Eli Kent and Chris Kelley, co-founders and managing partners of hedge fund seeding platform Harvest Fund, an affiliate of Moody Aldrich Partners, expect to see a surge in investment opportunities over the coming year or so as regulatory changes, increased fee compression and shrinking margins at many established investment firms prompt a flood of talent to go independent.
GFM: What is the background to your company and fund?
EK/CK: Harvest Fund was established in early 2010 to develop and manage a private special situations investment platform targeting a most dynamic segment of the asset management industry. The fund is a private equity-like structure that provides growth capital to promising, newly independent hedge management firms run by pedigreed teams with demonstrable expertise and capabilities to build a business. A first closing is planned for December.
Harvest Fund is managed by its founders and owners, William Moody and ourselves (Chris joined early this year). The management team has more than 25 years of combined experience in private equity and hedge fund seeding, with particular experience in identifying and seeding talent in a robust, highly disciplined structure focused on multiple layers of value creation.
Harvest Fund is an affiliate of Moody Aldrich Partners, a privately-held investment firm founded in 1988 that manages equity investment strategies for large investors through separate accounts and is owned by Moody, Amory Aldrich, Eyk Van Otterloo, Jeremy Grantham, Eli and Michael Pierre.
Chris brings extensive private equity and hedge fund seeding experience to the team, having founded Value Asset Management, a Bank of Boston-backed multi-billion-dollar holding company that acquired majority interests in investment firms. He later formed Weston Capital’s hedge fund incubation business, seeding 10 firms and expanding the business to USD1.2bn in assets under management.
The Harvest Fund team has been developing a pipeline of top seeding candidates, educating qualified investors about the opportunity and assembling the offering. In August, the firm announced an agreement with Wilshire Associates to assist with key aspects of the platform including investment manager and operational due diligence, risk management, separate account platform services and distribution support. We expect that Wilshire’s involvement, drawing on its 30-plus years of capital markets experience, will further enhance Harvest’s execution of its strategy in the hedge fund seeding space.
GFM: Who are your key service providers?
EK/CK:Our auditor is Ernst & Young, the administrator and custodian is SEI and our law firm is McDermott, Will & Emery.
GFM: What is the profile of your targeted client base?
EK/CK:Participation in the fund is limited to accredited investors with whom Moody Aldrich Partners has an established relationship. We anticipate that the fund’s strategy may appeal to institutions, family offices, insurance companies, and other strategic investors interested in the attractive economics associated with owning hedge fund management firms.
GFM: What is your investment process?
EK/CK:The investment process begins by establishing an asset allocation strategy. Harvest directors, with input from Wilshire, identify global economic drivers and investor preferences and determine desired hedge fund strategies to target, based on diversification objectives, current market conditions and tactical overlay.
Managers are sourced from the team’s existing network, client and manager relationships, prime broker capital introduction groups, conferences and Wilshire’s manager research group. Our manager qualification process will reduce several hundred candidates a year to about 100 for in-depth review. Harvest directors conduct a primary assessment, evaluating team pedigree, experience and education, investment process and trading skill, historical results, business plan, entrepreneurial capabilities and alignment of interests.
Wilshire’s staff conducts a secondary evaluation involving a comprehensive qualitative and quantitative analysis of investment strategy and process and operational due diligence, including business practices, risk management and compliance. Wilshire’s due diligence reports and recommendations are provided to Harvest directors, who then select those managers to recommend to the board for the initiation of negotiations.
Harvest Fund is currently studying global macro, equity long/short (US, global and Asia), commodities, and credit strategies, but always remains opportunistic for specialty funds or exceptionally talented teams. We expect to make five or six allocations over the next 12 to 18 months.
GFM: What is your approach to managing risk?
EK/CK:Harvest Fund negotiates venture rights that include full operational and investment transparency. Managers are seeded through Wilshire’s managed alternatives platform using separate accounts that enable detailed ongoing manager monitoring. Wilshire monitors and conducts analysis and regularly provides risk reports to Harvest directors. We are not subject to standard liquidity terms and may liquidate investments and/or remove a manager at any time if a risk parameter is violated.
GFM: What events do you expect to see in your sector in the coming year?
EK/CK: We see larger commitments and co-investment opportunities for larger institutions, much as you see on the pure private equity side, as well as bigger teams seeking larger amounts of capital up front. We are seeing trends toward mega-incubation deals, niche strategies and incubation geographically. Our platform is structured to be flexible and highly scalable in order to offer co-investment opportunities to our larger clients and potentially to partner with the right institution and/or strategic partner to accelerate growth.
We also expect the coming year to produce an unprecedented opportunity with the dismantling of the proprietary trading desks at the Wall Street banks. Investment talent seeking seed capital has never been better. Regulatory changes, increased fee compression and shrinking margins at many established investment firms are causing a flood of talent to go independent.
Hedge funds represent an investment framework that will play a growing role in the future of active management. Asset growth in the hedge fund industry will accelerate in the years ahead with a forecast doubling from USD1.6trn to USD3trn by the end of 2013, according to Casey Quirk.
Regulatory changes and shrinking margins at many established investment firms are prompting talented investors to start their own firms, although the cost and complexity of starting a new hedge fund firm have increased.
Institutions are replacing individuals as the primary drivers of growth in the hedge fund industry amid a transformation as it attempts to address key shortcomings in its business and operating models. The institutionalisation of the industry is playing out as higher standards in all facets of the business become essential to gather assets. Many promising emerging firms need a strategic seeding partner to help them navigate the new industry dynamics and accelerate growth.
An asset allocation paradigm shift is unfolding. Investors are beginning to move away from a single allocation to ‘alternatives’ and are increasingly integrating hedge funds by strategy into a broader allocation context. For example, equity long/short will increasingly fall into the equity bucket instead of being lumped into the alternative bucket with distressed debt, commodities, currencies and market-neutral investments. This means a larger addressable market for alternative strategies and underpins strong growth forecasts for hedge funds. Investor preferences for sophisticated risk management and flexible techniques to limit downside and produce alpha will further drive demand for hedge funds.
Current industry dynamics offer an unprecedented opportunity for a hedge fund seeding platform that provides managers with capital, consulting, marketing and distribution while aligning interests with investors. We expect to attract exceptional teams with proven strategies, demonstrable expertise and capabilities to build a business.
GFM: What differentiates you from other managers in your sector?
EK/CK: There are different types of seeding firms in terms of overall approach, manager deal structure and benefits that are shared with investors. The approach of some seeders is a more passive model that typically will offer seed capital but no platform assistance or structured marketing for the managers.
At the other extreme are those that integrate managers onto a common platform and provide marketing under a single banner. In this scenario, the manager may lose its independence. A third type of seeding comes in the form of large pockets of capital from institutional investors willing to back promising managers. These deals typically offer the dollars without the strategic guidance.
Harvest Fund is more of a strategic partner with our seeded managers. We offer our managers a boutique appeal and an entrepreneurial mindset, providing strategic guidance to help them build their firms with important compliance, risk management and other platform assistance, including personnel. This, coupled with our formalised marketing programme, is attractive to skilled investment managers who really want to start their own firms and retain their autonomy.
Our capital tends to be sticky, with minimum investment periods of at least three to five years negotiated up front. From a client’s perspective, we offer revenue-sharing and a share of the marketing fees associated with growing the seed managers. Our programme is designed to move managers through the maturation cycle and our experience allows us to craft sophisticated exit scenarios to ease the transition of managers to full independence and drive returns for our investors.
As larger players coming into the space, we offer a different model. The competition is for human capital. Our model is attractive to emerging managers who want to be allowed to develop their own businesses. When a manager is seeded by Harvest Fund, it is still their own firm, their own track record and their own name on the masthead.
This is an architectural nuance, but typically not the case with larger firms that are typically more hands-on and where managers become absorbed as part of that firm’s larger name business. Many teams don’t want that style or pace and want to run their own business, but still recognise the value of the institutional credibility a seed partner can provide, including help building their business. Our formalised marketing programme and distribution capabilities are also attractive to the managers we seed.
GFM: How do you view the environment for fundraising over the coming 12 months?
EK/CK:Fundraising will remain challenging as many investors are understandably cautious in the wake of a severe financial crisis and the failure by many investment managers to deliver on expectations. Nevertheless, we expect demand for hedge funds in general to continue to rise. Clients are interested in uncorrelated sources of alpha and unique strategies that present compelling investment opportunities will attract assets.