Few fields in finance are as ruthlessly Darwinian as starting out a new hedge fund, and securing its early-stage funding. It’s a crowded field, with 800 hedge funds getting the go-ahead in 2013, and an even larger pool that failed to hit their funding targets; as a result there’s a great deal of competition for investors, and many of those investors are comparison shopping for the lowest possible fee structures before allocating money and assets. It didn’t used to be this way. The golden age of hedge fund launches, in the early 1990s, and the second wave in the late 1990s, allowed managers to start up a reasonable hedge fund with 20 million of their own money as starter capital.
Now, established players and increasing regulatory oversight have raised the barriers to entry, and the barriers to successful launches, according to Anita Nemes, the head of capital introduction at Deutsche Bank. His guidelines for new hedge funds is to assume that the minimum buy in for a seat at the exchange is 100 million of capital raised in the first calendar quarter. There are also increasing expectations for institutional-grade support and infrastructure at the time of launch, and positive efforts on regulatory compliance, handled in-house, as part of the investor outreach process.
While the competition is fierce, Nemes feels that the 2014 outlook is strong for investor demand for new hedge funds; the long term trend is a nearly 30 per-cent growth rate initial seeding commitments from new and established investors. While there’s demand, there’s also the truth on the ground: a typical seed investor will talk to anywhere from 250 to 400 managers – that’s upwards of two per business day – and provide funding for only three or four. What causes those investors to choose a particular hedge fund managerial offering?
Experience. There are more second-generation and a few third-generation funds started by experienced managers looking to take their experience and try new angles and combinatorial approaches to investing. These experienced fund managers have an easier time than the traditional refugees from trading desks. Investors, as always, have to do due diligence, but the stratification of experience is making that easier for investors – and harder for new fund managers getting into the market.
Survival. The process of adding a fund to an investment portfolio is a long one, according to Philippe Ferreir of Lyxor’s managed accounts platform. While there’s a significant appetite for novel and innovative investment strategies and philosophical takes, there’s also an attitude of “wait and see if it flames out.” An example of a successful fund riding that rail is Melanion Capital, a dividend futures trading specialist.
New fund hesitancy also slides over into fund performance expectations. Investors in hedge funds are looking for clear statements of expected results, and will pull their assets if the funds don’t make them in short order – this is another side effect of a richly competitive arena for fund managers.
For managers looking to launch hedge funds, early-stage capital investors are a godsend. Names like Blackstone and Larch Lane and NewAlpha AM are large investors in this area, while Swiss private wealth managers also provide more secretive funding routes.
The other question that lingers is relative performance between older, legacy hedge funds and newer ones. Opinions on this vary; NewAlpha’s Philippe Paquet, believes that newer funds outperform legacy funds, especially in an adverse investing environment. Following that lead, Mariner Investments out of New York is investing the Alaska Permanent Fund Corporations assets in a series of hedge funds, covering a half a billion dollars, and is setting up specific hedge funds to meet that client requirement. Towards that aim, Mariner is trying to consistently recruit top talent.
Long term prospects for the hedge fund industry remain solid, as more companies are starting to invest capital they’ve hoarded since 2008. Couple this with a growing cadre of experienced fund managers, and there’s reason for cautious optimism, even if the “cowboy days” of starting hedge funds are on their way out.