Growing numbers of investment firms are quietly financing promising hedge fund managers, much as venture capitalists underwrite risky start-ups in the hope that some will strike it rich.
Hedge fund executives estimate that at least 30 providers of seed capital, often called incubators, have emerged the last three years. They include major Wall Street investment banks like JP Morgan Chase and boutique firms dedicated to financing young talent, like BRI Partners of Chicago and FrontPoint Partners of Greenwich, Connecticut.
"You're seeing a great deal of interest in seeding as a means of accessing smaller, undiscovered managers," said Sharissa Y. Jones, a partner at Capital Z Investment Partners, a hedge-fund and private-equity seeding company in New York.
Capital Z, backed by the Zurich Financial Services Group of Switzerland, has invested about US$800 million since 1998 in at least eight hedge funds, several run by individuals who had never run hedge funds before.
Hedge funds are lightly regulated, private investment vehicles intended for wealthy individuals and institutions; with the poor performance of the stock market, the funds have also gained wide interest among less affluent investors. The funds generally provide little information about their operations and the Securities and Exchange Commission last week warned investors to be wary of fraudulent offerings.
Some of the incubated hedge funds will provide investors with more information than the typical fund. In return for financing, some new funds are being required to reveal to their backers exactly how they invest their capital.
Such information is usually closely guarded by hedge-fund managers, who try to produce gains regardless of market conditions. And because hedge funds often use shorting strategies, which involve borrowing shares for future sale and can result in unlimited losses, an investment in the funds can involve considerable risk.
The funds are generally open only to investors with a high net worth, often a minimum of US$1.5 million, and many funds require a minimum investment of US$250,000.
The SEC has begun to investigate possible abuses in marketing hedge funds to people who are unaware of their potential risks, and it is contemplating a tightening of its regulations.
"The SEC laws generally prohibit hedge funds from making public statements that could be considered a public offering, or a solicitation to invest," said John J. Nester, a spokesman for the agency. "While public disclosure of a hedge fund's performance might not by itself be considered a public offering, it would depend on the individual facts and circumstances in which the disclosure is made."
Any hedge fund executive who publicly discusses a fund's investment goals, track record, or contact information would likely contravene the SEC's regulations, he said.
Hedge funds suffered their worst year last year, losing an average of 3 percent, according to the Hennessee Group, a hedge fund and tracking firm in New York. Still, hedge funds as a group outperformed the Standard & Poor's 500-stock index, which fell 23 percent last year.
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