What it’s like to launch a hedge fund when even the biggest managers are struggling and long-short equity is a ‘dirty word’

Launching a hedge fund in 2019 hasn’t been easy, and several people who are either raising capital or have recently launched gave us an inside look at the process.
More funds have been liquidated instead of launching, and even the biggest funds are struggling to keep assets right now.
"General long-short equity can kind of be almost a dirty word," one person told Business Insider, and new launches are better off with differentiated strategies that can help them stand out from the pack.
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Several people warned Greg Royce about the "rule of three" when he said he was planning to launch his own fund.

"It would take three times as long, and be three times harder than you originally thought, to raise a third of the capital you want," said the former SAC Capital, Visium, and Citadel portfolio manager.

Royce is planning to launch Maximus Long Short Equity Management in a managed account structure next month. That’s a tough undertaking in the best of times, but even more daunting given hedge fund closures have been outpacing openings and startup costs are rising. More people may be looking to "seeders," which provide a majority of start-up capital in exchange for a chunk of revenue once a fund gets going.

"It takes certainly a lot of hard work and persistence, and staying in front of people," Royce said.

"I certainly don’t have all the answers."

See more: Humans are beating machines, and Pershing Square and Greenlight are crushing it. Here’s how hedge funds performed in the first half.

For three straight quarters starting mid-2018, more funds have liquidated than launched, according to the latest data from Hedge Fund Research.

And investors are even leaving the most established funds, according to research from the law firm Seward & Kissel, which found 46% of the largest 200 hedge fund managers’ assets experienced "material decline" when comparing their 2018 assets to the prior year’s.

Investors lost even more confidence after 2018, when the average fund lost money, and big investors like Stanley Druckenmiller have called for an industry-wide culling of funds.

Hopeful hedge fund managers also have a higher bar to clear just to start, thanks to increased costs for technology, data, compliance, and more.

In a blog post on choosing third-party service providers for new hedge funds, Eric Christofferson, a managing director at cloud software provider SS&C, wrote that "the expression ‘two guys in a garage with a Bloomberg terminal’ can hardly ever apply to any start-ups today."

"Starting a hedge fund these days isn’t just about raising capital and running trades," Christofferson wrote.

That rang true for one person currently in the fundraising process that spoke with Business Insider who asked not to be named because their backer does not want them to speak with the media before launch. They said "you underestimate the amount of time it takes" to complete the "business aspects" of starting a fund, like hiring, filling out proper paperwork, and meeting with potential investors.

This year also hasn’t seen the mega-launches of 2018, when Michael Gelband, Daniel Sundheim, and Steve Cohen started multi-billion-dollar funds. The biggest launch so far has been $2 billion Woodline Partners, from former Citadel PMs Mike Rockefeller and Karl Kroeker. Another big one expected this year is a $600 million systematic fund by one of Cohen’s former quants, Michael Graves, with its primary backing from Paloma Partners, which also seeded DE Shaw.

See more: Former Bain & Co. and Sagard Capital partners are launching a small-cap-focused hedge fund

Still, a second person who recently launched a fund told Business Insider there’s appetite out there for strategies that stand out from the crowd.

"General long-short equity can kind of be almost a dirty word," said this person, who asked not to be named because their fund still may raise more capital. A recent report from Jefferies prime brokerage division found that only a quarter of new launches focused on equities over the last three years have been generalists, with most focusing on industries like healthcare and energy.

The toughest period is before you hit $50 million to $100 million, the person said — that’s when you feel like you might have made a mistake.

This fear might be contributing to the growth recent launchers have noticed in seeders, like Blackstone, Paloma and Lighthouse, that will give substantial capital to a fund in exchange for a piece of their business and revenue going forward.

See more: Meet the 5 rising stars presenting their investment ideas at the world’s highest-profile hedge-fund conference

"It’s a different kind of alignment with investors," said Robert Mirsky, head of EisnerAmper’s asset management division, about seeding, but overall, he sees it as a positive.

"I’m willing to give up a lot to get that first big investment through the door."

That would free up time for the aspiring managers to do the thing they want to do: invest. One person who recently launched said if they could do it differently, they would have less meetings with potential investors because it took away from the time needed to research and continuously update their strategy.

Because, in the end, it’s the track record that matters the most, Royce said.

While fancy lawyers and sparkling new tech are good selling points, "it’s almost imperative" to have a good track record, he said.

"It’s a data-driven business so to any extent you can report performance numbers, the better," he said.

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