Bloomberg Start-up Hedge Fund Conference London 2012: Key Points
Bloomberg Hedge Fund Start-up Conference 2012
$2.19 trillion - Total capital invested in global hedge fund industry (Hedge Fund Research)
$12.4 billion - Total capital invested in start-up hedge funds since 2009 (Citi Prime Services)
$15.9 million - Average capital allocation to launch hedge fund in 2011 (Citi Prime Services)
322 - Number of managers who control 60% of total global AuM (PerTrac)
Being a start-up hedge fund today, is no easy feat, as the above figures attest. Money is disproportionately flowing into the largest managers. Winton Capital Management, for example, attracted $7.3 billion of net new money in 2011, equivalent to roughly 60% of all capital allocated to start-ups since 2009. Capital raising is challenging, while regulation and added infrastructural and operational requirements are adding to start-ups’ woes. Nonetheless, there still remains an abundance of emerging talent in the industry, as evidenced by the growing number of prop-desk spin outs. As many of these new entrants are discovering, running a business is no way comparable to managing money. It is perhaps for this reason that Bloomberg held a conference exclusively focused on start-up hedge funds in London on November 28, 2012 hosted by Phillip Chapple, executive director at KB Associates, a boutique hedge fund consultancy. Here is a summary of some of the key points......
Where are the investors?
More money is flowing into hedge funds, mainly attributable to pension funds’ increased interest in alternatives. Unfortunately for start-ups, this capital tends to park itself in mid-sized or $500 million plus managers. One panellist did, however, acknowledge pension funds such as CalPERS, were not unafraid to put money to work at small managers although this appears to be the exception rather than the rule. Funds of funds, having had to justify their worth since 2008, are increasingly embracing start-ups or early stage managers. Despite funds of funds’ battered reputation, their influence should not be underestimated as they comprised of 70% of respondent to the 2012 Citi Prime Services investor survey. Family offices, historically institutions which chased high risk and high returns, are also re-entering alternatives in what should be a boon for start-ups. Most start-ups will rely on their own capital, or seeding from family and friends. Professional seeders are either extinct or inactive at best with the majority of allocators favouring early stage investing. One seeder said he received between 25 and 30 pitches per month yet made only several deals annually. The time lag between meeting a prospective manager and investing varied among allocators between three and 12 months. A delegate asked why women were so underrepresented in the industry catching one or two delegates slightly off guard. A panellist acknowledged female managers were underrepresented in hedge funds, although added he had seeded an all women event driven hedge fund in Paris.
What are investors looking for?
In terms of infrastructure, early stage investors and seeders recognise that start-ups will not get everything right. Nonetheless, they do expect the basics. A fund of funds CIO advised start-ups to read the standard AIMA due diligence questionnaire, and check the boxes prior to marketing their business. Investors also want their managers to have skin in the game to ensure an alignment of interests. Moderator Phillip Chapple asked investor panellists whether they provided feedback on operational due diligence shortcomings to prospective managers. Numerous start-ups complain investors do not inform them as to why they have failed due diligence. All of the panellists said they provided feedback.
Setting up a hedge fund and obtaining FSA approval to run money can be arduous. There was debate about regulatory umbrellas providing managers with FSA approval, as well as other services such as accounting, compliance and corporate governance. Panellists advised managers to read carefully the legal agreements they sign with providers offering regulatory umbrellas. This is essential as some umbrellas may be reluctant to make public a managers’ track record if they choose to leave the umbrella. However, a panellist, speaking afterwards, said such a scenario was rare and would be counterproductive behaviour by the service provider. Nonetheless, he warned managers conduct due diligence on other clients being serviced by these providers lest there are compliance issues. He warned there could be spill-over or contagion if one or more of these providers’ clients have a poor compliance record or tax issues. A minority of managers are also acquiring licenses free of charge from other firms, which may have ceased trading. This was described as ill-advised. Managers contemplating this were told to undertake due diligence on the firm they were obtaining the FSA licence from to ensure they are not taking on any liabilities.
An operational due diligence executive once asked to see a managers’ disaster recovery system. It comprised of a second server underneath the desk. Such complacency is no longer the norm. Start-ups must have disaster recovery in place, advised all panellists during the technology debate. In light of Hurricane Sandy, co-location of data is essential to ensure uninterrupted service. This is of particular importance to systematic or high-frequency trading managers. The vendors advised start-ups use private data hosting for email and cloud services as opposed to Google and Amazon. Private data hosting, they said, offered better back-up and security. Managers were also told to check where there data was being held – for example, a fund operating in the EU storing its data in the US could be subject to US rules and regulations. One attendee asked what would happen if a vendor operating a disaster recovery system or data hosting service went into bankruptcy. A vendor responded they were obliged to continue offering the service and would wind down systems in an orderly fashion to ensure no disruption to business.
Prime brokerage was discussed by representatives from J.P. Morgan, Deutsche Bank and Credit Suisse. All of the delegates gave a comprehensive overview of what prime brokerage entailed to these start-ups. Areas of interest included the different models employed at prime brokers to safeguard client assets. Special purpose vehicles or bankruptcy remote vehicles, whereby unencumbered assets are held in a separate entity to the broker dealer, were criticised for being untested. One honest panellist said prime brokerage was often not required for some strategies, such as FX rates. Investors are carefully analysing prime brokerage agreements to ensure managers are not getting an unfair deal or have unlimited rehypothecation, although a panellist did say rehypothecation was not the dirty word it once was. Moderator Phillip Chapple said he had noticed some mini primes emerge in Europe. This is of particular interest to smaller managers running sub-$5 million. One attendee, however, contradicted this, saying he had seen very few mini primes entering the market. This was reinforced by anecdotal evidence suggesting some bulge bracket primes are actively chasing small clients – some running just $10 million – which could jeopardise mini primes’ growth ambitions. Overall, most bulge bracket primes are taking on less business than they see. Acquiring a prime broker, therefore, for some start-ups, can be almost as challenging as finding investors.
The event was aimed at start-ups and it delivered on exactly that. Many of the start-ups present are unlikely to have run a business before, and historically relied on the operational safety net of an investment bank or larger hedge fund. The panel debates did not yield surprises but it certainly gave start-ups a flavour of what to expect as they grow their businesses.