15/02/2012 Author: Tony Griffiths

Raisers' edge

Capital raising services are valuable to hedge funds looking to magnetise big institutional mandates and a good way to bolster prime brokerage assets – so why do so few investment banks currently offer them?

Although by no means free flowing, hedge fund allocations appear in rude health. Just this week, administrator GlobeOp revealed a 12-month high on its monthly capital flows index, while stories of allocations and searches – within these pages for one – continue at a steady pace. However, while investor chequebooks are open, getting allocators to put pen to paper is another matter.

Third-party capital-raising services for hedge funds have long been big business and, with investors an increasingly picky bunch, have rarely been as relevant. Away from the dedicated third-party players, two of the biggest providers of capital raising services within the hedge fund space are Credit Suisse and Morgan Stanley.

Morgan Stanley, which has successfully raised hundreds of millions of dollars for, among others, Brevan Howard and Tiger Management, is believed to complete at least two hedge fund mandates a year. Credit Suisse is even more prolific, undertaking six to ten annually, and is looking to build the service out. The firm is looking to “expand” the service and is “speaking to a number of people about potentially doing that,” an unnamed source with knowledge of the Swiss bank’s plans told HFMWeek.

Of course, for investment banks with big pools of prime brokerage clients, a capital-raising service would seem to make sense. After all, more assets mean bigger revenue streams – a truism on which the auxiliary, and free, brokerage service of capital introductions is based. One could, therefore, think it strange that no one else appears to be doing it.

Other than the aforementioned two, HFMWeek research failed to unearth a single investment bank with an official capital raising service for hedge funds and a prime brokerage unit. Several interviewees were of the mind that it took place, usually on an ad hoc basis. “Most will offer it in some form,” says one prime brokerage source. However, they added, the chances of it being discussed are slim. And so it proved. All of the prime brokers HFMWeek spoke to proved sensitive about the matter – with few willing to commit to on-the-record comment.   

Deutsche Bank and SEB don’t offer it, the firms said. According to a company spokesperson, JPMorgan does not have a capital-raising service but “there are parts of the bank that will do it on a strategic basis”. Bank of America Merrill Lynch, meanwhile, declined to comment.

Denying categorically that it offers it either through its prime brokerage or cap intro teams, Goldman Sachs, who famously did fundraising for Eddie Lampert’s ESL Partners back in 2007, describes its approach as “sporadically ad hoc,” but stresses it had not undertaken a deal for several years.

The history of the current form of capital raising at prime brokering investment banks can be traced back to the early 2000s. Credit Suisse has been offering a fee-based capital raising service – or ‘hedge fund placement’ as it calls it – for over 10 years. Originally the service was smaller, run out of  the bank’s Private Funds Group (PFG) – an established player in the private equity capital-raising space. In 2007, the hedge fund service was moved out of PFG; providing the genesis for the current capital raising unit, Lesley Goldwasser’s Hedge Fund Strategic Services (HFSS).

The Swiss bank’s deals are chosen on a fairly select basis and, although it varies, the team aim to take on six to ten mandates annually. Capacity varies depending on manager and strategy. When Credit Suisse started out on the capital-raising trail in the early 2000s, figures of $250m-$500m were the norm. Now it’s often between $500m-$1bn – in some cases higher. As for fees, 2-3% is fairly typical for the industry.

Citigroup and what was then Merrill Lynch were believed to have dabbled in official capital-raising services for hedge funds, but Morgan Stanley, and more specifically the firm’s David Barrett, are generally credited with pioneering the industry’s best-known service. 

Having rejoined Morgan Stanley from Merrill Lynch, Barrett is believed to have suggested the idea of a dedicated hedge fund service to Morgan Stanley management in late-2008, before pushing for it to be moved out of the cap intro remit and established within the bank’s capital markets division. Now, it falls under the supervision of Raj Dhanda, Morgan Stanley’s head of global capital markets. Morgan Stanley cap-raise deals are bespoke; each one having a different structure. Barrett’s team is believed to have completed about half a dozen such deals for hedge fund clients since 2008, with Brevan Howard among the first.

More recently, Tiger Management’s Accelerator Fund utilised the service. Tiger Accelerator, via Morgan Stanley, pulled in $450m between March and August 2011, HFMWeek reported in October. “There is a tonne of opportunities out there,” the source says.

SAC Capital Advisors and KLS Diversified Asset Management were named by the source as in the midst of  Morgan Stanley-led investment gathering projects – each seeking around $500m. Tiger is thought to be considering a second round of cap-raising, although a company spokesperson says “no conclusion” on the matter had been reached as yet.

So why don’t more firms with prime brokerage arms do it? The  overlap with capital introduction can create confusion, one source suggests, but there is also the possibility that other hedge fund clients, in prime brokerage or otherwise, could be irked by perceived favouritism. 

Another possible disincentive could be the potential repercussions for a firm if a cap raise client was to run into trouble down the line. This is unlikely to be considered too much of an issue, according to the source. Interviewees at banks without capital raising offerings agreed.

“Most capital introduction teams will probably have looked at this, as it could be a nice revenue source,” an unnamed London-based prime brokerage professional says. “However, due to potential conflicts not many have decided to progress.”

Conflict of interest was the primary reason cited by interviewees at investment banks with prime brokerage units for the apparent apathy towards pay-for capital-raising services – and would go some way to explaining the apparent sensitivity attached to the subject.

“It could be really hard for clients to overcome the wall of paying a fee for capital raising when, down the hall, cap intro is available for free,” says Howard Eisen, managing director at outsourced middle- and back-office service provider Conifer Securities. Howard was  previously head of cap intro at UBS and a founder of a third-party marketing firm. “It becomes a hard sell,” he adds, “even though cap intro is different.”

“If the capital raising effort is unsuccessful, the bank could end up losing that client on the prime brokerage side. The risk is that they might not just produce a disappointing deal, but also lose existing revenue streams,” Eisen continues.    

Economies of scale mean that the Credit Suisse and Morgan Stanley services are only utilised by larger managers. Would smaller managers use such a service though? London-based CTA Cardwell Investment Technologies, currently seeking investment to push it towards $100m in AuM – the so-called ‘magic number’ – says it would “consider” the possibility, but would need to see how it compares with the bank’s free cap intro service. “Ultimately, the investor will always want to meet the manager and that’s what cap intro achieves. I think it would probably only be a product that funds without internal sales and marketing would consider,” says Angus Morison, the firm’s sales and marketing director.

In the competitive world of investment banking, it is rare to find a subject that divides as clearly as capital raising for hedge funds. With those offering an official service showing little sign of scaling back, and those that don’t apparently steadfast in their scepticism, neither side looks like backing down any time soon.