Hedge fund seeders flex their muscles in Asia

Abstract

Asia has historically been marked with a hedge fund seeding activity that could be best described as anemic and insignificant, and often, almost non-existent. The scenario, however, has changed considerably with a significant number of high profile seeding deals visible in the market, bringing with them high-quality managers with sizeable amounts of start-up capital. Myo Schollum, who heads Asia Prime Services coverage at Credit Suisse, says that a considerable amount of seed capital has been deployed to new managers in the region not only by traditional seeders, but also by large-sized hedge fund platforms and family offices in Asia.

With an influx of next-generation seeders and high-quality managers, 2015 promises to be a fertile period for seeding activity in Asian hedge funds

Top from clockwise: Myo Schollum, Chuak Chan and Michael Garrow

Asia has historically been marked with a hedge fund seeding activity that could be best described as anemic and insignificant, and often, almost non-existent. The scenario, however, has changed considerably with a significant number of high profile seeding deals visible in the market, bringing with them high-quality managers with sizeable amounts of start-up capital.

Myo Schollum, who heads Asia Prime Services coverage at Credit Suisse, says that a considerable amount of seed capital has been deployed to new managers in the region not only by traditional seeders, but also by large-sized hedge fund platforms and family offices in Asia. The activity accelerated in the latter part of last year, and there are no signs of a let-up in momentum for 2015.

"Unlike in previous years when most start-up managers were starved of capital as seeders were not focused in Asia, a significant amount of capital has been deployed to a number of Asian managers," he says.

Notable examples of seeding last year were Hong Kong-based Kontiki, which was seeded by the New York-based Ziff brothers' family office, and that of Pleiad Advisors, an ex-Soros team seeded by Hong Kong-based strategic investor, HS Capital.

Pleiad, through its partnership with HS Group, is understood to have attracted significant interest from institutional investors in the US and Europe. TPG Holdings, a global private investment firm with over $66 billion in capital, owns a stake in Hong Kong-based HS Group. A pan-Asia fund focused long/short fund, Pleiad was established by a team of former China and Japan specialists from Soros Fund Management in Hong Kong.

Seeding frenzy

Industry managers attribute the strong flow of seed capital to the abundance of high calibre talent in the region that have launched or are preparing to launch their new strategies and offerings. "The strong calibre and pedigree of these managers have whetted the appetite of big players, including large hedge fund platforms and family offices, to provide launch capital," explains Schollum.

The buoyant seeding mood was also given a lift by the strong performance last year of several large Asian-based managers such as Segantii and Myriad. Asian hedge funds have delivered some of the best returns recently, bolstered by a rally in equities in markets such as China and India.

Amid a seeding frenzy, strong trends are clearly emerging in Asia. For the first time, the region is seeing the rise of Asia-based seeders dedicated to doing deals with hedge funds in Asia. These firms run institutional-grade businesses, led by people who have spent many years in Asia and who have a deep understanding of the region.

They have deep pockets, solid backers, and hold specialist knowledge and resources to give Asian managers support from the ground with marketing, risk management and back-office help.

"Historically in Asia, people have tried to do seeding deals, but in most cases they were much smaller in size and the terms were not necessarily that attractive. The new Asia-based seeding groups are now in-line with global seeders, both in size of investment and terms," says Shane Bolton, head of Asia prime brokerage at Goldman Sachs.

Global investors traditionally dominate Asia's seeding landscape, but there is a broadening of the investment in terms of participants that are engaging in the region's seeding space.

The changing investor base now includes sovereign wealth funds, private equity groups, funds of funds, and high-net-worth family offices.

Singapore asset manager Dymon Asia Capital received a commitment worth $500 million last year from state investor Temasek Holdings to start a hedge fund seeding venture, while private-equity firm TPG has teamed up with HS Group for institutional seeding in Asia. There was also talk about Alibaba Group co-founder Joe Tsai backing a launch by former SAC Capital Advisors Andrew Bazarian.

Schollum is particularly excited by developments indicating that more wealthy families in China and around the region are looking actively to seed money into new managers who are prepping to launch themselves this year.

"What became evident when looking at our China private banking business is that there is a strong appetite among clients to invest significant amounts of money into successful managers and we have seen many opportunities emerge from that client segment," he says.

The robust seeding environment means more options for fund managers to grow their assets. Sound funding arrangements in seed ventures in terms of investment lock-up period and fees are creating a positive attitude among managers toward start-up deals.

"Doing a seed deal is now seen as a sign of strength: it means you have capital to attract other investors. It means you can invest in your business," says Bolton.

Stamp of approval

A deal with a quality seeder represents a stamp of approval that could attract international institutions to the fund. Before the financial crisis in 2008, the most talented managers did not need to be seeded. They were able to raise money easily and launch a fund without much help. The managers who relied on seeding platforms were seen as the ones unable to attract enough money on their own.

But that has changed. Today, even the pedigree managers are considering seed deals. The days of easily accessible cash are long gone and unlikely to return soon. Shrinking fees and rising regulatory costs are convincing managers to enter deals, where access to capital, technology and resources is easier.

"We're now seeing the emergence of some new, respected groups who are starting to deploy capital. This is great for the industry as it diversifies the sources of capital and growth for managers. It also provides more choice for investors seeking to allocate capital into Asia," says Chuak Chan, chief executive at Ascalon Capital Managers. Ascalon provides starter capital to Asian hedge funds and is a subsidiary of Australia's Westpac Banking Corp.

The preponderance of recent quality launches has been remarkable. Among those that have generated excitement are Wesley Wong who used to run TPG Axon in Asia and Feng Hsiung who previously managed a regional strategy at event-driven manager York Capital.

"Those two are launching with proper seeders, and we are seeing quality new managers holding as many as six term sheets in their hands. I don't think I have seen that kind of seeding activity before; many of them now want to seed, and to seed meaningfully," a market source told AsiaHedge.

Another notable regional start-up receiving substantial capital from HS Group is Zentific Asset Management, the systematic quant fund established by PM Christopher Lee who formerly headed BlackRock's systematic investment team in Hong Kong, and Burke Lau, former head for Asia quantitative research at Macquarie.

"The industry will gradually evolve to have more Asia-based investors supporting Asian hedge funds in the future," says Michael Garrow, chief Investment officer at HS Group.

In recent months, many of those that have succeeded in raising significant money obtained the capital mostly from well-established hedge fund platforms, such as Millennium and SAC Advisors, the Steve Cohen firm which has been renamed Point72.

Those hedge funds platforms are understood to have been funneling a lot of US money to new managers in the region, according to industry sources. Independent estimates, for instance, place the amount that Millennium has seeded into new funds in the region at close to $6 billion.

Millennium seeded Symmetry, which is considered one of the biggest new funds to launch in the region in years. Sources said hedge fund platforms, such as Millennium, saw the need to compete with seeders by helping some of their managers to set up external hedge funds. That is the same approach that Singapore-based macro hedge fund platform Dymon took with Port Meadow, the London-based long/short equity fund run by Carl Vine.

"While Port Meadow is related to Dymon, it is for all purposes and intents external to Dymon with Vine given the latitude to establish his own track record although the money he received from the government of Singapore has been filtered through Dymon," says a source. Vine is based in Oxford in the UK.

Meanwhile, Acion Partners, the pan-Asian event-driven hedge fund that former York Capital regional chief Feng will run from Hong Kong, is understood to have already attracted at least $160 million. Most of the seed money is coming from KKR & Co, the New York headquartered global investment firm led by billionaires Henry Kravis and George Roberts.

Acion is one of the most eagerly-awaited Asian start-ups this year given the strong pedigree and track record of Feng as a manager and given his success in convincing KKR to take an unspecified minority stake as part of KKR's 'broad partnership' with the firm.

Next-generation seed deals

"Compared to five to seven years ago, we are presented now with a broader range of investment strategies. As the industry matures, we can also deploy investments with managers at different phases of their company's life cycle, from incubation, early investment to capital acceleration," says Chan.

Every seeding deal tends to be slightly different because each one is individually negotiated, but the majority of the deals are for gross revenue shares in the business in return for certain amounts of assets committed.

Typically, the investors take a percentage of a fund's revenue stream in exchange for capital which stays with the fund over a period of two to three years. Performance and AUM triggers will apply.

"The upside is normally a big cheque. The bad news is that you have to start marketing from day one because your business has got to be big enough so it can withstand the withdrawal of the cheque within two to three years," says Katarina Royds, head of global business development at Ascalon Capital.

Some investors like Ascalon will offer capital in exchange for equity stakes in the fund management business. The investor becomes an active business partner of the fund.

"On the one hand, not every manager wants to sell a piece of their business. On the other hand, the deals are long term, and typically the strategic partner would be able to bring resources such as marketing, corporate governance and compliance," she adds.

Next-generation seeder HS Group espouses a third kind of deal structure, an "arm's length model" where seasoned, scalable managers receive significant long-term capital and advice to achieve institutional best practices, yet remain independent from the investor with the critical mass to be self-sustaining and stable.

Either model can mean huge returns for seeders. In exchange for millions of dollars of initial capital, investors get a share in whatever revenue or profit a fund manager makes. The seeder's return also grows in tandem with the fund's expansion.

Challenges abound

However, success isn't guaranteed. A blow up can happen -- weak fund performance can move investors to withdraw, forcing a fund to dissolve. Like any investment, seed deals come with risks.

There is also the issue of capacity. Seeders that require a strategy that has the capacity to grow over time will find it tough to find candidates in Asia where hedge funds tend to be small in terms of assets under management.

But the even bigger challenge has little to do with money: building trust and aligning the interest of both seeder and manager.

"Everyone has their own way of building trust but it generally requires time. The more difficult factor to achieve is alignment of interests. Some seeding models have greater alignment between the seeder and manager than others. Challenges may present themselves more to the manager than the seeder over time if interests are not aligned," says Chan.

From the perspective of a manager, competition for deals can be fierce. "Investors are only doing a handful of deals globally a year, so you're not just competing against other Asian managers, you're competing against all managers globally who might be interested in doing seed deals. And while we're seeing a growth in the number of groups interested in seeding, it's still a reasonably concentrated number," says Bolton.

For now, optimism around seeding is growing in Asia. Brighter days may be on the horizon for many of the region's start-ups.

"We continue to see great opportunities to partner with talented teams who have demonstrable experience in managing money and businesses in the Asian hedge fund industry," says Chan.