Q&A: What Do Institutional Investors Want From Hedge Funds?

Nov 9 2010 | 9:19am ET

Raising capital for a hedge fund has never been harder, but knowing what investors are looking for can increase your chances of success. FINalternatives' Mary Campbell recently spoke with Nan Mead, the New York-based vice president of client development for International Asset Management, about what pension funds and foundations want to see from managers. The fund of hedge funds executive also touched on the importance of developing long-term relationships with consultants, and the pitfalls emerging hedge funds make when allocating resources.

Who are investors allocating to, both in terms of strategy and asset size?

That’s an interesting question because this year we’ve seen a lot of interest in Asia and emerging markets…but in the end, where folks have been allocating dollars has still been in the more traditional, low-volatility, non-correlated strategies, because they want to reduce volatility in their overall portfolio.

What are institutional investors, such as foundations and endowments and pension funds, looking for when they evaluate funds for inclusion in their portfolios?
I would separate the foundation and endowment space from the pension fund space because I think both of those investor groups look at the world a little bit differently.

Pension funds, in the end, are all about being able to pay beneficiaries and meet their actuarial targets, so they tend to focus a little bit more on the non-correlated strategies. They also take a low-volatility approach to investing.

And if you look at foundations and endowments, clearly the endowment model allows for a much larger allocation to alternatives. Those folks typically have very sophisticated in-house staff to assess opportunities, whereas, on the pension side, you may have that or you may be working very closely with a consultant to assist you in that process. And the folks in the foundations and endowments space really are, at times, more inclined to take more risk, particularly in a period of distress. So when the rest of the world was de-risking after ’08, some of the folks that I know in the foundation and endowment space were actually saying, ‘This is a really interesting buying opportunity and we’re allocating to distressed and looking at some longer-dated strategies.’

Does a fund need a close relationship with a pension fund advisor to win institutional allocations?

I would say the answer is trending towards ‘yes.’ Clearly, any direct relationships one can develop with institutions are beneficial. Depending on who you’re working with on the consulting side or who an investor is working with on the consulting side, there may be room to insert yourself into a search process without necessarily being on a consultant’s buy list. But I think, at the minimum, consultants at least have to have knowledge of your firm, have some vital statistics on your performance, and have met with some of your professionals before they would be comfortable including you in a search. Then, obviously, if you do get an allocation, that usually will provide the groundwork for more traction to work with that consultant going forward.

How can a lesser known manager make itself more appealing?

In working with consultants, they like to see a full package of materials. It’s more than just sending over a tear sheet or a pitch book; they like to see those things, but of course they want to see a full, completed questionnaire—in the AIMA (Alternative Investment Management Association) format, if you will. They also like the ADV part I and II for review. I would say those are really the basics. And they prefer to get all of that data at the same time. The other piece is, of course, your willingness to upload your information to their database or their Web site on an ongoing basis. That can be a time consuming project, yet it’s time well spent if you target it in the right way. eVestment alliance caters to over 100 consulting firms and so, what we’ve done here at IAM is populate that database with all of our products, information, firm history, etc., and then, as part of my effort, I’m going to be reaching out to their constituents who are looking at hedge funds via that database.

What are some of the biggest mistakes fund managers make when approaching investors?

I would say the biggest mistake that managers make when approaching investors is to harbor the notion that you can have a meeting or two and secure an allocation. These days, it’s really a process. Whereas three to five years ago it might have taken you six months, now it will take you a year, and in some cases it might be a multi-year process, especially if you’re talking to major institutions like public plans. So it’s about being persistent and targeted, even when approaching consultants—just because you’ve had a meeting with a consulting firm and you’re giving them all your information that’s not necessarily sufficient; you have to continue to be in front of them and at least remind them that you’re still there, you’re in the game and that they should maybe spend a few minutes on you.

Again, all of those things require resources and take time so, if you know of a handful of firms where you would be a good fit and you’ve done your research, those would be the folks that you should be focusing on, rather than spreading yourself too thin and going all over the place.

What are some mistakes that emerging hedge funds make in terms of focus and resources?

I think where emerging managers may make the mistake—and I hate to say it because I’m on the marketing side—is they hire marketing folks before they hire operations people. The more you can separate those front to back office functions, [the better].

We’ve seen managers actively trading and then settling their own trades and doing the fund administrative functions as well, and that isn’t something that we like to see. In one particular case we saw a manager who was doing all of those things but they had four marketing people…and that money would have been better spent certainly hiring at least one if not two operational or administrative people in-house. And also, I think they didn’t have an audited track record.  Again, it’s about spending the money wisely—$20,000 on getting an audited track record as opposed to shelling it out in placement fees to a third-party marketer. I think the money is better spent on the audit because people will take a look at you once they know your track record is audited, but you could spend all the money you want on a marketer, that’s not going to move the needle.

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