Following the trends

John McGillian tells Jeff Benjamin about the best opportunities for hedge fund incubators ' in CTAs and macro hedge funds

John McGillian likes to cover all the bases and work all the angles. The 49-year-old owner of Symmetry Partners relocated from Paris to Boston a year ago and has positioned himself to react to trends in the Alternative Investment Market.

From his perspective, as an asset allocator for individual and institutional investors, the greatest opportunities these days are in commodity trading advisers (CTAs) and macro-style hedge funds. Pure equity hedge funds have become magnets for deep-pocketed prime brokerage companies and incubators. And the rush of money flooding in from these sources, he says, can skew the value of the investment process.

But that does not mean he will not be found occasionally dabbling in a seed capital venture with a new hedge fund, or allocating assets to an existing fund in exchange for a chunk of the fees.

Symmetry now has ownership stakes in three hedge funds: Three Bridges, a US long/short equity fund; Windham Pacific, a Japanese long/short equity fund; and Green T, a European high-yield fund. Combined assets under management of the three funds equals $610m.

On the CTA side, he has an ownership stake in Quest Partners, and he raised $200m last year for P/E Investments.

'What I really believe is that anybody who actually makes money for their investors will always be in business,' he says. 'So, my attitude is that if I bring a seed capital venture to my investors and they make money they're going to be happy. Or if I just bring them a hedge fund and that makes money, they will be happy. In both cases, as long as I don't lose money, I'll be in business.'

That said, McGillian admits the business of hedge fund asset allocation is not what it used to be and that CTAs are emerging as the path of least resistance. One need only look at the influence of companies such as Grosvenor Capital, Swiss Life, Asset Alliance, and Capital Z to realise that incubator firms are virtually falling over themselves to provide seed capital to new hedge fund managers.

The competition is getting so fierce that the hedge fund managers are now able to negotiate the ownership stake they will give up in exchange for start-up capital. It was just a few years ago that incubators were taking 50% ownership stakes in new hedge funds.

These days, says McGillian, those seed capital investors are happy with 20% or 30% ownership stakes.

'There are lots of money managers looking for seed capital, but there are also a lot more people willing to provide seed capital because there are so many incubator funds out there,' he says. 'I got involved a few years ago before this wave of incubator funds arrived, and now I think it's a lot more difficult to actually find quality managers who are willing to give up equity stakes.'

One big potential downside of all this, from an investor's perspective, is a general increase in risk.

At the same time, the more competitive market introduces the risk of diluting the quality of the next wave of hedge fund managers. It also increases exposure to risk by sheer volume of the dollars being invested.

'I like the idea of luring some guy from Putnam Investments to give him a million dollars or two in working capital, and then if he builds himself a track record, and if he's really good, he can go and raise a lot of money,' says McGillian. 'But what's happening instead is some of these guys are starting with $50m, and what happens if the guy's a screw up?'

The downside risk of such a large initial capital base for a new fund is that a loss of 20%, for example, equals $10m, as opposed to $400,000 when the capital base starts at $2m.

'I think the economics of these deals are not as good as they should be, because I just think the trading capital risk is too high,' he says. 'Doing these deals with money managers is just not as interesting as it used to be because they are now offering a smaller part of their businesses for more money.'

Therefore, McGillian's strategy is to work with the less-sought-after CTAs and macro-style funds.

'That's where I see the greatest opportunity right now because that is still an untravelled area,' he says. 'There's much more demand for CTAs and macro managers among investors. But the incubator firms are not focussed on that area as much as they are on equity managers, so I think it's an opportunity.'