Calling all ‘semientrepreneurs’

Can a pair of all-purpose servicing firms help asset management start-ups survive?

This just in: Not all stock pickers who defect from big money management firms are fleeing to hedge funds. A brave few, convinced that the hedge fund frenzy will eventually cool, are taking the long view and setting up conventional long-only asset management boutiques. The industry has seen 44 start-ups and 18 liftouts in the past three years.

Two start-ups of a different sort are counting on this entrepreneurial streak to continue. Stellate Partners and Ardmore Investment Partners have emerged, in November 2004 and January 2005, respectively, to carve out a niche servicing money management start-ups by doing everything from finding them office space to marketing their funds to helping keep their founders out of jail.

New York City¬based Stellate was co-founded by Paul Greenwood, a former director of equity research at Russell Investment Group, and John Mathai, who has 15 years of institutional marketing experience, most recently with Charlotte, North Carolina¬based money manager Charlotte Capital. Radnor, Pennsylvania¬based Ardmore was founded by Stephen Kneeley, who until June 2004 was CEO of $16 billion-in-assets Turner Investment Partners, and W. Gui Costin, who previously was director of intermediary distribution at Cramer Rosenthal McGlynn, a $7 billion money manager in New York.

“There’s a hangover from the industry’s consolidation of the 1990s, which has resulted in megafirms with disillusioned teams,” says Stellate’s Greenwood. “You have talented investors who know they are managing too much money, are overwhelmed with bureaucracy and are not having any fun.”

For money managers, going solo is fraught with its own perils. “Often someone who starts a firm doesn’t understand that he can’t do it all -- be the visionary and run the money and get the clients,” says Ev Nucci, head of Blue Bell, Pennsylvania¬based Nucci Consulting Group. “Fifty percent of start-ups fail in the first year.”

Stellate and Ardmore plan to help start-ups beat those odds. The firms aim to cover all start-up costs for their money management partners, in exchange for an equity stake and a share of future revenues and profits. Both will run central trading desks to serve all their managers and handle settlement and custody through third-party firms. Stellate and Ardmore also will locate and furnish offices and procure and maintain information technology and communications systems for their clients. Moreover, the two firms will develop and enforce compliance policies.

Most important to money managers, though, is likely to be the caliber of marketing support that Stellate and Ardmore purport to deliver. Founding partners at both firms boast long experience in institutional sales; their industry connections are a key part of their sales pitches. Says Ardmore’s Kneeley, “Ultimately, our portfolio managers are signing up for our contacts in the industry and our ability to present their investment processes to prospective clients.”

Both Stellate and Ardmore are going through their own start-up phases. As of mid-April, Stellate had struck just one deal, with fledgling JS Asset Management, a West Conshohocken, Pennsylvania, firm founded by John Schneider, a former portfolio manager at PEA Capital, a unit of Allianz Glo-bal Investors. Ardmore expects to sign its first client in the second quarter of this year.

Greenwood says he and Mathai are funding Stellate. Kneeley controls the majority of Ardmore’s equity, but a minority stake is held by West Conshohocken¬ based Rosemont Investment Partners, which has invested in a number of money managers.

Stellate expects to take no more than a 30 percent stake in any start-up. “We believe most of the equity belongs in the hands of the investment team,” says Greenwood. His firm will pocket a percentage of the profits in line with its equity stake. “We’ll put up the capital and get these firms to critical mass,” explains Greenwood. “But we do want the portfolio managers to own a significant chunk of their cash flow.”

Ardmore, by contrast, expects to take controlling stakes in its start-up partners. Under Kneeley’s formula an investment team would receive about 40 percent of revenues, from which it will pay its own compensation and rent, with the remaining 60 percent going to Ardmore. FrontPoint Partners of Greenwich, Connecticut, created a similar structure for a diverse collection of hedge fund strategies in November 2000.

Some start-up money managers may not want any partners at all. Those who choose to go it alone can always try to strike deals with third-party institutional marketers, such as Alpine Partners, in Englewood, Colorado, or Arrow Partners, in Purchase, New York. They can also outsource trading and settlement operations. But firms electing to do so will need either a CFO or a COO and someone to handle compliance.

“Stellate and Ardmore are a solution for semientrepreneurs,"says Chas Burkhart, founder and chairman of Rosemont. “They’re marketing to people who want their own firm but don’t have the guts, or the wherewithal, to create one.”

Schneider, of JS Asset Management, is the kind of client both firms would like lots more of. At the end of 2004, the 40-year-old money manager decided to leave PEA Capital, where he had spent six years managing the Renaissance Fund, whose assets grew from $650 million to $6 billion under his guidance. For the five years ended March 2005, the fund returned an average annual 18.7 percent, versus 16.1 percent for the Russell midcap value index. Schneider also grew PEA’s large-cap value fund, now known as the OCC Value Fund, from $150 million to $3 billion, over the same period, returning an annualized 16.9 percent, compared with 7.9 percent for the Russell 1000 value index.

PEA, however, became embroiled in the mutual fund scandals that rocked Wall Street in 2003. In September 2004, the firm agreed to pay the Securities and Exchange Commission a $50 million fine to settle charges of market-timing abuses, which PEA neither admitted nor denied.

Schneider, who was not involved in the charges, left PEA in February. He met with headhunters and interviewed with several asset managers. He also considered going out on his own. “But then,” he says, “I realized that your monthly nut can grow pretty quickly.”

Greenwood had become familiar with Schneider’s performance record while working as an investment manager at Russell and approached him shortly after he left PEA. Greenwood’s terms, which allowed Schneider to retain a 70 percent stake in JS Asset Management, were appealing. “The key thing for me was keeping majority ownership,” Schneider says. “I want to do this for the next 20 years, and I don’t want to wake up one day to find someone else is controlling my fate.”

Stellate and Ardmore face an uphill battle. With small sales forces, they’ll be competing against established managers with far more resources. Nonetheless, Greenwood sees bright prospects for Stellate. “As long as there are large firms, there will be great opportunities for folks like us,” he contends. “The big buy side has stocked a rich pond for us to fish in.”

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