Emerging Hedge Funds Need To Clarify Edge To Win Over Investors

Mar 18 2011 | 8:55am ET

By Steven Simmons Head of Prime Services, Maxim Group -- Many of my industry colleagues have expressed extreme optimism regarding opportunities for capital allocations in 2011, particularly for the emerging and middle tier managers. As a salesman, I am an eternal optimist, however I would like to strike a cautionary note before coming across like the mayor in “Jaws” declaring, “It’s a beautiful day, and everyone should be heading back into the water.” The dialed up rhetoric from some of the largest pension plans and traditional allocators reflects a renewed interest and commitment to the smaller end of the hedge fund spectrum, yet there still remains a decided lack of intestinal fortitude to commit financially.

Investor acceptance and greater understanding of the inherent positive return bias during the first few years of a fund launch and the relative outperformance compared to more established peers is a proven maxim within the space. And indeed, the number of investor mandates we have received for emerging and middle tier funds recently has eclipsed those from the last few years. However, there still remain significant headwinds for the smaller manager in 2011.

Returns for 2010 averaged 10.8 %, not a particularly high benchmark which many emerging and middle managers beat handily. Many of the “household” name funds (Bridgewater +38%, Paulson +35%, Third Point + 34%, and Pershing Square +22%) more than crushed the benchmarks. Therein lies the dilemma for an institutional investor with fiduciary responsibility to their respective pension plan or endowment fund: “Do I allocate to Bridgewater, Paulson etc., or do I put my money with an unknown emerging manager that also put up great numbers?” 

The old maxim of “not getting fired for buying IBM,” holds true when it comes to hedge fund investing. Despite rhetoric to the contrary, it is still very difficult for even the best performing emerging managers to attract attention—let alone capital—from the largest allocators.

With such fierce competition for capital, investors remain firmly in the driver’s seat, and the screening process, due diligence, and investment terms have never been more stringent. Many of the investor mandates we have seen are very specific in nature, however there have been a significant amount of investors simply asking to be shown the best managers capturing alpha, thus opening the door to a very broad playing field.

The biggest buzzword among institutional investors this year is “clarity,” specifically regarding the “clarity” of the strategy itself. The manager’s elevator pitch and corresponding marketing material has never been more important, and failure to deliver a concise vision of what it is they do to create alpha is the fastest way of alienating a potential investor.

Specific attention is also being given to the underlying teams at the funds. The “two guys in a garage approach” is long dead, and smaller funds are faced with the Catch -22 of having enough capital to hire a full-time marketer / investor relations person, who can ideally, raise enough capital to help expand and grow the business. Outsized returns may capture investor attention, but the delineation of job roles i.e., the portfolio manager not being the head of marketing and client relations etc. is very important as well, especially for those managers who have just hit the all important three year track record.

Now more than ever, proper infrastructure and the ability to coherently and concisely define your edge in creating alpha is paramount to just getting your foot in the door.

Finally, there has been, and continues to be a dramatic shift in the landscape for key service providers that deal with the emerging and middle tier managers. The introducing prime space, long the stalwart supporters of the developing managers, has seen a significant shake up via mergers and outright exiting the space. The introducing prime space traditionally has provided support for enhancing and delivering the manager’s message to the institutional investor space via capital introduction services. While many of the introducing primes have exited the space, larger, traditional primes rarely focus on the smaller funds, contrary to much of the rhetoric on the street. Only the largest funds will continue to be courted by tier one primes and receive access to capital introduction services. Newer managers must be extremely careful when selecting service providers in order to insure they are getting a true value added service with a partner that has a vested interest in helping them grow. 

One of the family offices we are currently working with stated, “We are very keen to put money to work this year with smaller funds; but we are looking for EVERY reason possible to AVOID putting money into them.” Any reason that they can “check the box” not to invest is used, and the first reason they cited was poorly done marketing materials and an incoherent vision. For the emerging and middle tier managers, success in raising capital in this tumultuous environment, beyond an excellent track record of outperformance, is largely dependent upon a clear vision and the ability to delineate it. Marketing pitches and materials should be reviewed and tested with outside eyes and ears. Funds need devils advocates, not cheerleaders.

There are numerous reasons to be bullish in this space. Funds with the ability to speak up clearly and say “here’s why were different, and here’s why we work” should reap the benefits of the renewed interest in this space. Without that clearly defined message, it might seem like a great time to go swimming, unfortunately it might be too late to realize you are only chum in the water.

Steven Simmons is the Head of Prime Services for Maxim Group, an independent, agency only broker dealer and investment bank catering to the needs of emerging and established hedge fund managers.


In Depth

Q&A: Open Season For Closed-End Funds

Aug 29 2014 | 10:00am ET

When Maury Fertig and Bob Huffman, former Salomon Brothers coworkers, launched...

Lifestyle

Och Funds Women In Finance Initiative At U-M

Aug 28 2014 | 3:01pm ET

Och-Ziff Capital founder Daniel Och and his wife have made a "generous donation"...

Guest Contributor

Looking Ahead: What’s In Store For Managed Futures?

Aug 22 2014 | 12:52pm ET

The last five years were phenomenal for investors in equity indices. Will the next...

 

Editor's Note

    Get A Sneak Peak Of The Alpha Pages

    Aug 25 2014 | 11:21am ET

    As many of you know, FINalternatives was recently acquired by the owners of Futures magazine, a firm called The Alpha Pages LLC. Today marks the soft-launch of a new sister site for both publications. As its name suggests, The Alpha Pages will cover all types of alternative investments, going far beyond the more well-known ones such as hedge funds and private equity. Read more…

 

Futures Magazine

July/August 2014 Cover

The time was right

Commodities/Futures magazine launched at the precipice of a revolution in the futures industry—really a revolution in the idea of risk management—that would move it from a small niche industry to ...

The Alpha Pages

TAP July/August 2014 Cover

The Alpha Pages Interview: Senator Rand Paul

Senator Paul sat down in the debut series of the Alpha Pages Interview to discuss the broken tax code, regulation surrounding Bitcoin, and his plans for the 2016 Presidential election.