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April 03, 2019  

SEC Filings Paint Bleak Picture for Startups

The pace of hedge fund launches so far this year is even slower than it was in 2018, when fund-formation activity reached its lowest level since 2000.

The SEC processed Form D filings for only 439 hedge funds in the first three months of the year — the lowest first-quarter total since the global financial crisis, according to a Hedge Fund Alert analysis. The finding follows a March 21 report from hedge fund tracker HFR that showed the number of fund launches last year at an 18-year low.

The volume of Form D filings in the first quarter was about 20% less than the average for the same period in 2015-2017. And it was down 27% from the first quarter of 2018.

The first quarter typically accounts for a disproportionate number of Form D filings — and is usually a good predictor of annual fund-formation activity. Operators of private funds are required to file a Form D within 15 days of booking an “initial sale” to a U.S. investor. In reality, the number of Form D’s is higher than the number of fund launches, due to the fact that managers file separate forms for onshore and offshore components of the same fund.

The bottom line: Expect the number of launches in 2019 to be well below the 561 counted worldwide by HFR last year. That figure was down from a post-crisis peak of 1,113 in 2011, and an all-time high of 2,073 in 2005.

The downward trend reflects an increasingly hostile environment for hedge fund startups. On the one hand, investors are demanding lower fees — particularly for management expenses. On the other hand, firms face ever-rising costs for compliance and technology. Talented portfolio managers who might have launched their own fund five or 10 years ago now are more likely to join a large multi-strategy hedge fund company, or run their own money.

“There used to be many more players that would provide day-one capital,” a veteran hedge fund marketer said. “To really make money and cover your costs for an institutional-quality launch, you need $100 million.”

Even when investors are willing to take a chance on a new manager, they’re committing smaller amounts of day-one capital, a prime-brokerage executive observed. “Last year, allocations were happening but they weren’t huge,” he said. “But now it has really dried up. A lot of these guys think they are going to launch with $50 million, and they launch with $5 million or $10 million.”

That said, a survey of 227 institutional investors by J.P. Morgan found seven out of 10 at least would consider allocating capital to a new manager. The survey report, out this week, says endowments, family offices and funds of funds are especially willing to look at launches.

“Allocating to new launches has been an increasing trend among hedge fund investors for multiple reasons including diversification and access to lower fees,” according to J.P. Morgan’s capital-introduction group. “However, the bar remains high for emerging managers to receive allocations, particularly from larger investors.”