Q&A: U.K. Hedge Fund Incubator Ramps Up Portfolio, Overseas Operations

Jun 16 2008 | 2:00am ET

PCE Investors, a British hedge fund incubator, is adding to its repertoire. The firm, which currently represents over US$1.4 billion in assets over a range of strategies, is spicing up its portfolio with the addition of emerging markets and frontier markets managers.

It’s also launching a US$100 million fund to seed managers on its platform, in addition to opening offices in New York, Toronto, Switzerland and Brazil to expand its footprint. FINalternatives recently spoke with George Cadbury, PCE’s president, about the firm’s business development plans and where it sees its next set of opportunities.

FINalternatives: What sort of managers do you seek to incubate? Are there any particular strategies that you're currently tracking that are more appealing than others?

Cadbury: Because of the convergence in alignment of interest between us and the managers, we have to have assurances that our future managers will perform and give themselves every opportunity to grow. Of course, we wish to develop a stable of diversified products that will appeal to a broader spectrum of investor, but ultimately we need good pedigree and an effective strategy that the investment community will be receptive to.
We are more proactive in our search for non-equity related products because we are heavily weighted in equities but we will consider anything.
FINalternatives: Does PCE take a stake in a fund’s general partnership, or share in its revenue?

Cadbury: We never take equity in the fund. It is their business and they should have complete ownership. Our fee schedule is based on a small share of the revenue, depending on the size of the fund.
FINalternatives: What services do you provide emerging managers who don’t have the resources to market themselves properly to investors?

Cadbury: For emerging managers who have not had experience in incorporating a fund business and managing the necessary third-party relationships, we will take on all the necessary duties, leaving the manager to do very little other than focus on alpha generation. On top of this migration of responsibility, we will also guarantee that the outcome of any cost/benefit analysis will be complimentary to the manager.
We are now being approached by more established funds—$200 million to $750 million—who are inquiring as to whether we can save them money with their back- and middle-office responsibilities. We have already seen some funds be forced into closure due to spiraling costs—it really doesn’t have to be like that if they are managed correctly.
Funds are also approaching us who want a quick route to market, particularly in the European Union. We can offer them regulatory cover and have their fund operational within six weeks.

FINalternatives: Can you give us an update on the new seeding fund and offices?

Cadbury: It is in our business plan to build a fund of funds, but we do not make investments at present. We have built a mutually-beneficial relationship with some prominent seeders who wish to use PCE’s services for funds that they capitalize and this will ultimately be one of our most important sources of referral. We wish to work closely with the seeding community not compete with it for the time being.
PCE USA will be launched in August. We have identified two senior professionals in the hedge fund community who are keen to transport our message to the U.S. We have no soft dollar arrangements and we offer a comprehensive set of services that are necessary to run an efficient fund, not just a desk and a constrictive marketing arrangement.
FINalternatives: What emerging and frontier markets are particularly interesting?

Cadbury: One of our main areas of focus at the moment is India, particularly because of our recently acquired foreign institutional investor registration with the Securities and Exchange Board of India. Our most recent product is an Indian macro fund, which we will be raising exposure for in September.

With regard to PCE expansion, we want to start building a global presence whilst developing a business model that benefits both the fund manager and the underlying investor. We are also in talks with a pan-African fund and our plan is to open an office in Brazil by 2011. 
FINalternatives: What are some of your thoughts on the ability of emerging managers, versus more established managers, to generate alpha?

Cadbury: Some investors have said that emerging managers perform better than their more established counterparts; others aren't so convinced. This year we have seen a massive inflow to established funds with strong recognition. There appears to be a misperception that larger funds afford a greater level of security to investors which simply is not the case, considering some of the failures we have seen in recent years, as many of the funds do not have the proper control mechanisms in place.

Many investors would like to have access to emerging managers because numerous reports have shown that excess returns, though not pervasive, are at least more likely in the first three years of a fund’s existence. Many of them do not receive a raft of capital because this is when the business of the fund is most at risk regardless of performance. Seventy-five percent of fund insolvencies three years from inception occur due to non-performance related events.

However, ultimately it is the savoir faire of the manager and his team and returns can be generated regardless of the size of the fund but investors should be able to invest in a tier one manager regardless of their size too – without being exposed to the risks implied by smaller managers because they can not afford to have the correct personnel and controls in place.

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