In September 2009, Larch Lane Advisors seeded fledgling hedge fund manager Didier Martineau, CEO of Sothic Capital Management, with $75 million. So far, London-based Sothic has not disappointed; by last month the European distressed-situations and event-driven fund’s assets had topped $260 million. As early-stage managers flood the market in Europe and the U.S., Martineau is well aware of his good fortune. “Not everyone is going to get funded,” he says.
What an understatement. In the year through September, according to Chicago-based Hedge Fund Research, 945 hedge funds launched. That’s the highest 12-month total since the year ended July 31, 2008. But demand for emerging hedge fund managers remains slim because investors prefer well-established shops. Smaller managers — often former proprietary traders who lost their jobs thanks to the Volcker provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act — must try to find a seeding firm willing to take a big risk.
Competition is fierce. “There is an exceedingly high bar to cross to get seeded,” says Todd Williams, director of seeding strategies for Rye Brook, New York–based Larch Lane. One of the top five hedge fund seeders, Larch Lane has helped launch a couple dozen managers since it was founded in 1999. The firm looks for people with pedigrees and track records, Williams says: “Second- and third-generation hedge fund managers can be attractive seed candidates based on their experience.”
Martineau — most recently a managing director of London- and New York–based GlobeOp Financial Services, a technology firm targeting hedge funds — founded Sothic with a team whose members fit that description. He has hedge fund experience too: In the 1990s he was a senior strategist at Long-Term Capital Management. In 2008, Martineau joined forces with Sothic CIO Gertjan Koomen and several other prop traders from the London office of JPMorgan Chase & Co., where they had specialized in distressed situations.
Still, some seeders won’t even consider former bankers. “We do not seed Wall Street prop desks,” says Jeffrey Tarrant, co-founder and CEO of New York’s Protégé Partners, which has 18 active seeds. A larger supply of emerging managers doesn’t equal more talent, says Tarrant, who distinguishes between those with real hedge fund experience and traders with little or no background in running a business.
For early-stage managers lucky enough to find seed, there are often strings attached. “People are willing to give up 25 to 40 percent of their business,” says Raymond Nolte, CIO of New York–based SkyBridge Capital; before the crisis it was typically 10 to 15 percent. SkyBridge, which took over Citigroup’s seeding business last June, has seed with 14 managers. For the handful of those deals that took place postcrisis, it provided each with about $20 million. But a seeded hedge fund still needs investors — no easy feat for small managers. All of SkyBridge’s seeded managers have fought to sustain growth since the crisis, Nolte says. “The largest hedge funds continue to garner the vast majority of capital,” he adds.
However, Nolte foresees renewed interest in emerging managers, who he says often yield better returns than their larger peers: “The funds are more nimble because they have smaller amounts of capital.” Other seeders agree that investors like this flexibility. “Many institutional investors are interested in smaller, younger managers to diversify their portfolio,” says Patric de Gentile-Williams, COO of London-based seeding firm FRM Capital Advisors.
But Sothic’s Martineau admits that inexperience, smaller infrastructure and vulnerability to redemptions make new managers riskier than big funds. He says there’s also a “question mark around the ability of a [manager] to transition from managing money in a bank environment versus a hedge fund.”
If investors were satisfied with the answer, there would be far fewer ex-bankers looking for work.
