Citi hedge funds find a new home

(Fortune) -- SkyBridge Capital has spent five years promoting the idea that start-up hedge funds can outperform the big guys. So what is it doing taking over a chunk of the biggest laggard of them all, Citigroup?

The answer, managing partner Scott Prince says, is that not every part of Citigroup (C, Fortune 500) is dysfunctional -- and many of the businesses the bank is dumping will thrive elsewhere.

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SkyBridge founder Anthony Scaramucci

Of course, you'd expect Prince to say just that, given that SkyBridge agreed Tuesday to acquire three hedge fund businesses from Citi. SkyBridge, based in New York, will take over Citi's hedge fund seeding and advisory businesses, as well as its fund of funds operations.

Terms of the transaction weren't disclosed, but Prince said there were three other bidders in a process that took months. He says that while SkyBridge is excited about the deal, Citi didn't sell for a song.

"They didn't just throw this thing out the window," Prince said in a phone interview. "The assets weren't core for them any more, and they make an ideal fit for us."

Hedge fund seeders provide capital and operational know-how to upstart hedge funds in exchange for fees or a share of profits. Funds of funds take investor money and funnel it into selected investment funds, in the name of reducing risk and improving returns.

SkyBridge has about $1.4 billion under management -- a figure that will quadruple once the Citi deal closes in June. The acquisition will make SkyBridge the biggest hedge fund seeder, Prince said.

To Prince, the two businesses have "obvious synergies" tied to expertise SkyBridge already has. The due diligence the firm performs on hedge funds that it considers funding can easily be turned to the fund of funds business.

That sector has been in free fall since the market crash of 2008 and the subsequent unmasking of fraudsters such as Bernie Madoff, whose scheme was fueled in part by flows from a number of fund-of-funds outfits that failed to keep tabs on him.

"We would have anticipated building this business ourselves, because of our research and operational focus," Prince said. "But the financial crisis changed that, and it gave us a chance to focus on firms that performed well but had deficient marketing."

That describes the Citi businesses SkyBridge is acquiring, Prince said. He said assets under management at the units being acquired were "flattish" in recent years, but all the firm's funds performed among the top 10% in their categories. Another attraction was Citi's diversified client base of retail and institutional investors, he said.

Anthony Scaramucci, a Goldman Sachs (GS, Fortune 500) alum who started SkyBridge in 2005, has been saying that the post-crash environment is the perfect time for starting a hedge fund. More than 1,000 funds closed in 2008-2009, according to Hedge Fund Research, and more than $200 billion is expected to flow into hedge funds this year, according to a report last month from Deutsche Bank.

In contrast to the bubble years of the middle of the decade, there isn't too much money chasing too few ideas, according to Prince, who's also a Goldman veteran.

He added that seeding firms like SkyBridge can "empower our investors" by getting lower fees and better terms from hedge fund managers.

And though many hedge funds cratered during the bust, investors pursuing a long-only strategy didn't exactly post stellar returns either. This, Prince believes, could benefit SkyBridge as more investors come to the realization that buying and holding stocks may not be the path to riches.

"As we get into a more normalized environment, hedge fund strategies will shine," Prince said. "There's been a lost decade in equities, so long-only investing isn't resonating with people now."