Regulation has forced prop traders to launch start-up hedge funds, but hedge fund seeders question their track records.

The 2008 so-called Volcker Rule is smoking out the proprietary trading banks from large investment banks. Often sources of large revenue for banks, the scrutiny on prop desks has forced the exodus of top talent into their own ventures. Yet, the transition may not be easy.

“Institutional investors will rarely invest in start-up hedge funds, as they want to see a track record, a minimum asset level, and a certain level of operational infrastructure,” said Patric de Gentile-Williams, chief operating officer of FRM Capital Advisors (FCA). The FCA is the hedge fund seeding division of U.K. based fund of hedge funds group Financial Risk Management (FRM)

“Operational infrastructure” was easily handed to prop traders at investment banks, but this is an area that might prove to be a “distraction” from their core talents—trading and making profits—according to Mr. de Gentile-Williams.

“Prop traders always face the added difficulty of persuading investors that their profitability was not due in large part to the advantages they may have enjoyed as employees of large investment banks,” he said.

While prop traders may be talented at making speculative trades and playing esoteric strategies, many prop traders are not known to investors and it is therefore extremely difficult for them to raise capital prior to launch.

The exception is the small group of prop traders who were head of prop trading groups and, “therefore the stars,” according to Mr. de Gentile-Williams.

“Most prop traders will need a strategic backer of some sort, which may or may not be a seeder,” said Mr. de Gentile-Williams. “They need to build a track record and demonstrate an ability to generate returns as a hedge fund before most investors will consider them.

At investment banks, prop traders may have a plethora of resources, not available to them as start-up hedge fund managers.

“In addition to information flow, funding advantages and other institutional aspects could have significantly contributed to returns,” Mr. de-Gentile Williams told Markets Media.  “It is only after a number of months (or even years) of trading independently that prop traders can prove they can replicate their previous profitability in a standalone environment.”

When it comes to seeding new hedge funds, FRM prefers “teams over individuals, and looks for skills and strategies that should translate well to a hedge fund structure,” noted Mr. de-Gentile Williams.