Capitalised in January 2009 with €250m from the Netherlands' APG following the recommendation of a working group from the Holland Financial Centre, IMQubator intermediates the allocation of seeding and operational capital from third-party institutional investors to early-stage boutiques. Martin Steward spoke to founder and CEO Jeroen Tielman about the business model
IPE: You are not really a fund of hedge funds. Aren't you really a private equity fund specialising in asset management businesses?
JT: We are similar to private equity, but with a shorter time horizon of 3-5 years. I expect that by the end of this year we will begin preparations to raise a second fund.
The time and effort we devote to monitoring these teams is of a different dimension from that of a fund of hedge funds. We typically can't select based on a past track record, so we have to consider investment process alone. We do so at four different levels - investment management, risk management, operations and team dynamics - based on standard due diligence questions as well as extensive interviews. Once we invest, we have CIO-to-CIO meetings at least once a week and impose close guidance and monitoring on operations, risk management and business development: we are well aware that the main causes of early-stage casualties is operational or business development failure.
On fees, we charge 1% plus a 5% performance fee. The underlying funds are paid 1% plus 15%. Add these up and it is slightly less than the classic 2-and-20 you would pay for a private equity fund. If investors join IMQubator with at least €25m, which is what is necessary to get a seat on our investment committee, they also get an option on €100m of direct capacity with each underlying fund at the same fee levels as IMQubator but without the IMQ fees - thereby getting our guidance and monitoring for free. If you find any model that is better value for money, let me know.
IPE: There are three basic models for investing with early-stage managers: the straightforward LP relationship; the LP relationship with a negotiated revenue share; and direct ownership stakes. Why has IMQ chosen the third?
JT: We are looking to establish a 3-5-year relationship with the managers and, while it might be tempting to take a share of the gross revenue, it is not really consistent with our long-term objectives. We give them enough seeding to get them on the map and build a track record - but, as an encouraging push in the back, we don't give them enough to break even. It would not be consistent for us to say: ‘If and when the next investor joins, we'd like to take 25% of the top line', because that would simply extend the break-even point.
It works the other way too, of course: most costs for an early-stage asset manager are salaries, and we want these partners to have skin in the game and part of that is deferring salaries. Teams typically include three key persons who have been financially successful in the past and can afford to defer salaries.
IPE: How do you find these talented managers?
JT: The key is to create a level playing field. That means being broadly visible and accessible - any proprietary network creates potential bias, so we encourage everyone to apply through our online entry form, which automatically feeds into our database and gives everyone the same opportunity to be evaluated. People started applying, based on rumour, even before IMQubator really existed, and that resulted in a tilt towards Dutch applications at the beginning. But by the summer of 2009, the majority were coming from abroad. Today, it's 90-95%; still mainly from within Europe but increasingly from Asia.
IPE: But you do ask for a preparedness to establish the business' ‘centre of gravity' in the Netherlands. Indeed, you prefer that they not only share a single office building, but a single floor. Doesn't that limit you somewhat?
JT: This is not about Dutch preference. Physical proximity enables us to guide and monitor managers. On the one hand, we want to reach out to the best talent there is; on the other, we don't want a portfolio of managers dispersed between New York, Amsterdam and Hong Kong. So we ask managers to relocate for the first one to three years when the risks are highest.
As an example, Cavenagh, based in Singapore, came over to Amsterdam in 2010. At the time most of their trades happened to be in the US timezone, but after a few months, trading activity switched back towards Asia, and the traders started work at one in the morning and went home at 3.30pm. They didn't complain, but after a year we concluded that this wasn't sustainable long-term: we were confident in the way they were managing their operations, and advised them to move back to Singapore. We appointed a local representative for monitoring, and we still conduct a weekly call between our CIO and theirs. We also now have an agreement with Synergy Fund Management, a fund of funds in Hong Kong, under which they source local managers, focusing on Japan and China, and we advise on providing seed and accelerator capital.
IPE: You have just signed your tenth agreement. When you choose managers, do you give portfolio construction any thought at all, or do you just sign the best managers you can in whatever strategies they happen to be running?
JT: With this level of intense interaction we think 15 is the optimal number. We start with the talent. We can't really start with a pre-defined pie chart that tells us that 22.8% of the hedge fund industry is global macro so we should aim to have three global macro managers in our portfolio. But exceptional talent is often related to a particularly specialised strategy, so we feel that we are likely to achieve diversity almost by default. However, when we propose an investment we make a ‘good, bad and ugly' assessment of how we think a strategy would perform in different environments, and that helps identify potential concentration risks. Our CIO, Rikard Lundgren, can decide whether we need to take measures to reduce that risk.
IPE: If one of your managers gets into difficulty, which is not necessarily related to strategy underperformance, do you have the option of making an additional capital injection?
JT: We would not want to dilute our existing equity shareholders. If a manager has trouble raising assets we could see a business risk emerging and that could be a reason for us to pull the plug - but it would always be a dialogue. And there are ways we can support them: we negotiate a discounted fee, and in certain cases we have the option to offer a subordinated loan to the level of what their standard fees would be if they need more capital for their operational set-up.
IPE: The APG brand can't do any harm when it comes to raising those early assets?
JT: I agree, it can't do any harm. Seed money needs to be sticky - potential follow-on investors take comfort from a seeder who is committed and locked in, but who also has a close guiding and monitoring relationship with the manager. But we are still in a climate where everyone thinks twice about anything that is not mainstream, and is distracted by pressing issues other than finding niche alternative investments.