Emerging Hedge Fund Manager: Beware Of The Capital Raising Twilight Zone...
"The only place where success comes before work is in the dictionary."
Vidal Sassoon, b.1928, hair stylist
Not too long ago I was asked to make comments on the pitch book presentation for a U.S. based Long/Short Equity manager. Before I got to "the numbers" (the bottom line) in the book, I figured from the investment focus that the strategy would have a risk/return profile pretty close to that of the NASDAQ - lots of vol., feast or famine on returns and heavily driven by liquidity flows. I was pretty close to being correct.
One issue with this fund, not related to the performance, was the following: After three and a half years in existence it still hadn't broken the US$100 million AUM (assets under management) barrier. What was the reason behind this fund being trapped in an "AUM Twilight Zone"? I figured that the experience and lessons could very well be transferred to Asian hedge fund single managers. An April 2006 university study claimed that 64% of all Japan hedge funds are managers with AUM under US$ 100 million.
The "AUM Twilight Zone" is a tweener existence - AUM are small enough for the fund to be classified emerging. That means that it is not really big enough to be picked up by the vast majority of institutional investors who like to allocate in US$ 1 million to US$5 million slugs then follow-on with US$5 million to US$ 10 million slugs once a comfort level has been reached. On the other hand, the track record of 3-4 years is long enough that the fund should have already hit the US$250 million barrier.
So why the disconnect?
First, one must get real. Only a handful of special case managers start out with over a billion dollars on day one. The vast majority do not have GS-padded resumes, gilded reputations made on trading desks and the luxury of knowing that there is a whole team of people all moving into a new, locked and fully loaded operation. The fund launches and is closed.
The vast majority of single managers are boutique players- probably good traders or portfolio managers but less so business-builders or entrepreneurs. For many of these hedge fund players that is their dilemma - to build a team, overcome second seating and key man risk issues, and understanding where resources need to go in the race to build AUM. Investors expect this kind of planning and execution. And for the vast majority of managers their previous employer probably handled the majority of these issues including trade reconciliation and other back-office issues.
While the media prefers to portray the glamor side of capital raising the reality follows this type of pathway: friends and family (initial US$10-15 million); a couple of cocktail parties in Geneva and London and a White Knight investor drops (US$ 25 million) and you are off to the capital raising races. The firm might also hire one/more TPMs to divvy up investor segments for a 20% trail arrangement. At the same time the COO finds that he/she is spending spending an awful lot of time at broker cap intro conferences, making appointments and preparing marketing materials, populating commercial databases, revamping the firm's pitch book, paying to meet "serious" investors and thinking about SEC compliance issues in discussion with onshore and offshore attorneys etc.
In the meantime, the manager has to contend with the vissisitudes of beating market performance. And you can bet that in the start up phase, there has been a market upleg and downleg. The latter might hit performance and put the manager in the investor's penalty box, with investors effectively going "cold", meetings drying up and once warm lead allocators saying that they are "on hold for now." The manager has fallen victim to fashion roadkill, and is stuck in a Capital Raising Twilight Zone.
Tips to escape the Capital Raising Twilight Zone
The manager should re-think his business development strategy and consider:
1/ Outsource marketing or business development as the existing set-up clearly has not worked, and if it is already outsourced fire the 3PM (third party marketer) and find someone who delivers!
2/ Focus on the existing "pitch". Find a similar risk/return fund with a prominent name that is in the fund's peer group and find ways to explain how your fund is better - albeit just a little under-developed. Think about how the risk/return profile measures up against long-only benchmarks and show that it is better and not simply beta.
3/ Focus on product rollout - maybe a Long-only or 130/30 fund structure would get traction with institutional investors
4/ Avoid the splatter-gun approach to marketing and target specific investors better, meaning if FoHFs are "hot money" allocators think about other investor groups
5/ Get the message of the fund/manager out there in the media (conference panels and newspaper mentions) in his/her the area of expertise (no cheesy advertising though!)
6/ Approach Japanese and Middle Eastern investors as they are currently flush with cash and may be quicker to pull the trigger in return for capacity gurantees with an up and coming manager. True story. Back in the day, George Hall was seeded by a Japanese trading company in return for 40%-50% of the equity of his firm (I don't know the exact amount) 5-6 years later Mr. Hall bought out his Japanese investor an estimated US$300 million on the way to building a US$ 8 billion hedge fund firm that became known as Clinton Group. It could happen to you.
7/ Consider merging either by selling a stake in the firm to a regional bank (strategic investor) or a larger multi-strategy shop that may be looking to diversify their product offerings
8/ If performance is the issue - find additional PM talent and give up equity to do so. This deals with the substance and not form of the fund and is vital to avoiding the Twilight Zone
9/ Start speaking to seeders or incubators, if you must!
10/ And managers, do not swing for the fences (use excessive exposure and/or leverage) if performance looks sickly one year, it really won't help and shrewd investors will see through it pretty quickly.
Remember, success takes a lot of hard work. Mahalo.
"The only place where success comes before work is in the dictionary."
Vidal Sassoon, b.1928, hair stylist
Not too long ago I was asked to make comments on the pitch book presentation for a U.S. based Long/Short Equity manager. Before I got to "the numbers" (the bottom line) in the book, I figured from the investment focus that the strategy would have a risk/return profile pretty close to that of the NASDAQ - lots of vol., feast or famine on returns and heavily driven by liquidity flows. I was pretty close to being correct.
One issue with this fund, not related to the performance, was the following: After three and a half years in existence it still hadn't broken the US$100 million AUM (assets under management) barrier. What was the reason behind this fund being trapped in an "AUM Twilight Zone"? I figured that the experience and lessons could very well be transferred to Asian hedge fund single managers. An April 2006 university study claimed that 64% of all Japan hedge funds are managers with AUM under US$ 100 million.
The "AUM Twilight Zone" is a tweener existence - AUM are small enough for the fund to be classified emerging. That means that it is not really big enough to be picked up by the vast majority of institutional investors who like to allocate in US$ 1 million to US$5 million slugs then follow-on with US$5 million to US$ 10 million slugs once a comfort level has been reached. On the other hand, the track record of 3-4 years is long enough that the fund should have already hit the US$250 million barrier.
So why the disconnect?
First, one must get real. Only a handful of special case managers start out with over a billion dollars on day one. The vast majority do not have GS-padded resumes, gilded reputations made on trading desks and the luxury of knowing that there is a whole team of people all moving into a new, locked and fully loaded operation. The fund launches and is closed.
The vast majority of single managers are boutique players- probably good traders or portfolio managers but less so business-builders or entrepreneurs. For many of these hedge fund players that is their dilemma - to build a team, overcome second seating and key man risk issues, and understanding where resources need to go in the race to build AUM. Investors expect this kind of planning and execution. And for the vast majority of managers their previous employer probably handled the majority of these issues including trade reconciliation and other back-office issues.
While the media prefers to portray the glamor side of capital raising the reality follows this type of pathway: friends and family (initial US$10-15 million); a couple of cocktail parties in Geneva and London and a White Knight investor drops (US$ 25 million) and you are off to the capital raising races. The firm might also hire one/more TPMs to divvy up investor segments for a 20% trail arrangement. At the same time the COO finds that he/she is spending spending an awful lot of time at broker cap intro conferences, making appointments and preparing marketing materials, populating commercial databases, revamping the firm's pitch book, paying to meet "serious" investors and thinking about SEC compliance issues in discussion with onshore and offshore attorneys etc.
In the meantime, the manager has to contend with the vissisitudes of beating market performance. And you can bet that in the start up phase, there has been a market upleg and downleg. The latter might hit performance and put the manager in the investor's penalty box, with investors effectively going "cold", meetings drying up and once warm lead allocators saying that they are "on hold for now." The manager has fallen victim to fashion roadkill, and is stuck in a Capital Raising Twilight Zone.
Tips to escape the Capital Raising Twilight Zone
The manager should re-think his business development strategy and consider:
1/ Outsource marketing or business development as the existing set-up clearly has not worked, and if it is already outsourced fire the 3PM (third party marketer) and find someone who delivers!
2/ Focus on the existing "pitch". Find a similar risk/return fund with a prominent name that is in the fund's peer group and find ways to explain how your fund is better - albeit just a little under-developed. Think about how the risk/return profile measures up against long-only benchmarks and show that it is better and not simply beta.
3/ Focus on product rollout - maybe a Long-only or 130/30 fund structure would get traction with institutional investors
4/ Avoid the splatter-gun approach to marketing and target specific investors better, meaning if FoHFs are "hot money" allocators think about other investor groups
5/ Get the message of the fund/manager out there in the media (conference panels and newspaper mentions) in his/her the area of expertise (no cheesy advertising though!)
6/ Approach Japanese and Middle Eastern investors as they are currently flush with cash and may be quicker to pull the trigger in return for capacity gurantees with an up and coming manager. True story. Back in the day, George Hall was seeded by a Japanese trading company in return for 40%-50% of the equity of his firm (I don't know the exact amount) 5-6 years later Mr. Hall bought out his Japanese investor an estimated US$300 million on the way to building a US$ 8 billion hedge fund firm that became known as Clinton Group. It could happen to you.
7/ Consider merging either by selling a stake in the firm to a regional bank (strategic investor) or a larger multi-strategy shop that may be looking to diversify their product offerings
8/ If performance is the issue - find additional PM talent and give up equity to do so. This deals with the substance and not form of the fund and is vital to avoiding the Twilight Zone
9/ Start speaking to seeders or incubators, if you must!
10/ And managers, do not swing for the fences (use excessive exposure and/or leverage) if performance looks sickly one year, it really won't help and shrewd investors will see through it pretty quickly.
Remember, success takes a lot of hard work. Mahalo.
posted by Franklin Scruggins | 5:32 AM
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