Have you ever wondered what it would be like to run a hedge fund? Hedge funds are both glamorized and villainized by both popular culture in TV series like “Billions” and on the political and legal arena by recent high profile lawsuits by activist investors like Bill Ackman and Carl Icahn. However, for most hedge fund start-ups, the reality is far from glamorous and requires a huge amount of work and unwavering commitment. Nancy Davis, the CIO and founder of Quadrant compared starting a hedge fund to “a very expensive hobby.” Hedge fund start-up founders should expect to put a significant amount of personal financial capital as well as sweat equity into the business for at least a year before seeing any return on their investment. Most hedge funds are small and have a hard time scaling: according to Hedge Fund Intelligence, only 305 hedge funds out of the 7,500 comprising the universe manage more than $1 billion. In other words, it no longer takes two guys and a shingle open shop. The high-level of competition, regulatory scrutiny and investor due diligence is actually good for investors and for the few committed hedge fund entrepreneurs who are passionate about markets and building a business.
Unlike tech founders, hedge fund founders have few resources to rely upon when starting a hedge fund. Thus, when I read Ted Seides’ book “So You Want to Start a Hedge Fund,” I was excited about the wealth of lessons learned he has shared with prospective hedge fund entrepreneurs. I recently had the opportunity to sit down with Ted and discuss his book. Ted is uniquely suited to this topic because he’s seen so many new managers as an allocator (the term used for institutional investors) at one of the most successful endowments (the Yale University Investment Office) and as a co-founder of a successful hedge fund of funds.
In a nutshell, we both see some interesting things happening that suggest the industry is at a significant crossroads for both hedge fund managers and investors. Asset growth is slowing. Competition is shifting from industry-wide growth, grabbed from traditional asset classes, to market share capture between hedge funds. Low cost ETFs and index funds are capturing market share and have grown from 10% of total asset under management (AUM) in 2000 to close to one third of total AUM in 2015, according to the Boston Consulting Group. Further, recent mediocre performance for the sector as a whole has everyone is looking for answers. For example, NYC Employee Retirement System recently decided to fire their hedge fund managers, with one critic of the NYCERS portfolio famously announcing in the news: “let them sell their summer homes and jets.”
Size notwithstanding, there is a real demographic challenge for the industry, too. Many of these large funds are overseen by a founder (or founders) who created real wealth for themselves and are approaching retirement. In fact, firms with leaders over 60 years old manage one-third of the assets in the industry and those with principals in their 50’s comprise another third. Some of these big funds will not survive their founders’ departures, suggesting that large investment allocations may get shifted to different managers.
With this landscape in mind, Ted and I see opportunities for rising stars and for allocators facing “retirement risk” in their existing portfolio.
Q: Ted, why did you decide to write this book?
A: Over the years, I met with hundreds, probably thousands, of start-up asset managers. From my first days in the business working for David Swensen at Yale through the last decade and a half at my prior firm, I spent nearly all of my professional career analyzing and investing in early stage managers.
Managers regularly came to me seeking advice when preparing to set out on their own. I tended to say the same thing over and over, yet it always was new information to the first-timer. I realized that I had acquired a body of knowledge from the many lessons I had learned that could be valuable to many.