World’s Smallest Hedge Funds Increase Assets as Investors Seek ‘New Blood’

The world’s smallest hedge funds struggled to raise money in 2010. This year, investors want in.

Funds managing less than $5 billion increased assets by $16.3 billion in the first quarter after adding $10.7 billion of new money in the whole of 2010, according to estimates from Hedge Fund Research Inc. Firms with $500 million to $1 billion of assets had the biggest reversal of fortune, bringing in $4.7 billion in the first three months of the year after $2.8 billion of net outflows in 2010.

“Investors are looking for new talent and new blood,” said Dominic Freemantle, a London-based managing director at Morgan Stanley who helps the firms attract money. “We are definitely starting to see some of the small and mid-sized managers raise decent assets.”

Clients who sought stability in big hedge funds after the collapse of Lehman Brothers Holdings Inc. (LEHMQ) roiled markets three years ago are increasingly looking at smaller firms in a search for better investment returns, clients and consultants say. Smaller firms are also seeking investors at a time when some of the biggest hedge funds have stopped taking money, said Craig Stevenson, a senior investment consultant at Towers Watson & Co. in London.

“The inflows have to go somewhere,” said Stevenson, who helps pick hedge funds for pension funds and other clients that oversee about $20 billion. “People are less concerned about firm risk and business risk.”

Saba, Pelham

Firms that have attracted capital include Saba Capital Management LP, the fund started by former Deutsche Bank AG credit trader Boaz Weinstein, Hutchin Hill Capital LP and Pelham Capital Management LP.

Smaller funds have the potential to outperform in the months ahead as markets react to Europe’s sovereign debt crisis, inflation and the end of a program initiated by the U.S. Federal Reserve to buy $600 million of Treasuries, said Saleem Siddiqi, a London-based partner at Tapestry Asset Management LLP.

“There are a lot of unknowns on the radar screen,” said Siddiqi, whose company tailors hedge-fund holdings for institutional investors. “Being nimble is imperative to navigate these choppy waters.”

Size shouldn’t be an obstacle to raising money if managers can show they’ve produced good returns for two to three years and posses a “strong pedigree,” meaning they’ve previously been a trader at a Wall Street investment bank or well-known hedge fund, said hedge-fund investor Henrik Molin, head of development at Frey Quantitative Strategies Ltd. in London.

Hutchin Hill

Weinstein started New York-based Saba in 2009 with $150 million. The fund, which posted an investment gain of 11 percent in 2010, now oversees $3 billion, according to two people with knowledge of the matter, who declined to be identified because Saba is a private firm.

Assets at Hutchin Hill have jumped to $1.5 billion from $350 million after the New York-based hedge fund began to take money from new clients last year, two people with knowledge of the matter said.

Neil Chriss, a former Goldman Sachs Group Inc. trader who later managed a portfolio at SAC Capital Management LLC, started Hutchin Hill in 2008 with $300 million from Renaissance Technologies Corp. founder James Simons. Hutchin Hill, which trades stocks and bonds, gained 7 percent last year after rising 17 percent in 2009, according to an investor.

Ross Turner founded Pelham in 2007 after leaving Lansdowne Partners Ltd., a $16 billion hedge fund based in London that bets on rising and falling stocks. Pelham’s assets have increased to $1.7 billion from $57 million, investors say. The London-based firm rose 13.5 percent in 2010 after gaining 26.7 percent in 2009, according to data compiled by Bloomberg.

‘Definitely Easier’

“It’s definitely easier to raise money than it was two years ago,” Turner, 33, said. “It’s still difficult, but you will find interest if you have the right product.”

Saba’s Weinstein and Hutchin Hill’s Chriss declined to comment.

Hedge funds on average rose 8 percent in 2010 and 9 percent in 2009, Bloomberg data show. The smallest hedge funds, those with less than $100 million of assets, reaped an annualized average gain of 13.5 percent from 1996 to 2009, according to a September study of more than 4,000 firms by PerTrac Financial Solutions. Firms managing between $100 million and $500 million returned 10.7 percent a year on average over the same period. Those with more than $500 million increased 9.8 percent, the New York-based investment-software company said.

Favorable Terms

One attraction of smaller firms is that they will sometimes accept money on terms that are more favorable to investors, said Jeff Majit, head of European hedge-fund investments for New York-based Neuberger Berman Group LLC. Hedge funds typically charge investors 2 percent of assets under management to cover performance costs and 20 percent of any profits.

“We’ve had more success getting discounts on management fees, discounts on incentive fees and full portfolio transparency with emerging managers,” said London-based Majit, who’s firm allocates about $4 billion to hedge funds.

Bigger firms that are considering closing funds to new investors include Steve Cohen’s SAC Capital Management LLC. The $14 billion Stamford, Connecticut-based company told clients last month it may stop accepting money into the firm’s largest fund to ensure returns remain high. Daniel Loeb’s Third Point LLC, the New York-based firm that oversees more than $5 billion, plans to close its funds to new investments.

Och-Ziff Funds

Too be sure, many big firms remain open. These funds have the capacity to absorb the multimillion-dollar checks written by sovereign-wealth funds, pension funds and endowments and they are still attracting most of the money coming into the industry.

Inflows from clients and investment performance have added $2.4 billion to Och-Ziff Capital Management Group LLC (OZM)’s funds this year, increasing the New York-based firm’s assets to $30 billion at the end of May, according to filings with the U.S. Securities and Exchange Commission.

Firms such as Och-Ziff that manage more than $5 billion got half of the $32.5 billion raised by hedge funds in the first quarter, according to Chicago-based Hedge Fund Research. The biggest hedge funds received 80 percent of the $55.5 billion investors added to the industry in 2010.

The inflows mark a turning point from 2008 and 2009, when hedge funds of all sizes experienced outflows of $285.6 billion. The redemptions were a consequence of 2008, when the industry lost 19 percent of investors’ money on average and a record 1,471 firms went out of business.

To contact the reporter responsible for this story: Jesse Westbrook in London at jwestbrook1@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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