Not that I really care or that I even keep track, but today someone informed me that TechCrunch has posted the top 100 VC blogs based on number of Google Reader subscribers. This blog came in at #53 and I thank all the readers who continue to enjoy its content.
When this blog started it was more of an experiment to help me flush out my thoughts and post on interesting topics specifically in the field of venture capital. Over time, I really couldn't help myself but post on all areas of private equity that I am involved in including real estate, hedge funds, leveraged buyouts, and general market commentary. Hopefully I haven't alienated too many readers by broadening my horizon.
While Google Reader is only one source of readers of this blog and this list doesn't really mean much, it does confirm that there is a hunger out in cyberspace for information on the overall venture and private equity industries. And we all know that where there is demand, supply will come.
I am happy to be one of those suppliers of information. Feel free to drop me a line anytime with questions, ideas, or comments. Thanks again for joining me in this rewarding endeavor.
A lot people are surprised at how far our new president has gone to propose regulations over the financial markets. Clearly, times are changing for the entire financial industry. Bonuses are being targeted to firms that have taken federal bailout money. The government is now pressing banks to shakeup their boards. A transaction tax may be implemented on all stocks and bonds sales to pay for bailout funds. And now the tradings of derivatives will be regulated over central clearing exchanges. Clearly the new administration is trying to regulate risk and speculation.
On the one hand, it seems like the administration is out to punish the industry for sins that have caused the financial meltdown. On the other hand, it is trying to stimulate the economy by encouraging lending. Ultimately, risk taking must return in order for the economy to get moving. Further regulation will only confirm that risk taking in this country will never be the same again. It will also confirm that the poor administration really has no clue about what drives financial markets.
History has shown markets that encourage risk and speculation thrive and grow faster while those that do not ultimately wither and die.
Speculation and greed will never disappear from humankind no matter what kind of regulations are put in place. It is only a matter of finding that next frontier where all of this can happen. There will be plenty of countries opening their doors and taking advantage of this rare opportunity. If our administration doesn't realize this soon, the US financial markets will not be premier place to do business. There already is a scramble going on among a lot of firms that are looking to move out.
For those of you who haven't heard, Citadel is expanding into the investment banking arena by hiring some ex-Merrill guys. I've said this before - when times get tough and there is pain it is a great time to take advantage. The financial turmoil and destruction of almost every investment banking unit on Wall Street has created a huge opportunity for those looking to expand. Almost every boutique bank I know of has been hiring non-stop all of the bulge bracket refugees, looking to become the next big player.
Expansion and diversification into financial infrastructure plays is not new to Ken Griffin and Citadel. A lot of people don't know but Citadel makes a ton of money in its market-making business. It essentially has so much market flow that it IS part of the financial exchanges as we know it. Additionally, it has a turn-key hedge fund infrastructure program that caters to the hedge fund industry.
So not only it is a hedge fund, it is knee deep into the infrastructure of the US financial markets. Expansion into I-banking is a natural step and a very smart one. A lot of big players such as Blackstone do advisory work that practically equates to banking but most have not officially crossed the line. It will be interesting to see how it all plays out and whether someday Citadel's hedge fund will only be a tiny part of its overall business.
It's been a while since I posted but a reader recently asked me to comment on Hurdle rates. For those of you not familiar with what a hurdle rate is, it is generally the preferred rate of return an investor requires to make an investment. Some refer to it as "cost of capital". If you consider the many options of where money can go to make a return, for an investment to be attractive it should exceed the most commonly available rates of return. There are many differing opinions on what this common rate of return should be. For example, some people feel that a good preferred return is that of what money would cost to borrow from a bank such as 7% on a fixed 30 year loan or a few points above LIBOR. Others may use a benchmark of the average return of a broad stock index such as the S&P 500.
Another way to look at the hurdle is the percentage return after which a fund manager can charge fees. For example a manager may say that his fees will only be charged on the return in excess of the hurdle. The logic is essentially that the investment should return better than a commonly available return and thus only fees should be paid on that excessive return.
I have never been a fan of hurdles or preferred returns in private equity. The main reason is that I am not a nickel and dimer and if I am investing in an investment looking for an outsized gain I am not going to fuss over the terms of a preferred return. If I wanted a hurdle type of return I would just put my money in a mutual fund or buy a piece of commercial real estate and get a good cap rate. When I invest, I want the manager to make big returns and be rewarded on the back end for the great return.
It is sort of analogous to investing in public equity for dividends. I am not a dividend investor and would never invest in a stock for its dividends but more for its appreciation. Additionally, in a private venture type investment, taking a dividend in a startup does not make sense to me because you want the cash to stay in the company to add value to the equity. An LBO is a different scenario because the company is cash flow rich and taking a dividend should not weaken the company materially.
Thus to me the hurdle rate should be a non-issue and in a private deal where I am looking for a good return, I do not want the manager to focus on the hurdle. I would rather that it be clean and simple. I want to be able to calculate the return and fees that I paid to the manager in my head or on the back of a napkin, not through a complicated spreadsheet.
If I am investing in a fund, I am looking to build a relationship is someone who can earn good returns over any cycle. I may negotiate some terms or fees, but the hurdle certainly is not one of them. I would rather go with a talented manager with a low hurdle than a first-timer with a high preferred return.
It was interesting to listen to the testimony provided by several hedge fund managers on Capitol Hill this week. Although I do not agree with all of the support toward more regulation, it was nice to see and hear from some of the more secretive hedge fund managers who do not typically show their faces in public. One thing is clear, the government does not really know anything about the hedge fund industry - there was no rhyme or reason why they chose those managers instead of others. And it was even more clear by the varying testimony that the managers themselves did not know exactly why they were testifying.
Do hedge funds need more regulation and disclosure? Definitely not. A hedge fund is nothing more than a pool of money that is used to make money by any means necessary through a hedged strategy. It really does not make any difference if it is a hedge fund or an individual person that has billions to throw around. I certainly do not want to have to report all of my transactions to the government on a daily, weekly, or monthly basis. And I certainly do not need to tell anybody how much margin I am using and what I am buying or selling.
Regulation is necessary to keep a fair marketplace intact and to ensure that rules are followed. Regulation cannot control greed or risk. You cannot regulate speculation. You cannot regulate irrational exuberance. And you definitely cannot regulate bearishness or short selling. If I want to bet the farm that a company is going down or going up, I am allowed to do so by the rules of the SEC and by the margin limits of my brokerage. Any additional regulation would amount to nothing more than a Sarbanes-Oxley type of thing for the hedge fund industry. And you know what SarOx did for the new issues market.
All regulation will do is make people leave. And this is not the time to get dollars flowing out of the USA. Financiers are smart enough to figure out a legal way around the rules.
If hedge funds had anything to do with the bringing down of the market then perhaps it is good they were around. They did all Americans a favor by exposing the overleveraging of the financial system and have helped weed out the companies who should not survive. In every cycle there must be a boom and a bust. We are definitely in the bust but it is all a set up for the next wave. If the government sets up too many rules, then there will not be another booming wave. Or perhaps it will occur somewhere else.
As I've mentioned before, there is a lot of pain in this market right now. All broad market indices are down signficantly for the year. Most mutual funds are showing big losses. And now many hedge funds are being forced to liquidate positions and "unwind" as investors redeem capital.
If you are a hedge fund, you should be thriving in this environment. If you are mutual fund disguised as a hedge fund then you are not thriving. If you are a value fund and are buying shares while they are cheap only to see them go lower then you are not a hedge fund. You are an investment fund that does not hedge. The whole point of a hedge fund is to "hedge" or curb your bets so that you control risk. If you are suffering big losses then you are not hedged and you really are not a hedge fund. This is the type of market in which the real hedge funds show their attributes.
There are plenty of rumors going on in the HF world about turtle traders being let go by SAC and other firms because they cannot produce. While I do not like to see people lose their jobs, the one thing that I like about the HF industry and in particular the turtle model is that if you do not produce you are let go. If you do not produce it means that you are losing big. If you are losing big it means that you are not adequately hedged and so you should not be in the hedge fund business.
I received a nice comment from a reader who continues to want information on the hedge fund space and how to seed your hedge fund. Thus I will put together a series of posts on the topic for my reader's interest.
Indeed there are hundreds if not thousands of prospective hedge fund managers that are looking to get their fund seeded and get some investors. And most if not all will not have the pedigree or connections to get big dollars from a select few investors.
I continue to believe that there are generally two or three paths to starting your hedge fund. The first is having that pedigree and/or being in a lift-out situation with a strong track record and connections to investors in your old fund or even sponsorship from your old manager. The second is starting small and building that track record over time. The third is treating your fund as a startup company and actually going out and raising funds and selling equity in the underlying manager.
I'm not going to talk about the first method since I've addressed that in previous posts. The second and third paths are the interesting ones. They are the ones that are less glamorous. They are the ones that take time. They are the ones that depend on manager persistence.
The economics of a hedge fund really only start to make sense at the $50 mm and above level. At that level you can start to hire ancillary fundraising staff and really start to get a machine going. Under that amount you are bootstrapping and anybody involved in the fund is going to have to do a little bit of everything. Thus, how do you get to that level of assets under management that is scaleable?
Well, if you can't put together a few hundred thousand or even a million bucks then you probably have no business trying to be in the hedge fund business. When people say "the rich get richer" it is sad but true. Even in a true merit-based fundraising system, it would be unlikely to find someone with adequate financial experience and trading experience to be able to run a fund without having the economic ability to put together a million dollars either from friends, family, co-workers, or investors. As I've said before, running a hedge fund is really running a business. All business is based on sales. In the hedge fund business you need to be able to sell yourself and your fund to investors. If you can't sell the promise and hope of great returns then you definitely should not try to run a hedge fund.
The guys at SkyBridge have seeded another fund - Capital Returns, a NY based global long/short equity fund focused on the insurance industry. Capital Returns is run by Ron Bobman, previously of Bedford Oak Advisors and Sam Zell's Capsure Holdings. It's the final fund to be seeded by SkyBridge's first fund. Word is that SkyBridge is out pounding the pavement raising its second seeder fund and will no doubt have success in this endeavor. I look forward to seeing the Capital Returns of Capital Returns.
We've been getting all sort of emails and notes from people who are looking to seed their hedge fund. Some of them are lift-outs from other firms, others are first time funds from people with some prior experience, and others are from people with no industry experience. I've previously written about hedge fund seeders and what they typically look for. The truth is that most hedge fund managers will not qualify with a traditional seeder who is looking for the pedigree, track record, and the connections.
So what to do if you are in that other 99% of fund managers that want to start a fund? To put it simply, you have to view launching your hedge fund the same as you would launching any other startup. It takes hard work, salesmanship, persistence, and skill. Nobody really cares that you returned 100% last year based on a back-tested simulated model in ten different markets. Nobody really cares that your system is invincible and that you have worked at various firms in the industry. What really matters is that you know how to start and run a business and have great products.
In the hedge fund industry the business is managing other people's money and "institutionalizing" the business with analysts, traders, and capital raising specialists. The product is a good fund with good returns. How many traders do you know that can do both things well?
Thus, in this industry you tend to find people that are good at one or the other but not that great at both.
If you are a new hedge fund starting up, treat your business like any other business - take risk and invest time and energy accordingly. VCs love to see entrepreneurs who have invested a ton of their own capital and time into a business. Similarly, a new fund manager should invest all or most of his net worth into his own fund. VCs like to see entrepreneurs who have raised an insider round from family and friends - this shows that the person has invested a lot into the company and put relationships on the line. Similarly, a new fund manager should have some investors and have significant skin in the game.
The list can go on and on of things that are important for someone starting a new fund. I'm not going to spell everything out, but if anybody wants me to keep going on, let me know.