Edoma – a case study in how not to run a new hedge fund

Mon Nov 26, 2012

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The shutdown comes at a time when the flow of new hedge fund launches from other bank prop traders is running at a high level


By Nick Evans 

It is usually not a great idea to extrapolate events at individual hedge funds into industry-wide themes or trends. In this most idiosyncratic of activities, what makes one fund or firm succeed - or fail - rarely applies more generally, in what is essentially a business about people.

But the shutdown of Edoma Partners, the London-based event-driven fund launched amid much fanfare two years ago by Goldman Sachs prop trading star Pierre-Henri Flamand, does seem to be one of those rare moments that illustrate some generic industry issues.

The demise of the firm, which had been running more than $2 billion at its peak with a team of some 20 people, was not surprising in itself. Edoma had struggled from the start, with the fund being down by about 7% since inception by the time that Flamand and his partners decided to throw in the towel at the start of November.

The view of one day-one investor that the fund's performance was "crap" might be a little on the harsh side. Event-driven investing has been difficult over the last two years or so, to be fair, and other funds have also struggled.

But Edoma's large and apparently experienced team never really seemed to get any positive momentum going, pretty much from the get-go. And Flamand's view that "unprecedented market conditions" were responsible for the firm's failure - and for the decision to shut down as soon as the two-year lock-ups, to which many investors were subject, expired - seems somewhat lame at a time when all sorts of other hedge funds are continuing to battle away on behalf of their investors.

Flamand is not the first manager to conclude that he is unable to make money in the current environment. And he will not be the last either, with longstanding long/short European equity boutique OMG also deciding to call it a day this month for similar reasons.

But, as our initial nominations for this year's EuroHedge Awards show, a great many funds are continuing to do a great job of producing strong risk-adjusted returns for investors in conditions that certainly are not easy - but which, as these excellent performers and many others besides them have been demonstrating, are not exactly impossible either.

And the pity of the Edoma shutdown is that it would seem to confirm some of the negative points about hedge funds at a time when hedge fund investing is under fairly intense scrutiny - and can only make it even harder for other new hedge funds to launch at a time when the industry needs new blood, new energy and new ideas.

The whole saga raises questions about the ability of prop traders to make the transition to asset managers; about managing capacity and size; about industry fee structures; about long-term commitment and alignment of interests; and about the pros and cons of investing with people who are new to the asset management game.

The shutdown comes at a time when the flow of new launches from other former bank prop traders is running at a high level - with the potential for the hedge fund industry to take on many of the roles and opportunities previously undertaken by the investment banks themselves.

That ought to be a good thing, both for the industry and for investors. But the Edoma episode will harden the view of many people in the industry that early-stage investments in funds led by traders whose previous experience is in running bank prop capital, and in a very different operating environment, are often bad bets.

Although some of the most successful European hedge funds are run by former bank traders - notably Brevan Howard and BlueCrest - and despite the fact that several of the world's largest and best-regarded hedge funds over the years have been founded by former Goldman executives, many other bank spin-outs have failed to live up to expectations as standalone hedge fund operations.

Moreover, Edoma's decision to take more money than it had said it would do - peaking at over $2 billion against an indicated cap of only $1 billion - laid the firm open to charges that it was more interested in asset-gathering and management fee generation than in performance, while also making life more difficult for itself by having more money to invest than it could handle.

Ultimately the reasons for the firm's failure are probably more down to individual mistakes than to industry-wide issues. But anyone who believes that new funds that start with too much money are more likely to fail than to succeed - of which there have been many examples over time - now has another perfect piece of evidence to support their view.

And anyone who has been paying management fees to Edoma for the past two years while receiving a stream of negative returns will probably think at least twice before giving capital to the next 'hot-thing' investment banker who wants to reinvent themselves as a manager of other people's money.