Goldman Said to Plan Blackstone Challenge on Hedge-Fund Startups
Goldman Sachs Group Inc. (GS) is seeking money to bankroll fledgling hedge funds, its second attempt since 2008 to break into a business now dominated by Blackstone Group LP (BX), according to three people with knowledge of the plan.
The bank has spent the past year trying to attract clients for a seeding fund, which provides managers with startup investing capital in exchange for a cut of their fees, said the people, who asked not to be identified because the effort is private. Blackstone recently raised $2.4 billion for its second seeding fund, the industry’s biggest.
Reservoir Capital Group, Larch Lane Advisors LLC and PineBridge Investments LLC also are marketing new funds, saying it’s a good time to back startups because after the financial crisis investors are reluctant to trust even talented traders going out on their own. Goldman Sachs, based in New York, shut a fund in 2008, underscoring that betting on new managers can be tricky even for one of Wall Street’s savviest firms.
“Seeding isn’t an easy-money business,” Alexis Graham, co-founder of Acceleration Capital Group, a New York-based firm that works with seed investors, said in a telephone interview. “There are only a small percentage of people out there who can consistently outperform, build a business and scale assets.”
About half of the 100 or so firms that financed startups before 2008 have curtailed their investing or quit the industry, Graham said. Reasons for the shakeout include poor manager selection and hard-to-navigate financial markets.
Slice of Fees
Seeders generally invest $100 million to $150 million in a hedge fund, providing a pool of capital to help the manager begin trading. In return, the seeding fund gets 15 percent to 25 percent of the hedge fund’s fees. Hedge-fund managers typically charge clients 2 percent of assets and take 20 percent of investment gains.
The seed money is often locked up in the hedge fund for three years, and seeders return initial capital to their investors after about five years. Seeding funds retain their ownership stake until it’s bought out by the manager or a third party.
“If you have a 10-fund portfolio and three funds climb over $1 billion, then the economics work and you have a winner,” said Eric Weinstein, who runs the $4 billion fund-of-fund business at Neuberger Berman Group LLC in New York. Seeders target annual returns of about 12 percent to 15 percent for their investors, he said.
Blackstone, the world’s largest private-equity firm, jumped into seeding in 2007 with a $1.1 billion fund that took stakes in eight managers. While one of the hedge funds failed in 2008, the New York-based company’s portfolio has returned about 50 percent since inception, according to investors. The remaining firms collectively manage $7 billion, and three have more than $1 billion, including Senrigan Capital Group Ltd., run by ex-Citadel LLC trader Nick Taylor in Hong Kong.
Goldman Sachs, the fifth-biggest U.S. bank by assets, plans to seed managers through a new venture between its hedge-fund strategies group, which allocates money to managers for clients, and its Petershill Fund, which buys stakes in established money managers, said the people familiar with the matter. They didn’t disclose how much money Goldman Sachs is seeking for the effort, which will be led by the firm’s Ali Raissi.
The bank’s seeding effort in 2008 involved financing two hedge funds, one person said. Ed Canaday, a spokesman for the bank, declined to comment.
Demand for seed money tends to be strongest at times like now, when hedge-fund investors are reluctant to put money into new managers and instead focus on firms with established records. When investors are willing to take more risk, startups can get rolling without giving up equity to seeders.
Institutions have eschewed new managers since the end of 2008, when hedge funds lost an average of almost 20 percent, their worst performance on record. In 2007, six new managers started with about $1 billion or more. Last year there were two: Pierre-Henri Flamand and Morgan Sze, both former heads of Goldman Sachs’s global proprietary-trading groups. Such in-demand funds don’t need seed investors.
There’s about $2.6 billion available to seed new mangers, according to Acceleration Capital, a unit of Arcadia Securities LLC. That’s up from $1.3 billion in the second half of 2009. The number of managers wanting to raise money is on the rise as banks disband their proprietary trading desks to comply with U.S. legislation that restricts trading with their own money.
“You have the highest-quality managers coming out of hedge funds and proprietary desks, yet there is still an aversion from institutions to invest on Day One,” said Robert Discolo, managing director of New York-based PineBridge, which farms out $4 billion in to hedge funds and is partnering with Larch Lane for its latest fund.
Scaramucci Alters Strategy
While the timing may be good for seeding, SkyBridge Capital LLC, run by Anthony Scaramucci, is changing its strategy after losses. The New York-based firm, which has invested in 15 managers since 2006, terminated contracts with six of them, and only Westport Capital Partners, a real estate fund, has surpassed $1 billion in assets. SkyBridge’s oldest seeding fund has lost 5.3 percent since the start of 2006.
“The performance is disappointing,” Scaramucci said. “I thought seeding was like running a fund-of-funds with an equity kicker, but it’s a venture capital business.”
Funds-of-funds select money managers for clients. A venture capital fund invests in companies that are just getting started or are in the process of developing their first products or services.
Scaramucci says he will focus on providing so-called acceleration capital to smaller managers who’ve been in business for a few years to help get them to a level where they can attract more investors.
Julian Robertson, founder of Tiger Management LLC, started seeding managers after he closed his New York hedge fund in 2000. Robertson has used an older model of seeding that gives managers $25 million in exchange for a 25 percent stake. While that worked in the earlier years, his newer seeds have had a tough time climbing beyond $200 million in assets. Of the almost 40 managers he’s seeded, four surpassed $1 billion.
The pitfalls of seeding extend past managers whose returns or asset growth don’t live up to expectations.
Among those that Robertson seeded is Bill Hwang’s Tiger Asia Management LLC. The New York-based hedge fund is being investigated by U.S. and Hong Kong regulators following government allegations in Hong Kong of insider trading, the firm told clients in October.
Tiger Asia, which denied any wrongdoing, told clients it’s cooperating with the U.S. Securities and Exchange Commission and was fighting an injunction to freeze some of its assets filed by the Hong Kong Securities and Futures Commission.
Protege Partners LP, which was founded by Ted Seides and Jeffrey Tarrant and oversees $3 billion, has seeded about 40 funds over nine years, of which about a dozen are still in existence. New York-based Protege, which doesn’t run a dedicated seeding fund, financed two startups last year and has yet to invest in a fund this year.
The firm had invested in Barai Capital Management LP, the New York-based hedge fund that shut this year after its founder, Samir Barai, was arrested and accused by the government of insider trading. He has yet to enter a plea and has been in talks with the U.S. on whether he will cooperate with the government, prosecutors said in court papers filed in April.
The appeal of seeding hedge funds is rooted in the track record of managers such as Ken Griffin, who got $1 million from Frank Meyer, founder of Glenwood Capital LLC, to start Chicago-based Citadel in 1990. Griffin, 42, now manages $11 billion.
Daniel Stern, then president of Ziff Brothers Investments LLC, seeded Och-Ziff Capital Management Group LLC, the New York-based firm founded by Daniel Och in 1994. Och now oversees $29 billion. Stern, who later co-founded Reservoir Capital, had also helped raise money for HBK Capital Management, which was started by Harlan Korenvaes in 1991 with $30 million. The Dallas-based firm has $5.7 billion in assets.
“Everyone seeks to replicate the successes of the seeders during the 1990s when the pool of talent starting their own hedge funds was smaller and made up of the most entrepreneurial and innovative traders,” said Simon Irish, principal of New York-based investment firm SWH Capital LLC, who previously ran Man Group Plc’s North American seeding business.
“Now one needs better insights to identify the winners, not the least given the fragility of the current economic environment.”
To contact the editor responsible for this story: Christian Baumgaertel at email@example.com