Prior to 2000, hedge funds were typically incubated within banks or seeded by wealthy individuals. After the financial crash of 2008, institutional investors and consultants have become more important players in the market.
The business of putting “seed” money into the world’s hedge fund industry is an investment space in its own right, according to a white paper published by Investcorp-Tages, the investment firm created as a joint venture between Investcorp and Tages.
An early-stage investment into a hedge fund offers investors the opportunity to take a stake in the fund itself, thereby allowing them to directly participate in the management and performance fee revenues.
The authors of the report, entitled Enhancing Returns: The Case for Hedge Fund Seeding, said they expect demand for hedge fund seeding to “grow significantly in the coming years.”
“There is a strong pipeline of highly talented managers facing increasingly high barriers to entry. These include immediately visible increasing regulatory, compliance, and operating costs, but also more indirect barriers such as rising minimum asset size requirements from prospective institutional investors,” the report said.
It noted that the breakeven range in terms of assets under management for a newly-launched hedge fund currently lies at around $100 million to $150 million. Seeding or “acceleration capital investments” can help investors with patient capital to cut hedge fund investment costs and raise hedge fund returns.
“In exchange for making a day one investment or early-stage investment into the manager’s hedge fund, investors can directly participate in the management and performance fee revenues of a hedge fund manager’s firm,” it said. “This economic interest is typically structured as a gross revenue share participation which allows the investor to receive a percentage of the management and performance fees earned by the manager without bearing exposure to the costs of running an asset management firm. This economic interest is received at no additional cost to making the initial investment in the manager’s fund.”
The study notes that invested capital is typically subject to a commitment period of two to three years, during which the investor may not redeem, unless certain pre-negotiated negative events have occurred; for example, a predefined loss of capital.
There is a large gap between hedge fund investing with and without taking part in the seeding process, as the following chart illustrates:
Source: Investcorp, Tages