Seeding yet to recover, while start-up managers need more ops help, says Old Mutual
Investors are yet to rush back into seeding, although those that are have been advised to provide start-up managers with increased operational and infrastructural support to help facilitate better returns, a senior executive at Old Mutual Global Investors has said.
“Investors are not returning en masse to make seed deals of the pre-crisis mould. One of the major factors behind this has been the somewhat disappointing returns being posted by hedge funds, while a number of once promising start-ups and spin-outs have not quite delivered,” said Donald Pepper, managing director of alternatives at Old Mutual Global Investors, which is currently in the process of expanding its hedge fund business.
Investors’ enthusiasm for seeding has waned since the crisis. A survey of investors by J.P. Morgan’s Capital Introductions Group in 2012 revealed 68% would not provide seed capital. “Seed capital is hard to come by. High-profile seeders will have hundreds of meetings per year, but only make one or two seed deals,” said Pepper.
This comes as Old Mutual unveiled a Cayman Islands-domiciled hedge fund – the Arbea Fund, a global equity market neutral fund, of which Old Mutual provided $50 million in seed capital. “We would consider this deal to be less of a seed deal and more of an accelerator deal as the strategy had been running for four years in a Ucits format before we invested,” said Pepper.
However, a number of exciting new prospects have disappointed investors and seeders alike. While capital introductions teams at prime brokers never tired of emphasising the Volcker Rule would herald a surge in talented hedge fund managers, few have succeeded while some have returned external capital or shuttered completely.
The highest-profile closure was that of Edoma Capital Partners, an event driven manager which spun out of Goldman Sachs in 2010 initially raising $2 billion. Nonetheless, the fund’s performance proved lacklustre prompting redemptions, and ultimately shut in 2012.
A number of these ex prop-desk traders have struggled to master the operational challenges of running a business. “A number of prop-traders were excellent traders but did not comprehend how important the non-investment side of the business was when they launched hedge funds. A lot of these spin-outs found themselves getting bogged down with regulatory compliance and operational issues, which hindered alpha generation,” said Pepper.
Pepper highlighted seeders could take a more proactive role in helping these managers with their operational burdens. “Old Mutual and a few other early stage investors will provide operational and compliance support for our hedge funds so managers can do what they do best and trade, and deliver returns. We will help early stage managers with their infrastructure and regulatory requirements so as to ensure they are not distracted. I believe seeders should be more proactive at providing infrastructure, operational and regulatory support to these new entrants,” said Pepper.
The barrier to entry for new managers has been raised exponentially since the crisis as investors increasingly demand institutional standard operations and infrastructure. This, coupled with the onslaught of global regulations, has stifled recent hedge fund entrants. A 2012 Citi Prime Finance study illustrated the cost struggles facing smaller managers, estimating sub $250 million hedge funds spent on average 198 basis points of their 2% management fee on operations and third party service providers alone.