In the trading space, much like the rest of the world, some of the best ideas and strategies come from emerging managers, or the “new kids on the block.” The trick is finding the right right win-win partnership to help get them on their way.
Today, it is the large managed funds that control most of the assets. A recent study from hedge fund research firm Preqin shows that big funds – those with over a billion under management, manage more than 90 percent of the assets. And last year, the hedge fund space had $3.2 trillion assets under management, according to Preqin, while the commodity trading advisors held $333.4 billion in Q3 2015, according to Barclayhedge.
That concentration of assets creates a problem for small or new funds, looking to get seed money that will propel the firm forward. According to Allison Yacker, partner at Katten Muchin Rosenman, part of the solution lies in “seeding arrangements,” whereby a larger, established firm provides the working capital and other elements that allow an emerging manager to focus on trading. The challenging trading environment since the 2008 financial crisis, coupled with more regulations and compliance costs, has created a more competitive environment for firms looking to attract capital.
“Where a manager used to rely on sustained returns and grow organically, that’s just no longer the case,” Yacker said. “Managers (now) find that they must at least entertain the idea of seed capital and often take it, not just to prosper but just to survive.”
Most seeding arrangements require a revenue sharing deal of 20 percent of their gross revenues, which means 20 percent of the management fees, incentive fees or allocations to which the fund manager is entitled. And that is across all products. Lock-up periods on seed arrangements typically run 24 to 36 months, with some triggers that could end the relationship earlier in the cases of poor net asset value performance or any regulatory or legal investigations.
“They also have to agree to give up some level of control,” she said of fund managers. “Maybe not day-to-day control but they have joined forces with someone and have entered into not just a seeding arrangement but a strategic partnership.”
For Yacker, seed arrangements allow for such firms to focus on what they do best, trading.
Beyond a capital injection, the deal can also benefit the fund manager in terms of management, administration, operations and infrastructure and even compliance. Seed arrangements can also provide valuable networking support, which can help grow the investor pool.
Ultimately, Yacker said these deals work best when the fund manager and seed investor work as strategic partners, not just a simple early stage seed investment.
“The trend idea and I wish I could it see reinforced more often, is to look for a relationship between an emerging manager and a seed investor that is truly a partnership… that will let the asset manager grow,” Yacker said.