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12:51 PM
Justin Grant
Justin Grant
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Startup Hedge Funds Battle Gale Force Headwinds

From fundraising difficulties, to IT and regulatory headaches, smaller hedge funds are struggling to take off while investors seek security with the larger players.

Morgan Stanley credit strategist Hidetoshi Ohashi is the latest high-profile investment banker to leave a lucrative role at one of Wall Street's most venerable firms in search of the chance to earn exponentially higher returns by running his own hedge fund.

Citing an unnamed source, Bloomberg News said Ohashi will leave his job at Morgan Stanley at the end of June to start a Singapore-based fund with a focus on Japanese corporate bonds and credit default swaps.

But even if Ohashi proves successful in scoring some seed capital from his current employer - along with additional funds from investors - the road to success for startup hedge funds is rockier than ever. And delivering solid returns isn't the only obstacle to success.

Former Goldman Sachs star traders Pierre-Henri Flamand and Morgan Sze had no problems raising money to get their new businesses off the ground, with both managing to raise $1 billion right off the bat. Their Goldman pedigrees obviously played a big part in that, but both have been money-losing ventures so far. It's even been reported that their former Goldman colleagues who've also ventured into the hedge fund world are faring no better.

But taking their strategies and the general market environment out of the equation, there are more roadblocks to success for startups than ever before. For starters, unlike a decade ago, a new hedge fund needs to have accounts with more than one prime broker. Experts tell me this is a significant burden for a new hedge fund's IT department right out of the gate, since it means they'll need to either develop or pay for technology platforms to aggregate those accounts.

Meanwhile U.S.-based funds with more than $150 million in assets under management will have to deal with the new Form PF requirements that were brought on by Dodd-Frank. Market participants liken this requirement to the operational equivalent of a colonoscopy as opposed to their typical back office headache. This challenge is also a particularly annoying one for hedge funds since they'll need to staff up their compliance departments, something the industry loathes doing.

Ohashi obviously won't have to deal with the challenges brought on by U.S. and European regulations. But then there's also the challenge of securing funding from investors, who seem to be casting their lot with larger, more established funds these days. We reported last week that while the amount of money investors are pouring into hedge funds is climbing, nearly all of it is going to established hedge funds with more than $5 billion in assets under management.

Meanwhile smaller players are seeing outflows through the first quarter of 2012 since investors want to see a track record of at least three years, no more than two months of drawdown, and a strategy they can believe in before casting their lot with a fund.

Time will tell whether Ohashi, or those former Goldman prop traders will be successful. But they'll have to overcome gale force headwinds to do it.

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio
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