The hedge fund space in Europe is currently offering some potential but, with little seed capital about, it is proving tricky for start-ups to gain a foothold in the sector.

“It’s hard work to set up as a hedge fund right now,” said Lord Stanley Fink, widely known as the ‘godfather’ of the UK hedge fund industry, who is now chief executive of International Standard Asset Management (ISAM), a modestly sized commodity trading adviser (CTA) based in London. “First of all, people expect a lot of a track record and then people want to do a pretty high level of due diligence.”

However, it is not all doom and gloom as the prospects, once established, are quite appealing as hedge funds, traditionally, can perform positively in both favorable and non-favorable market conditions.

“It’s a good time for hedge funds if you can get it right because there is distortion and dispersion,” one London-based hedge fund executive told Markets Media. “But there isn’t a great deal of seed capital about. Even if you are lucky to find a bit of seed capital, that is not enough to grow an institutional grade hedge fund business.”

Extremely volatile markets can be the scourge of hedge funds, though, and many are being forced to change strategy on a near daily basis to cope with the market convulsions.

“The biggest issue has been the changing volatility—so it’s like going through risk-on risk-off, not quite every day, but every couple of days,” said Lord Fink. “That’s a challenging market for a CTA.”

And many hedge funds are still recovering from the brutal late summer of 2011, which Lord Fink described as a “tsunami” hitting the industry, not to mention the developing eurozone crisis.

Mark Parsonson, executive director of UK-based fund of hedge funds manager Liongate Capital Management, which has $3bn under management, told Markets Media: “Last year, there was a lot of volatility in the summer months of 2011 and through October and November; it was an exceptionally difficult trading environment. The volatility was high, although not as high as 2008, but it was the length of the volatility that was dramatic. It was among the longest periods ever of sustained volatility.”

Some hedge funds decided to take a step back from the highly volatile trading environment of late 2011 and invest in safer instruments, but this approach has had its limitations too.

“There are some people that have the discipline to hold back the capital but one of the things some people feel is if you invest in Treasury bills or very safe investments you are getting an awful return that isn’t covering you against inflation and you are having to pay tax on the interest,” said Lord Fink at ISAM. “So, some hedge funds are holding back but its not an entirely risk-free or painless thing to hold back.”

And the costs of doing business for hedge funds in Europe are also rising, following in part to the collapse of New York-based broker-dealer MF Global, in October last year after a $6.3 billion trade—partly funded by customer accounts—on European sovereign debt went badly wrong and subsequently exposed an estimated $1.6 billion shortfall in customer funds.

“Things like MF Global have made it more expensive,” the London-based hedge fund executive said. “Everyone wants separate managed accounts and everyone wants separate prime brokers who manage your accounts so you have to have a lot of prime broker relationships and different administrator relationships so there is an operational burden there and they also want to discount their fees. So, the point at which you become profitable has gone further away and it’s harder to raise assets, particularly in Europe.”