An interview with Jeroen Tielman, CEO of IMQ Investment Management.
IMQ Investment Management represents an unusual premise in the realm of hedge fund seeding. Developed over 2008 by Jeroen Tielman following a recommendation from a working group of the Holland Financial Centre, the firm and its IMQubator seeding fund have two distinct but related goals: to realise a return for pension fund investors and to encourage more talented investment managers to set up shop in The Netherlands.
IMQubator launched with €250 million from APG, the asset manager for Dutch pension giant Stichting Pensioenfonds ABP. After Rikard Lundgren joined IMQ as cio, the fund made its first allocation in June 2009 when it committed €25 million to the Branta Solutions Fund, a sustainable-investing hedge fund managed by startup Roodhals Capital. In line with IMQ’s requirements, Roodhals’ founders had recently returned to Amsterdam from London. IMQubator made its second investment, to an undisclosed manager, in December.
Seeded managers are also incubated, with IMQ assisting with risk management, marketing, operational infrastructure and advice on the investment management process. The firm expects all seeded managers to relocate and work with IMQ’s team face-to-face. The seeder has begun the New Year by moving to a larger office in Amsterdam big enough to house at least its first 10 seeded managers.
IMQ has received over 170 applications from managers, the majority from outside The Netherlands. The firm expects to be invested in 10 managers by the first quarter of 2011.
Tielman started his career in 1986 with ABN Amro as an investment analyst. A decade later he was global head of product development for ABN Amro Asset Management. He left the firm in 2000 to found FundPartners, an independent product-engineering boutique for the pension fund industry. The firm was acquired by Dutch merchant bank NIBC in 2004 and Tielman joined the bank as director of pension business development. He later worked for pension administration company Cordares before setting up IMQ.
AR: How has the seeding landscape changed in the past few years?
Jeroen Tielman: Obviously funding has become more difficult for emerging managers since the start of the crisis, and we know of some examples where seeding platforms have been restricted in funding as well, or even stopped operations. We have charted about 24 seed platforms, but we haven’t known them long enough yet to draw general conclusions about the global seeding market. We think that the flow of talented managers establishing their own fund management companies might have increased somewhat in the past few years, although a temporary dip could be expected as the funding climate is still quite challenging. IMQ is still receiving funding applications, especially from non-Dutch teams.
AR: With hindsight, was 2008 a good time to set up as a seed investor?
JT: Yes, absolutely—the combination of having fresh funding for IMQubator in a market of scarcity in capital for emerging managers is attractive for us. But I have to admit that the timing of our initiative in this context has been more luck than wisdom.
AR: So has the financial crisis been a good or bad thing for a hedge fund seeding firm?
JT: This depends on the duration of the crisis, and how long funding remains tough for emerging managers. If it takes too long, we could see emerging manager candidates being discouraged from starting their own asset management firms and investors focusing on areas other than innovative alternative strategies. However, at this moment stock markets seem to see light at the end of the tunnel and we are seeing a steady stream of high-quality applications. So if we assume the financial system has seen its worst moments, the crisis has been good for a seeding platform with capital available for investment.
AR: How much do you invest in each fund, and do you take an equity stake in the management firm? Do you receive a share of fees?
JT: We invest €25 million in each fund and we do take an equity stake in the management company. We’ve chosen an equity stake instead of a gross revenue share as we want the manager to preserve cash in the typically vulnerable period at the start of their operations. This is also in the interest of subsequent early-stage investors, who like to see stability. We support the manager in making their investment strategy and processes operational. In doing so we are paving the way for early-stage investors. As we require the emerging managers to run their new fund from our office location, we think IMQubator can distinguish itself with its guiding and monitoring of emerging managers. The fund will realize an additional return for its investors when the equity stake in the manager is sold, which would normally take place three-to-five years after our initial investment.
AR: What are the main criteria you look for when deciding whether to allocate to a manager?
JT: An innovative element, either in the opportunity universe exploited or in the method. We are only interested in managers who can show a strong risk discipline experience and track record. Besides investment preferences, we also look at the way the organization and operations are set up, and of course the people involved. We look for talent and alpha, irrespective of the strategy.
AR: How do you evaluate a manager’s integrity?
JT: We do that through both internal and external background checks, and it is clearly an issue on our radar during the extensive interviews we typically have with managers in our final rounds of selection. But even after we’ve decided to invest in an emerging manager fund, we will always insist on checks and balances in the investment and risk management process design—for example, the requirement of a separate custody of assets.
AR: What hedge fund strategies do you expect to do well this year, and why?
JT: We do not try to predict the performance of individual strategies for a single year. There are too many policy, regulatory and capital allocation issues at play to make meaningful projections. But the opportunity universes that look potentially appealing at the moment are those for commodities, emerging markets, global macro and mean reversion in different market segments.
AR: Are there any strategy types that you are purposely avoiding, and if so, why?
JT: We prefer not to follow the crowd into overpopulated strategies. We also avoid those where the main performance driver is a single price correction of a cyclical nature, such as some elements of credit last year. We have a longer investment horizon than a single year. We generally avoid illiquid strategies unless we get adequate compensation for taking that added risk.
AR: Do you prefer to invest in established managers or startups?
JT: We focus on managers who are anywhere between just starting operations, within let’s say three-to-six months, and managers who have started operations not longer than about 18 months or two years ago. Institutional investors typically exclude managers with a track record for their new venture of less than three-to-five years, so we pick the managers we believe to be attractive for institutions to invest in when they have a track of three years.
AR: How long do you typically spend negotiating with a manager before signing contracts?
JT: That depends on many factors, and is mainly determined by our findings in the due diligence process, but the range would be between 10 weeks and four months. If it takes longer, the chances of concluding a successful deal decrease considerably and ‘broken deal’ costs become too high as a consequence. We have recently cut off negotiations with a party where we felt that after four months of weekly contact we were going around in circles. On the other hand, in December we committed to a team within three months of first contact.
AR: 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?
JT: So far, we have received about 170 applications and counting. We’ve chosen about 130 for one or more meetings, and we are conducting an intensive due diligence process with about 10% of total applicants. We expect we will eventually reach a deal with five-to-seven of them. So we seed about 4% of the managers we decide to have a first meeting with, and about 3% of all applications. These ratios do not imply that we do not get quality applications; they might indicate that we put the bar quite high.
AR: The industry has changed and most hedge fund 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?
JT: A substantial launch nowadays is with launch assets of more than €40–50 million and annual revenue of €400,000-500,000, in most cases. But it depends on the amount of working capital provided by the manager itself, average fees paid, lock-ups, availability of sticky capital from friends and family, willingness and ability to defer salary payments by the founders, and so on. For next-round investors to join, we believe a manager needs to have assets of €50-75 million, with a one- or two-year track record at least.
AR: What can a hedge fund manager do to increase their chances of securing seed capital?
JT: There is not a standard recipe for this, but the manager should just focus on what they are particularly good at: having profound experience in an international institutional investor environment; having a very well-thought-out process for investment management and also for risk management and the back- and middle-office operations.
We think that key men within a hedge fund firm, who combine the natural characteristics of being an entrepreneur and a proven, talented investment manager, have a considerably bigger chance of securing seed capital. Last but not least, the key-man team should be composed of mature and complementary-skilled professionals who communicate well, share common values, are team players and have a deep-rooted feeling for the market. If the manager hasn’t started yet, the unconditional commitment should already be there to get started.
AR: Can you describe some of the situations in which you have opted not to invest in a fund, and explain why that decision was taken?
JT: Let’s look at some examples of teams who dropped out as ‘semi-finalists.’ Reasons to abort the further selection process with candidates in this phase have included imbalances in the composition of the key-man team; risk management process issues; budget restrictions; unforeseen complications when disentangling from their current employer; and last-minute family issues coming up in cases where a move from another continent was imminent. I’d like to note that we rate highly the skills and professionalism of all parties who make it to the final rounds of selection, and it is with regret that we stop the process with a team who have made it to the final selection rounds.
AR: Do you have a plan for how to redeem from a seeded manager? How do you judge when a fund has hit maturity, and what factors would make you exit an investment?
JT: As far as timing is concerned, we will look at a combination of the development of growth in assets and performance. If you assume that the development of growth in assets would be S-curve shaped, then you could expect us to look for a timing of redemption around the middle of the S-curve.
Our investment covers the €25 million allocation to the fund, as well as the value of our 25% equity stake. Once we think that investing €25 million in another fund provides a better return for IMQubator, it is time for us to redeem.
Interview conducted by Robert Murray.