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Institutions Damp Hedge Fund ‘Startup Spirit,’ Citi’s Roe Says

Hedge-fund startups are slowing as institutional investors favor larger managers and regulators increase oversight of the industry, according to Citigroup Inc.

“We are seeing the larger funds getting larger and less of the startup spirit that really typified the hedge fund industry five to 10 years ago,” said Nick Roe, London-based global head of prime finance at Citigroup. “A continuation of institutional flows and increased regulation in international markets are making the traditional entrepreneurial hedge fund startups more difficult.”

The number of new hedge funds worldwide declined to about 150 in the fourth quarter, from almost 250 a year earlier, according to a February report by Singapore-based Eurekahedge Pte. More than 80 percent of the $55 billion put into hedge funds last year went to those with more than $5 billion, Chicago-based Hedge Fund Research Inc. said in January.

“Institutions stick to a certain profile of a manager that comes with an experienced track record and certain operating conditions,” Roe said in a Feb. 17 interview at Citigroup’s Asia-Pacific investor conference in Singapore. “That tends to play into the hands of the larger operators than it does the traditional startup funds.”

There will be “slightly less startups” in Asia as managers struggle to find seed capital, Hannah Goodwin, Citigroup’s Hong Kong-based head of prime finance in the region, said in the same interview.

Prime brokerages provide services such as cash and securities lending, custody, introduction to potential investors and startup consulting services to hedge funds.

Bigger Startups

Global funds moving to Asia are hiring local talent “that may have once started their own funds,” Goodwin said. Managers such as New York-based Soros Fund Management LLC, founded by billionaire George Soros, and Fortress Investment Group LLC are setting up shop in Asia as the region’s economic growth outpaces the rest of the world.

“Locally, we’re not seeing a large number of startups,” Goodwin said. “Those that are starting tend to be bigger; the prop shops coming up and setting up their own businesses.”

Former proprietary traders from Goldman Sachs Group Inc. and Credit Suisse Group AG are setting up hedge funds in Asia.

While institutional money is starting to flow into Asian hedge funds that manage between $200 million and $500 million as bigger managers stop taking in assets, smaller firms are still being left out, Goodwin said.

Smaller funds and startups will rely on wealthy individuals and family offices for capital, Roe said.

Europe, U.S.

In Europe, managers put on hold their plans to set up hedge funds last year as the European Union took months to agree on new regulations for alternative investment managers, Roe said. European lawmakers in November approved regulations requiring hedge funds to set limits on their use of leverage and avoid pay practices that encourage risk taking.

The U.S. Congress in July approved the Dodd-Frank Act, which forces hedge funds to undergo routine inspections by the Securities and Exchange Commission and requires firms that manage more than $1 billion to disclose their investments, leverage and risk profile to regulators.

The U.S. is “being dictated by institutional flow,” Roe said. Citigroup is seeing fewer startups in the U.S. as institutions prefer to invest in “well-run” managers, Roe said.

A majority of assets under management by hedge funds globally are from institutional investors such as pension funds and university endowments, according to the London-based Alternative Investment Management Association.

Industry ‘Institutionalization’

More money from institutional investors will continue to flow into the hedge fund industry, as investments from fund of funds decline, Roe said. Hedge funds are coming up with products, including regulated fund formats known as UCITS, to attract institutional investors, he added said.

“We’re seeing the institutionalization of the hedge fund industry,” he said. “That hasn’t necessarily hit Asia in a big way yet but we can certainly see it coming.”

Citigroup plans to hire more staff for its prime finance business in Asia, focusing on services for hedge-fund clients in the futures and over-the-counter market this year, Roe said. The firm started its Asian prime brokerage business six years ago and currently has a team of 70 in the region.

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