With an estimated 8,000 hedge funds in the marketplace and more managers setting up shop each day, one of the biggest challenges for fund-of-funds managers is picking the winners. Increasingly, fund-of-funds are turning to new talent, who they say provide better returns than their more established counterparts.
"We look at young, unproven managers because we view new funds as having superior risk/reward opportunities than older, proven ones," said Geoffrey Stern, president of Muirfield Capital Management, a New York-based fund-of-funds.
Stern, speaking at the Fourth Annual Fund-of-Funds conference in Manhattan this week, told the audience, "Our ideal guy is in his early thirties, has been in the business for 10 years, but hasn't made his [big] money yet."
One example of a young manager Stern took a chance on was Christian Leone, founder and managing partner of Luxor Capital Group. "He was about 31 years old at the time," said Stern, who turned to his Wall Street contacts to gather information on the rising star. "When a partner at Goldman [Sachs] told me he would invest his own money with him, well, that's the best recommendation you can get." An executive at Luxor Capital declined to comment on the firm's assets under management or its performance.
Paul Pomfret, ceo of Palm Beach, Fla.-based PDP Capital Investments, a fund-of-funds specializing in offshore vehicles, also focuses on young, emerging fund managers.
"The optimal period of time to invest is early in the lifecycle of a fund," says Pomfret, who formerly played pro-football with the Green Bay Packers. Pomfret favors managers with two to seven years of experience and $50-600 million in assets under management. "The average size of a hedge fund we invest in is $35 million," he says, adding that 80% of the funds he invests in are now closed, which he views as a good sign.
Pomfret has strict rules when betting on new talent. Besides looking for the best and the brightest, he doesn't give seed financing and he will never go over more than 10% in a new fund.
Another fund-of-funds manager who is bullish on new talent is Edward Horner, managing director of London-based Eden Rock Capital Management. This comes as no surprise as Horner, who founded Eden Rock in 2001, began his financial career at the age of 18 while working on the London International Financial Futures Exchange. He was also the youngest financial consultant in Merrill Lynch's international private client group in London.
Horner places an emphasis on investing with fund mangers who display an excellent qualitative skill set and have a high level of transparency. "When we do our due diligence, we like to see managers with a well thought out legal process," he says, explaining that because his firm invests with funds that employ an asset backed lending strategy, one of the biggest risks his firm faces is with the quality of the collateral used to secure loans. He also likes to invest in new, niche funds, believing they supply superior returns. The average fund Eden Rock invests in has $160 million in assets under management.
Despite fund-of-funds managers interest in emerging managers, 2005 is proving to be a tough year for fund-of-fund managers all around.
"The days of double digit returns with little volatility are over…There will be more volatility and more risk if you are going to get returns," said Stern.