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Antoine Rolland, chief executive of NewAlpha Asset Management, says that incubation of emerging hedge fund managers is more vital than ever in the current economic climate because it can provide the reassurance investors need about the transparency, liquidity and operational risks associated with hedge fund investment.

HW: What is your company’s background?

AR: Based in Paris, NewAlpha Asset Management is a leading European hedge fund seeding specialist. The firm was created in 2003 to support the development of emerging managers by ADI, which itself was seeded by OFI Asset Management in 1997 and enjoyed strong growth at the beginning of the decade.

With a total of more than USD400m in seed capital invested with 12 investment groups, NewAlpha has achieved real legitimacy among emerging managers and investors. Today it is a wholly-owned subsidiary of OFI Asset Management, a pioneer in multi-management with 250 professionals, including 110 people dedicated to management and investment, OFI has 22 partnerships with external investment groups and USD28bn in assets under management.

HW: What is the role of hedge fund incubation in the current environment?

AR: The unprecedented crisis experienced by financial markets has resulted in creating huge investment opportunities. It has also created distrust among investors and changed drastically their requirements in terms of transparency, liquidity and operational security.

Now more than ever, managers need a strong infrastructure in investment management, risk control, operations, compliance and business development, which generally are available only once managers have gathered enough capital. The role of the incubator is on one hand to provide emerging managers with seed capital, enabling to focus on their investment strategy, and on the other to provide investors with security and transparency in addition to returns.

Various academic and empirical studies have demonstrated that early-stage managers deliver higher returns than established players while taking less risk, even in tough times like in 2008. The benefits for investors in emerging managers include a pure and understandable strategy, greater flexibility within the organisation, and the ability to adapt and innovate.

Seeding investors are also closely associated with development during and even beyond the fund incubation period. In the case of innovative investment strategies with strong potential, income from the partnership with the emerging managers can represent a very significant additional return on the capital invested during the incubation. Today hedge fund incubation stands midway between alternative multi-management and private equity-type investments.

HW: What is your investment process?

AR: NewAlpha has developed a rigorous identification and selection process that culminates in the structuring of a partnership with the seeded managers. The first stage consists of identifying investment opportunities by studying the qualities and potential of new but experienced and talented managers around the world.

The investment strategy and its operational achievements but also the opportunity set offered by the asset class are thoroughly assessed. At the end of this analysis process, an investment committee will select funds for incubation. Our opportunistic approach does not exclude the establishment of specific mandates for institutional investors.

The partnership is signed for a fixed period, on average eight years, including a three-year incubation period during which NewAlpha will assist the managers in their development while providing consulting and investment monitoring services for the seeding investors. The firm acts as a partner in the incubated asset management company and ensures control as well as transparent communication to investors.

HW: How many funds and strategies are in your portfolio?

AR: Since 2004, we have seeded 12 investment managers, encompassing a wide spectrum of asset classes including bonds, equities, asset-backed securities, commodities and derivatives. Currently we are invested with six managers via two incubation vehicles.

Our current allocation includes long/short Europe and US, trade finance, credit and distressed, commodities and event-driven. Our managers are based in the US (New York and North Carolina), London, Geneva and Singapore. In the past, we have backed managers in Mumbai, Prague and Hong Kong.

HW: How many proposals do you receive?

AR: Since 2003, we have received more than 600 proposals, and the current pace is around 250 per year, with US and emerging markets managers dominant in our pipeline. In terms of strategy, long/short, CTA and multistrategy managers are the most numerous among seeding candidates.

We continuously look for investment opportunities, and when we find one that matches our criteria, we seal a deal with the manager and invest. When we exhaust the commitments of our seeding investors, we establish and launch a next-generation seeding vehicle. We currently manage NewAlpha Genesis 2 and NewAlpha Genesis 3.

Hedge fund incubation cannot be commoditised; each situation is very specific in terms of the manager, investment strategy, opportunity set, development plans and current resources of the management company.

Although the decision-making process can be quite short, with as little as three months between first contact and seeding investment, our investment horizon is long-term. We assess seeding projects with a horizon of between four and eight years.

Separately we plan to open a managed account platform based in Luxembourg, leveraging the existing infrastructure operated by our parent company OFI Asset Management, under the name of OFI Lux. This platform, regulated by Luxembourg’s Financial Sector Supervisory Authority (CSSF), will provide investors with secure, liquid and transparent access to emerging managers selected by NewAlpha via sub-funds of Ucits III Sicavs.

HW: What makes a manager or strategy special enough for you to select them?

AR: We focus on finding investment managers whose characteristics will match investor demand and have an investment process able to generate performance over the long run. We are looking not only for excellent portfolio managers but efficient and energetic entrepreneurs with a high level of ethics. This emerges through a very detailed assessment process, using independent reference checks and our own industry network.

HW: How are your funds structured?

AR: Our two French-registered and regulated contractual funds are structured and operate like private equity funds. They are pooled investment vehicles used for seeding the funds selected by NewAlpha on behalf of the limited partners, which are institutional investors.

The funds are funded with capital raised from the limited partners, and the capital is returned at the end of the seeding agreement when exiting the investments. The funds charge only performance fees. In contrast to true private equity funds, the investors receive their share of the profits generated by the seeded managers via another independent limited partnership.

HW: How have your funds performed?

AR: Like private equity investments, the performance must be appreciated as a total return, consolidating the performance of the pool of seeded funds and the share of profits generated by the managers.

Our first vehicle, NewAlpha Genesis 1, returned to investors an annualised net 7.25 per cent over three years. NewAlpha Genesis 3, launched in July 2008, was up 1 per cent in 2008 and 9.5 per cent for the eight months of 2009, and is currently providing a net internal rate of return of 14.6 per cent to our seeding investors.

Thanks to the nature of incubation, our products have weathered the financial crisis relatively well. NewAlpha Genesis 2 returned an annualised 3.2 per cent between April 2006 and August this year. This compares well with an equivalent investment in a hedge fund index, which would have produced an IRR of minus 10.3 per cent.

It’s worth noting that, in addition to the alpha generated by comparison with the average fund of funds, the volatility of returns is very low. NewAlpha Genesis 2 offers a standard deviation of 2.5 per cent with a worst monthly decline of 2.9 per cent in March 2008.

HW: What trends do you expect to see in your sector in the year ahead?

AR: While some industry players are starting to celebrate the first capital inflows, we believe the industry remains in a transitional stage with drastically modified investor expectations on transparency, liquidity and operational risks associated with hedge fund and funds of hedge funds.

We also see increasing demand for a better alignment of interests between investors, hedge fund managers and funds of hedge funds. Certainly, the latter’s business model is seriously challenged, especially on the fees side.

As liquidity and operational requirements are clearly at the foreground of investors’ requests, we believe that managed account structures will become a more common form of hedge fund investment.

Overall, I’m not worried for the hedge fund industry. Increasingly we are seeing institutional investors claiming that they are reconsidering their strategic allocation, cutting equities and shifting into alternatives such as real estate, commodities and hedge funds. Stricter asset and liability management regulations such as Solvency II for insurance companies are emphasising the effects of the recent financial crisis. In this respect, incubation matches all the new and previous requirements stated by long-term investors.

HW: How will these developments affect your own portfolios?

AR: One of the benefits of the crisis has been the lengthening of investment horizons for almost every kind of investor – there is no longer any ‘free lunch’. Therefore our next-vintage incubation vehicle to be launched in the fourth quarter of this year will have an lock-up period extended from two to three years to give seeded mangers more time to really develop their business. Eventually, seeding investors may expect higher IRR from this extension.

We believe that that incubation will move away from the fund of hedge funds model and become closer to the features of private equity funds.

HW: What differentiates you from other managers in your sector?

AR: NewAlpha is a truly independent investment manager, focusing exclusively on hedge fund incubation since its launch in 2003. As we don’t manage classic funds of hedge funds, we rely on our expertise in sourcing and selecting young managers. Size, reputation and ‘buzz’ are not primary criteria. In addition, NewAlpha is a quality label for investors, as all our initial investors have repeatedly matched our fund-raising efforts over the past three vintage products.

We have built our reputation on developing and applying a rigorous investment process covering sourcing, selection, monitoring and supporting the seeded managers, while providing our investors with a very transparent and timely communication.

In addition to being itself a seeded investment management company, NewAlpha differentiates itself through the mix of professional experience in hedge fund management and development offered by the team.

Finally, NewAlpha acts as an independent consultant to the manager and provides a variety of services over and above what a prime broker may offer in areas such as business strategy, investor communication, capital introduction and risk management, helping the managers to establish and maintain credibility with investors. To investors, we position our offering clearly as the only transparent and secure investment vehicle available in the marketplace for gaining exposure to small and mid-size hedge funds.

HW: What is your attitude toward risk in the current environment?

AR: Hedge funds can combine risk from almost any financial instruments. The recent turmoil has highlighted various failures in standard risk management practices and increased demand for reassessed and efficient risk control. In fact size doesn’t reduce risk, as some high-profile hedge funds failures highlighted recently.

Hence we have developed different operational processes from the experience gained within the internal risk, operational and control departments of OFI. Our primary objective is to preserve capital during tough times and reduce volatility.

The partnerships structured with the seeded managers include therefore full transparency, shared governance of the funds, continuous dialogue with the staff involved in portfolio management, risk control and operations, both in the investment group and in the external service providers. In addition, OFI provides us support in risk management, compliance and legal areas.

HW: How would you assess investors’ expectations and how do you deal with them?

AR: Investors need increasingly to allocate to alternative investments due to their long-term benefits in terms of uncorrelated returns and portfolio diversification. The big issue for them apart from transparency and security is the sustainability of returns.

Incubation matches these needs by offering investors a controlled exposure to innovative and highly motivated managers. Aligning the interests of emerging managers and institutional investors in the short, medium and long term is a unique characteristic of incubation.

HW: What is the profile of your client base?

AR: We market our products directly to institutional investors, primarily life insurance companies, pension plans and health and general insurance mutuals.

HW: Are you planning any further launches in the near future?

AR: We plan to launch NewAlpha Genesis 4 during the last quarter of 2009. This AMF-registered contractual fund will target long-term investors, primarily insurance companies, pension plans, sovereign wealth funds and family offices. For the first time, we intend to market this product to non-French institutions, primarily in Europe.

Like the previous vintage products, investors will be separately shareholders of a limited partnership that channels the stream of revenues coming from the seeding agreement with the manager, the fee-sharing revenues of dividends from the equity participation. This additional revenue has historically added between 1 and 3 per cent annualised on top of the return from the incubated funds.

HW: Who are your key service providers?

AR: Our administrator and custodian are Caceis Bank and Société Générale Securities Services respectively.

HW: Have there been any recent changes to the management team?

AR: We have just hired a new team member for operational processes and we are recruiting an analyst on the investment side to develop our sourcing and selection capabilities.

Earlier this year, we expanded our business development capabilities with the hiring of an experienced marketing person, Philippe Paquet, whose role includes supporting our seeded managers’ development in addition to the marketing of our own products.

Relocating the business into OFI’s building in Paris has helped to create profitable synergies, especially in business development and risk management. For instance, our seeded managers systematically benefit from introduction to OFI institutional investors including insurance companies, pension plans, private banks and family offices.

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