September 25, 2023

DealBook: Starting Up, Funds Turn to ‘Seeders’

Far from Wall Street, few have ever heard of Robert T. Discolo. But in the world of hedge funds, Mr. Discolo is one popular guy.

He oversees a seeding fund at PineBridge Investments, which means he provides cash for hedge fund start-ups whose managers harbor dreams of becoming the next Steven A. Cohen or John A. Paulson.

While seeding funds have been around for the better part of two decades, they are staging a recovery as more prospective fund managers spill into the market but struggle to attract investors.

Executives at seeding funds say it has never been easier to find talented hedge fund managers eager for cash.

“This is probably the best environment I’ve seen since I started in the business back in 1988,” said Mark Jurish of Larch Lane Advisors, which is PineBridge’s seeding partner.

DESCRIPTIONChester Higgins Jr./The New York Times Robert T. Discolo, right, of PineBridge Investments, with Mark Jurish of Larch Lane Advisors. Together, the two firms are now creating a $1 billion seeding vehicle.

The hard part, however, is finding great investment strategies and backing funds that will not wilt and die.

Just a few years ago, analysts, traders and others on Wall Street who wanted to open up their own hedge fund shops practically had money raining from the skies. The joke inside Goldman Sachs was that if you couldn’t raise more than $1 billion to open up your hedge fund, don’t even bother.

What has changed is that many investors, including pension funds and university endowments, now are more inclined to put money into established hedge funds with proven track records rather than bet on start-up managers.

Also, the start-ups are turning to seeders with back-office resources as costs rise to comply with new hedge fund regulations that require compliance officers, audits and more disclosures.

As a result, a number of firms — including the Blackstone Group, Goldman Sachs, Reservoir Capital and upstart seeder firms like NewAlpha Asset Management — have been raising money from investors to place with new managers.

An investment in a hedge fund that becomes a sensation can be lucrative for the seeders, who typically take equity stakes in the hedge funds or a portion of the fees the hedge funds generate, typically 2 percent of total assets and 20 percent of any profits.

Industry titans David E. Shaw of D.E. Shaw and Daniel S. Och of Och-Ziff Capital Management, whose firms oversee a combined $50 billion, both started with money from seeding funds in the late 1980s and early 1990s.

Of course, for every Shaw or Och there are dozens or even hundreds of hedge fund managers who flamed out or simply never attracted enough cash from outside investors.

Despite lackluster returns in recent years, the hedge fund industry has rebounded sharply. Its assets have surpassed the 2008 peak and now stand at more than $2 trillion, according to Hedge Fund Research, based in Chicago.

Seeders are raising more cash too. The amount of capital expected to be invested with emerging managers in the first half of this year is expected to total around $2.5 billion, according to the results of a survey of about 40 global hedge fund seeders conducted by the Acceleration Capital Group, a New York-based firm. While that amount is double what a similar survey showed in 2009, it is well off the $7.5 billion that emerging managers expected in the industry’s heyday in late 2008, according to data from the firm.

Even with the revival, it can be tough to get the attention of a top seeding executive.

“You call them, you call them again and then you call them again,” said Steven R. Gerbel, the founder of one hedge fund firm, Chicago Capital Management. “Finally you get through and you’re told 12 bogus reasons why you’re not getting a seed. It is incredibly frustrating and horrifically painful.”

Mr. Gerbel says he has spent years searching for someone to provide capital to increase the size of his fund, which manages about $36 million and says in its marketing materials that it averages yearly returns of around 19 percent.

Recently, Mr. Gerbel said, one potential seeder told him his firm had too much infrastructure — investor support and regulatory compliance — while another said he didn’t have enough.

“I’ve come to the conclusion that my infrastructure is properly sized,” he grumbled.

While Mr. Gerbel would welcome the money, he is less than thrilled with the onerous terms of the seeding deal itself.

“The seed capital providers own it all: the stadium, the bats, the balls, the bases, your uniform, your cleats, the field and the concessions,” said Mr. Gerbel. “And if you want to play you just have to live with it.”

More managers are in the market in part because Wall Street shed certain businesses like proprietary trading in the wake of the financial crisis. Not all of them have a compelling investment strategy.

“In today’s world, you have a more attractive world of partnering with the talent and less attractive world of strategies,” said Daniel H. Stern, the chief executive of Reservoir, who has seeded a number of successful hedge funds, including Och-Ziff, across Wall Street over the years.

Mr. Discolo at PineBridge said that recently managers had been knocking on doors with funds looking to invest overseas, particularly in Asia. And then there are the truly unusual strategies, Mr. Discolo said, noting that he had seen funds that were planning to invest in leveraged life insurance settlements, receipts for televisions stored in warehouses and Pakistani equities.

The Larch Lane-PineBridge partnership is in the midst of raising a $1 billion seeding vehicle that will invest in about a dozen hedge funds. The seeder fund has already backed an equity fund managed by Stonerise Capital of San Francisco and a United States bank-loan fund managed by the Boston-based Feingold O’Keeffe Capital, according to a report on Hedge Fund Alert.

PineBridge is the renamed former asset-management arm of the American International Group, which sold it to the Asia-based Pacific Century Group in 2010.

PineBridge’s press relations firm declined to comment on the fund, citing Securities and Exchange Commission restrictions on hedge fund marketing activities.

In general terms, however, Mr. Discolo said a selective seed manager might invest in about one out of every 100 hedge fund managers.

“Everybody thinks they’re going to be the next Marc Lasry,” Mr. Discolo said, referring to the manager of Avenue Capital, which oversees $13.7 billion. “He’s a great manager, but there are not that many Marc Lasrys out there.”

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