"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only."

-Charles Dickens, A Tale of Two Cities, English novelist (1812-1870)

When we look back to 2010 hedge fund start ups, will we be quoting Charles Dickens? Despite the enormous challenge of raising investor capital in this post-Madoff environment, many other aspects of starting a hedge fund have rarely been more favorable.  The pool of available talent (both front and back office) is wide and deep and can be accessed at a lower cost than just a few years ago.  The Volcker rule is pushing entire teams out of investment banks and many are looking for a new home.  Service providers (administrators, prime brokers, attorneys and accountants) are hungry for business and agreeing to take on newer and smaller firms just to get their foot in the door.  Real estate is more plentiful and less costly and lessors are willing to cut better deals.  There is a lot of available space already built out which saves precious dollars for new hedge fund managers.  Technology is also more readily available and cost-effective when accessed through a hosted (ASP) environment. 

Looking forward, allocators (pension funds, life insurers, endowments, etc.) have made promises to their constituents which they will not be able to cover in a low interest rate/return enviroment and will need to seek out the higher returns that alternative investments are known for.  I have seen some commentary forecasting a 2-3X increase in AUM for the alternatives industry over the next 20 years.  Firms starting up now will have a chance to build a track record in advance of the coming needs.  Speaking of needs, while it is clear that the largest hedge funds are attracting the lion's share of the assets currently being allocated, I am hearing an increased din of unhappiness with the largest firms.  Feedback along the lines of the larger firms are too correlated with the markets (and each other) and that returns have decreased as AUM increased.  This has lead many investors to seek out newer and smaller firms with good pedigrees. 

We will not know for some time whether 2010 was such a great year to start up, but as the saying goes, "You have to be in it to win it". 

George Roeck, Chief Operating Officer & Chief Financial Officer, Charter Bridge Capital Management LP

Executive Board Member, HFBOA

We’ve heard talk amongst industry commentators that hedge funds are regaining negotiating power with investors, the result of improved performance more generally and an increase in investor interest as sophisticated investors begin to re-engage with the marketplace. The HFBOA was curious: How much has leverage in negotiations been affected by the fiscal crisis? And are investors really expecting better terms and lower fees, or just greater transparency and openness during more rigorous and ongoing due diligence? So we sat down with a panel whose members represent a wide range of investors and asked them what they think about fees, liquidity, leverage, and the outlook for negotiating power in the hedge fund space.

Check out the latest HFBOA newsletter  to read the interviews!

Comments?  We'd love to hear them!  Post your thoughts below

Over the last six months I have had the opportunity to meet with a number of individuals looking to start up a hedge fund. Whether it is a proprietary trader at a large investment bank or a portfolio manager/trader at an existing hedge fund, the result has been the same. They have not launched or are trading their own money. Why? First, capital raising is extremely difficult. Hedge fund investors, if they are allocating at all, are adding to existing positions in large hedge funds with established track records and institutional grade operations. There is little appetite for taking a flyer on a start-up hedge fund. The typical proprietary trader at a large investment bank has had no exposure to outside investors and thus, has no Rolodex to mine. The portfolio manager/trader may or may not have had exposure to investors while working at the hedge fund they are leaving. Some investors like to bet the jockey. To some extent, they believe that past performance is indicative of future results. For both groups, whether their performance record is portable is a big issue when it comes to marketing the fund.

Secondly, running a hedge fund "business" is vastly different from portfolio management or trading. Investors are looking for hedge funds that they believe will survive and thrive. Start up hedge funds face significant obstacles to execution on the business/operations side. Most start ups lack the money to invest in institutional grade systems and hire the people necessary to monitor the systems put in place. They take for granted the infrastructure they previously operated under while part of a larger organization. To gain the capital needed to launch a hedge fund business, some start-ups are seeking out seed capital but this is viewed as less than ideal given the trade offs in economics.

Third, the regulatory landscape is unsettled and many people believe that waiting until things stabilize will allow for better decision making. Examples here are the Volker proposals on proprietary trading, potential SEC registration rules, change in taxation of carried interest, increase in income/capital gain tax rates and Medicare taxes arising from the health care bill, etc.

Fourth, many of these individuals are on Gardening Leave and prohibited from starting a new venture until the expiration of the non-compete agreement.

Build it and they will come is not a mission statement. The good news is that once the obstacles clear, there will be a significant wave of start up hedge funds. They will need CFOs and COOs and CCOs and IT and back office. While the preference would be to hire experienced personnel to fill these slots, (and money well spent given the economics of greater AUM that experienced hires may have access to or help land) opportunities will arise for first timers to land one of these roles given the pressure on compensation.

-George Roeck