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Survey finds that seed investors support start-up hedge funds over established hedge funds

Monday, February 27, 2012
Opalesque Industry Update - Globally, 78 leading investors who provide capital to hedge fund managers upon launch (Day One) or within the first 12 months of a fund’s existence (Early Stage) allocated $12.4 billion to Day One/Early Stage managers from 2009-2011, with an average ticket size of $16 million for new funds compared to $37.7 million for established managers, according to a survey released today by Citi Prime Finance. The report, “Day One & Early Stage Investor Allocations to Hedge Funds” sheds light on the most important factors investors consider when assessing Day One/Early Stage opportunities including the size and frequency of allocations, preferences for investment strategy type, and fund terms.

The findings show that 75% of global investors surveyed approach hedge funds opportunistically, evaluating emerging managers alongside more established funds. Survey respondents, however, risked significantly less money on new funds than with proven managers. Across the investors surveyed, only 39% of Day One/Early Stage allocations transitioned to a core investment, but when the manager was successful, the size of that core position, on average, was nearly 5 times the initial ticket in both the US and EMEA and 3.6 times in APAC.

Raising Day One/Early Stage capital remains a substantial challenge. Hedge fund managers interviewed for the survey indicated that they had to pursue up to 100 meetings to win 2-4 allocations. On average, investors made only 5.0 Day One/Early Stage allocations each over the past 3 years, and 2.2 such allocations in 2011.

“Our Day One & Early Stage survey provides a glimpse into the investor’s decision-making process, giving new funds this valuable insight for the first time,” said Chris Greer, Global Head of Capital Introductions, Citi Prime Finance. “Given the ongoing market volatility and shifting landscape for hedge funds, it is necessary that managers understand investor demands in order to raise capital and ultimately mature.”

The investment team’s previous experience and its track record were noted as the two most important criteria investors considered when making Day One/Early Stage allocations. These were followed by the stability of the investment team, as demonstrated by the general partner’s ownership structure, and the fund’s operational infrastructure support. “It’s not just a matter of transparency and reduced fees anymore,” Greer added. “We found investors also want more two-way dialogue with the new funds management and portfolio teams.”

“Our survey indicates that US investors were the most active Day One/Early Stage allocators, with overall mandates more than three times those of EMEA investors,” said Michael Kane, Head of Capital Advisory, Citi Prime Finance. “There is a general perception across the investment community that a manager’s initial performance is often a fund’s best. Early investors are typically offered management and performance fee concessions to compensate for the incremental risk of providing capital, which makes getting in early an attractive proposition.”

The survey also finds that experienced hedge fund investors such as fund of funds tend to be the most frequent investors in newly launched funds. Day One/Early Stage investors are acutely focused on the incremental risks involved in successfully launching and managing a new fund and rely on experienced teams to evaluate potential opportunities, with the majority of survey respondents citing teams with more than 10 years of allocation experience.

The research paper details the results of a series of qualitative interviews and quantitative surveys, conducted by the Citi Capital Advisory and Capital Introduction teams, with more than 90 managers and Day One/Early Stage investors globally, including fund of funds, family offices, private banks, and endowments. Participants were surveyed to determine key trends that have emerged since 2008 and to better understand the most important factors they consider when placing capital with managers.

Press release

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What do you think?

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The title of your article missed an important point of the study: "It should be noted that in this report we draw a clear distinction between Dl/ES investors and investors that provide seed capital (seeders). In exchange for providing a critical amount of capital, seeders obtain economic participation in a fund's future revenue. While D1/ES investors may negotiate some preferential fees or terms, they do not have a financial stake in the fund or manager. Seeders were not a target audience for this survey, as we believe the dynamics surrounding such investments, which have both hedge fund and private equity characteristics, differ greatly from D1/ES investing."   February 28, 2012 06:29:26 PM
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