Infovest21 Analysis: Seeding becomes more diverse as industry recovers and evolves

Due to the expense of starting and running a hedge fund and investors taking longer to do due diligence and investing in smaller amounts,
there is a growing recognition that without an anchor investor, it is hard to launch a hedge fund. Seeding has become critical to the growth of the hedge fund industry.

Deal terms have become favorable to seeders because of the general lack of seed capital available. A huge increase in talent exists because of the lingering threat of the Volcker Rule as well as stress at some hedge funds, resulting in the top tier being of new managers being of very high quality.

"Given the current demand for capital and the level of liquidity, seed capital providers are in a position to be selective. To be viable, teams need to consist of seasoned professionals with portfolio management experience and the ability to prudently operate and grow an alternative investment business. In other words, to obtain seed capital and gather sufficient assets under management, managers need to be reputable and "strategically complete,"says Michael Linn, a start-up specialist.

Expectations are the number of seeders/incubators will increase as there have been more announcements of transactions and seeding operations, says FRM's Patric de Gentile-Williams.Funds of funds as important sources of seed capital to emerging funds, which dried up in 2008 and 2009, are starting to come back.

One seeder observes that the first half 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."
As previously reported, a number of funds of funds have launched or are in the process of launching funds that are raising money or seed capital. Asset Alliance's Manager Participation Fund, Blackstone's new seeding fund, CYAN Management Group, Larch Lane/PineBridge Investments' Select Plus Fund, NewAlpha Asset Management, Reyl Asset Management's Reyl Accelerator Fund and SkyBridge III to name a few.

Pensions are also becoming more active - APG, which manages the assets of Dutch pension ABP, backed IMQubator. New York State Common Retirement Fund selected Rock Creek to manage the first installment of the pension's new emerging manager program. CalPERS now has $1.6 billion in its Manager Development Programs, $470 million in the emerging manager funds of funds program (which is part of the external manager program), about $450 million in the fund of emerging hedge fund program (which is part of the Risk Managed Absolute Returns Strategies program). In the latter program, CalPERS has about $141 million with PAAMCO's fund of emerging funds, $158 million with Rock Creek fund of emerging funds and $143 million with 47 Degrees North.

Yet some seeders connected to fund of funds say they haven't seeded recently. Part of it is a function of size e.g. they can't allocate $150 million pieces. It is also a function of the changing nature of the business. Others say the economics don't make sense as scalability doesn't exist unless the seeded manager can raise significant assets early on.
Asset raising has been tough in general for the hedge fund industry. While the largest managers have been the beneficiaries of whatever assets have come in, the asset raising situation is much more difficult for smaller and emerging managers.

Man's RMF Global Emerging Managers Fund said in June that it is putting its seeding activities on hold while it focuses more on liquid strategies with short lock-up periods.

As a result, seeding transactions are fewer and far between and the weaker candidates are getting weeded out.

Some industry experts believe that it will be difficult for many seeders, outside of the largest seeding players, to flourish in the current environment. They expect that seeding may revert back to the situation in the 1970s and 1980s when very talented individuals were seeded opportunistically by wealthy individuals and family offices on a one-off basis. This time around, family offices and wealthy individuals will be joined by endowments and some large funds of funds.

"Without having a dedicated business, they can stay in the loop. They don't have to have expensive people and resources dedicated to it without generating results. If an interesting manager comes along, they can look at him," says Simon Lack of SL Advisors.

********************************************
Excerpt from Infovest21's just-released Special Research Report: New Developments in Seeding.