Painfully aware that some Australian institutional investors have “drawn a line” through hedge fund-of-fund investments, a subsidiary of FRM is taking a different approach that generates not only returns from underlying managers, but also a share of their corporate revenue streams as well. FRM Capital Advisors (FCA) launched its Catalyst Fund in late 2007, and so far has US$350 million under management, which it has invested in six managers ranging from Victory Park Capital, an asset-backed lender, to Varna Capital Management, the equity long/short fund run by Svetlana Lee, who brought her analyst team with her from Citadel. Rather than merely make an investment, however, the Catalyst model “recognises the value in the due diligence process we have gone through to make that investment itself ”, according to Clive Peggram, the deputy CEO of FRM and boss of the FCA subsidiary.

“Five years ago, institutions were willing to back the proverbial ‘two guys and a Bloomberg terminal’, but now they are setting much higher standards around corporate governance and operational soundness. The validation that comes from getting seeded by FRM, a US$9 billion business that everybody knows, is worth at least as much today as the capital itself.” The Catalyst fund attempts to exploit this shift by seeking not only an investment return from its investee managers, but also anywhere between 15 to 30 per cent of the revenue across their businesses, for anywhere between five and 10 years. The Catalyst fund pays the investee manager a full commercial fee in the meantime, and also offers “strategic advice” to help the manager present themselves more appealingly to institutional investors.

The proportion of revenue share steps down as the investee manager surpasses preagreed FUM targets. As investment banks shed their hedge fund and private equity teams to comply with new US financial services regulations, FCA is betting that there will be enough hedge fund start-ups in need of FRM “validation” to give up the revenue share. Peggram said taking revenue share was superior to the “blunt instrument” of owning equity in an underlying manager, which “creates tension from day one”, was illiquid and carried the potential for full capital loss.

“Under the revenue share model, the agreements are structured such that if the performance or business growth is not there after a couple of years, we can pull out whatever’s left of the seed capital.” Peggram admitted that the Catalyst fund could not be as quick to withdraw capital from an underperforming manager as a pure-play hedge fund-of-fund might be, but he said the additional source of returns from the revenue shares compensated investors for this. FRM’s Australia head, Richard Keary, said the Catalyst model should appeal to fee-conscious super funds, as the revenue share income could be used to offset the fees paid to the hedge fund-of-fund, and if successful would eventually “swamp” them.

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