The Shrinkage of Hedge Fund Seeding Capital

I have written in the past (http://simonkerrhfblog.blogspot.com/2009/11/gathering-assets-still-difficult-for.html , http://simonkerrhfblog.blogspot.com/2010/01/excess-supply-of-emerging-managers-to.html ) that my expectation is that emerging manager hedge funds will find raising capital difficult. Part of the reason for this view is the shrinkage of seeding capital providers. Infovest21 is the source for this overviewing of the status quo in hedge fund seeding:



The size of assets committed in the overall seeding industry dropped in 2008/2009 as has the number of seeders actively providing seeding capital.


Seeding is very resource-intensive. It requires sourcing a wide range of proposals, having the skills and resources to analyze diverse strategies, having negotiating skills and helping put businesses together. This cuts down on the number of firms that can do it, says Patric de Gentile- Williams of FRM’s Capital Advisors. “People are getting out of seeding business because it is a very hard business - you need to find the talent, be a risk manager of the talent and have a disciplined marketing plan for the business,” adds Anthony Scaramucci of Skybridge Capital.

In 2007, there were 50-90 seeders. Today, there are just a handful of active seeders. Many of the active seeders don’t expect the seeding activity to get back to 2007 levels. Many key personnel at some of the larger seeders have left. Many are virtually out of the business but not publicly admitting to that, says one seeder.

The vast majority of seeders were a part of larger businesses. Those businesses became stressed by events in 2008 and had to refocus on their core business at the expense of their peripheral business. “Where seeding was a peripheral activity, it had to be sacrificed even though this is the one of the best times for seeding. In addition, some seeders were within investment banks and were using capital from the bank’s balance sheet. When 2008 arose, much of that capital was withdrawn,” adds Gentile-Williams.

It may be tough for some of the fund of funds’ seeders to come back. Scaramucci says, “If they don’t have the right resources in their organization, then they think they’re in the funds of funds business as a seeder. They’re not in the funds of funds business: they’re in the private equity/intellectual capital management business…When a fund of funds goes into the seeder business, they approach it the way funds of funds would. They don’t get deal terms right. They’re not partnering as tightly with the manager.”


In terms of seeing new candidates to be seeded, seeders say they haven’t seen a better environment. There are large numbers of talented people who want to be entrepreneurs who have been displaced by either the collapse of the firms they were with, whether hedge funds or investment banks, or are in an existing platform where they can’t supply enough capital.


Outlook



Gentile-Williams observes that the first quarter of 2010 has been more active than last year. “The pipeline is very strong; eight or nine managers are in [our] pipeline which could lead to a transaction in the next few months.”

Asset raising at the seed level i.e. raising a new fund is still challenging, say a number of seeders.As general interest for hedge funds picks up, emerging managers will benefit. The challenging piece is that some of the established largest managers, who had been closed, opened up to new investment following the financial crisis. Some of the largest allocators are currently going directly to the larger funds.

If the hedge fund situation improves and liquidity returns to the market, former seeders could return but they will probably do one-off deals rather than a dedicated fund. It could be done as a side letter not as a cookie cutter fund, says a former seeder.

There will be more capital committed and new players. There will be a small number of large players. Some family offices and some institutions are seeding. On the family office side, seeding is often viewed opportunistically. For example, The Koffler Group seeds only one manager or so a year. It seeded EchoBridge with $20 million in 2008. Another example is Parly Company which has seeded about 25 funds in the past.

Some larger pensions are also entering the seeding arena. CalPERS is considering providing start-up money to hedge funds similar to what it has done with private equity. The UK pension fund Railpen is expected to start a hedge fund seeding operations in order to gain greater control of alternative assets. Details haven’t been publicly disclosed yet but sources expect the model will follow the CalPERS and Hermes’ models.

In 2010, New York State Common Retirement Fund seeded London-based Finisterre’s emerging market hedge fund with $250 million.