Hedge fund seeders benefit from financing draught
January 20, 2010
"My advice is always that if you haven’t got the stomach and cash to fund yourself for three years of unpaid toil then don’t start a hedge fund."
An interview with Paul Smith, CEO of Triple A Partners.
Asia Alternative Asset Partners, known less formally as Triple A, was set up in January 2007 to provide seed capital and asset-raising assistance to Asia-related hedge fund strategies.
The firm’s early backers included Iveagh—the private wealth office for the Guinness family—and CLSA Asia-Pacific Markets Group. The two investors withdrew their capital during the financial downturn, causing Triple A to put its seeding activities on hold about a year ago. Since then, the firm has found other partners and now has access to over $100 million in seed capital. Triple A is seeking to raise another $100 million this year.
In the past few weeks, Triple A has entered into a joint venture with fellow seeder Penjing Asset Management, and the latter’s $30 million seeding fund has been rebranded the Penjing Triple A Partners Emerging Managers Fund. Triple A has also combined with Hatfield Advisors—now Triple A Partners Australia—to expand its distribution network.
Paul Smith co-founded Triple A with Hans Tiedemann. He has an extensive background in the hedge fund industry, having been global head of alternatives fund administration at HSBC (formerly Bank of Bermuda) from 1996-2004. He was previously managing director of fund of funds firm Ermitage International for 11 years.
“We will seed managers based anywhere in the world, but primarily look for an Asian focus,” says Smith. “The number of funds we add will depend upon the assets that we raise, but we feel we would like to have a stable of around 20-25 managers.” There are eight seeded funds in the stable at present.
How has the seeding landscape changed in the past few years?
Paul Smith: It’s always very difficult to establish the number of seeders out there in an exact way as so many seeders are “ad hoc”—family offices and institutions who will occasionally look at a deal. Current theory states that well over half of the available seed capital in 2007 has left the market over the last two years. This feels about right given how very tough it has become for startup managers to attract capital. Further, many of the remaining seed capital providers are looking more towards “accelerator capital” deals (providing additional funding to already up-and running businesses), rather than to startups, as business risk in the underlying seeded manager is less in this type of trade.
So, has the financial crisis been a good or bad thing for a hedge fund seeding firm?
P.S.: It’s been excellent. Shortage of capital drives up the price of that capital. In addition, its lack of availability means that for those of us left in the business there is reduced competition for the best deals. Thus, the adverse selection bias that is inherent within the seeding business (the best deals don’t need seed capital) is much, much less pronounced.
How much do you invest in each fund, and do you take an equity stake in the management firm?
P.S.: We invest up to $25 million and do not take an equity stake as a rule.
What are the main criteria you look for when deciding whether to allocate to a manager?
P.S.: First, second and third: the strength of the investment proposition and the investment team. We base all decisions on whether or not we like the investment thesis. We put that first and our seed economics and other business concerns last.
So do you identify a strategy type for inclusion in your platform, and then look for a suitable manager? Or do you seek out talent, regardless of the strategy they’re running?
P.S.: A bit of both. The nature of our industry is that it is reactionary and can be difficult to build a well-diversified portfolio. In times of intense competition this is more of a problem. So right now we do have the luxury of planning the portfolio with much more confidence. Our drive is to have a very well-diversified mix of managers by strategy and by geography within Asia.
Which strategies do you expect to do well this year?
P.S.: Multistrategy, market-neutral arbitrage funds. I think equity markets will be quite choppy as some of the liquidity that drove returns in 2009 leaks away. Therefore, I feel that multistrats that invest in a non-directional fashion across the capital structure will do well. I would also want them to have the ability to trade volatility. I suspect volatility will pick up as the year unwinds.
Are there any strategy types that you are purposely avoiding?
P.S.: Our style is to invest in the liquid end of the hedge fund universe. This has always been the case and remains so.
Do you prefer to invest in established managers or newly-founded startups? Are there pros and cons to both?
P.S.: This is a big topic. We look at both and have done both types of deals. We have also funded new products from established managers. Operational risk is a lot less with established managers and their brand also has a value which helps the capital-raising process. Against that, you have all the problems of working with a business that has an existing set of business issues. A startup relationship is much easier as you have a clean slate to work on.
How long do you typically spend negotiating with a manager before signing contracts?
P.S.: Start to finish, it can be three months at best, six months at worse.
How many managers do you meet with for every one you seed? And roughly what proportion of ‘serious’ discussions fall apart before a deal is reached?
P.S.: Very few, if any, discussions fall apart once heads of terms are agreed. This is quite rare, especially in today’s market. Around 20 to 30 deals would be reviewed to find one that is worth pursuing, as an average.
The industry has changed and most launches are smaller now than three years ago. What constitutes a substantial launch, and how much capital does a manager need to get off the ground?
P.S.: A substantial launch would be anything that gets up to around $50 million. A manager needs only $100,000 to get off the ground. That’s not the question. The real question is: How long can the manager last out sub-scale—say $100 million—before their patience and working capital run out? Each manager has a different pain threshold in this regard. My advice is always that if you haven’t got the stomach and cash to fund yourself for three years of unpaid toil then don’t start a hedge fund. Following the crisis, that is now probably four years. I would estimate that 70% of the people in hedge funds at any one point in time would be paid a lot more at an asset management company than at a hedge fund. Most are not great businesses. The public only hears about the 1% of people who hit the ball out of the park. Underneath this stratum is a bunch of people struggling away valiantly.
Interview conducted by Robert Murray.