hedge Fund Research, more hedge fund investors are cashing out than putting in. The upshot is that seeders are being restored to their former role as crucial players in hedge fund creation. “Almost everyone needs help getting started,” notes Jeffrey Tarrant, CEO and CIO of New York–based Protégé Partners, a $3.5 billion seeding firm and fund of hedge funds that has stakes in about 50 hedge funds, both seed and arm’s-length managers. “We’re going back to the way it used to be,” says Scott Prince, co–managing partner of SkyBridge Capital, a New York–based seeder ﬁrm with $1.56 billion under manageof newer hedge fund–seeding businesses. Many funds of hedge funds, ﬁnancial services providers and investment banks created in-house platforms for doling out start-up capital and services. By 2003 seeders had begun to come under pressure from rivals crowding the ﬁeld, among them prime brokers and third-party marketers. If a manager could raise a half-billion dollars at a capital-introduction meeting with a prime broker, why would he or she need a seeding deal that would cost a piece of the ﬁrm or a chunk of the gross? But that was then, this is now — credit has dried up, the markets have tanked, and hedge funds have lost much of their luster. By October 31 the industry was down $200 billion on the year, and sages in the business foresaw more losses to come. In a late-October speech at the Massachusetts Institute of Technology, hedge fund pioneer George Soros predicted that one half to two thirds of the world’s roughly 10,000 hedge funds would disappear before a reversal ensued. Still, although funds are indeed vanishing, managers aren’t, and many are looking to start anew only to ﬁnd the usual doors closed. That leaves seeders in extreme demand — and in a position to drive hard bargains, such as 30 percent revenue shares or provisions that cede them sizable equity stakes. In the meantime, even established hedge funds are asking seeders for help as their assets are pared by sliding markets and investor redemptions. Sometimes unable to pay the rent — much less retain talented staff — many funds with less than $5 billion in assets under management are in the market for rescue capital. “A lot of seeding activity will be involved in relaunching or rescuing ﬁrms,” predicts Daniel Stern, the founder and co-CEO of Reservoir Capital Group, a New York– based seeding ﬁrm with $3 billion in assets. eeder firms have noble roots. Fifteen or 20 years ago, when there were few hedge funds and not a lot of capital to set them up, Goldman Sachs alumni and aspiring hedge fund managers like Daniel Och and Thomas Steyer turned to private equity investors like New York–based Ziff Brothers Investments and San Francisco–based Hellman & Friedman to get their starts. These early seeders bestowed both money and advice, helping young managers build infrastructure, teams and assets, often even providing operations support and office space. Hellman & Friedman invested $4 million with Steyer to start Farallon in 1986, then helped him raise an additional $11 million. Farallon today has about $30 billion under management. In 1994 the Ziffs gave Och unusually generous terms: $100 million in return for a 10 percent equity stake. They also gave him space in their New York ofﬁces, the classic incubating model of seed deals. Stern, who helped found Ziff Brothers, went on to start his own ﬁrm, Reservoir Capital, in 1998 with Ziff colleague Craig Huff. Stern is credited with giving a number of prominent hedge funds “One hundred million dollars is a magical threshold, when other investors and funds of funds will give managers money.” — CHRISTY WOOD, CEO, CAPITAL Z ASSET MANAGEMENT S ment. Prince says it is long overdue for hedge fund managers to be realistic about who will invest and how much investors will commit. The success of hedge fund seed investments in the 1980s and 1990s — such as those that helped launch hedge fund giants Farallon Capital Management in San Francisco and Och-Ziff Capital Management in New York — set the template. Traditional seeding ﬁrms were passé for much of this decade, as institutions poured pension and endowment assets into increasingly numerous hedge fund vehicles, seeking safety after the bursting of the dot-com bubble. The subsequent 20 to 25 percent annual growth in the overall number of hedge funds spawned a cottage industry 38 • INSTITUTIONAL INVESTOR’S ALPHA • NOVEMBER 2008

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

Institutional Investor's Alpha Magazine - November 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Risk Rewarded The Good Guys: In the Here and Now Interview: Minister of Finance Cover Story: The Agony of Dan Zwirn Strategies: The Early Birds Are Awake Strategies: The Call of Shari’a Profile: Sweet Home Chicago Research Center: What Stampede? Alpha Bytes: Centralize the Data Unhedged: Commentary: Learning from the Wreckage

Institutional Investor's Alpha Magazine - November 2008

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