Sat, 01/10/2005 - 22:00
One good way of annoying fund salesmen, those from publicly-listed investment groups like Investec, Man Group or Singer & Friedlander, is to enquire whether one would be better off buying the new fund (whatever it is) or the company's shares. After all, if you buy a fund, you are paying fees but as a shareholder you are a partial beneficiary of the investment company's income stream.
Of course, the salesman will tell you that the new fund has been carefully structured to achieve significant profits from strategies which have been proved particularly effective in today's market conditions whereas, to some extent, the company's share price is at the mercy of those same market conditions. Also, and obviously, without fund sales the company's shares will be flying south.
At a more serious level, the arguments leading to companies seeking a public listing are well known and apply just as much to a large investment house as to an engineering group or a bank. They include capital raising, the establishment of value, the ability to use paper to finance takeovers, the use of options to incentivize staff and so on.
There is also a significant benefit arising from heightened profile - particularly for a big alternative investment group. It would, for example, be hard to argue that Man Group has not gained significantly from the press exposure and public transparency its position in the FTSE 100 Index brings with it. At a time when many institutions are still wary of the benefits of hedge fund investment, the comfort factor arising from dealing with a large London-listed operation must be considerable.
All well and good, but the question I want to pose in this column is whether these positive arguments equally apply to an individual hedge fund manager or whether, in fact, there are potential conflicts in a publicly-quoted manager (as opposed to a fund-of-hedge funds manager or an investment house).
This question came to mind when reading a recent (15 March 2004) Bloomberg article about RAB Capital Management coming to the London Alternative Investment Market: "This week, RAB Capital Management, which had USD 1.1 billion in assets early this year, will make its debut on London's Alternative Investment Market. The initial public offering will raise as much as 8 million pounds (USD 14.4 million) and value the business at about 86 million pounds." (The story was in fact, quite widely reported).
Now I do not want to make any specific comments about RAB, which is a successful and impressive alternative investment management company. The launch, however, does raise some important general issues.
Recent studies have shown that as many as 50% of hedge fund closures (i.e. close-downs), at least in Europe, are a direct result of operational failures rather than poor performance. And indeed, many hedge fund managers will tell you that running the business can be as challenging as running the money - and is too important a commercial element to be wholly delegated.
This being so, one has to ask how much more operational pressure must there be on a manager who chooses to float his operation? Preparing a company for listing always takes a great deal of time and attention and, I would argue, there is a definite risk that a manager might lose focus on his core money management activities during the listing process.
Stated succinctly there is a risk that in choosing to float, a loss of focus could remove value as the listing materializes.
A successful flotation naturally creates another investor group within the hedge fund business - the shareholders - and business of informing, answering and on occasion pacifying this group could easily prove a drain on a manager's time.
It's fair to say that many managers resist much contact with all but their largest fund investors claiming this would prove too much of a distraction. In these circumstances, it's normal - assuming financial circumstances allow - to appoint a client liaison officer. The problem with (some) shareholders, on the other hand, is they often wish to be in contact with the man in charge.
The Power of Money
In the case of RAB Capital Management, only a small proportion of the company was floated at the IPO but consider the case of a large operation offering a relatively high proportion of its shares in a substantial and well-subscribed offering. The upshot here will inevitably be a substantial lump sum for the principals although, given the amount of money that a good private hedge fund can generate, it is difficult to believe this cash generation would be a core reason for going public.
Nonetheless, there have been arguments suggesting that a sudden influx of personal funds could cause a manager to become less interested in handling client money and become more interested in running and enjoying his own. I have to say I doubt this particular concern. One of the positive qualitative indicators one looks for when selecting managers is that they have a large proportion of their personal net worth co-invested with their investors - and this arrangement seems to boost, rather than diminish, the quality of performance. Second, there continue to be a large number of very wealthy and still very successful managers - and in fact I can only think of two or three - most notably Munroe Trout - who have walked away while still at the top of their game.
One of the core reasons talented (and less talented) managers are drawn to setting up hedge funds is income generation. It is not, for example, uncommon for a fund group managing, say, USD 1 billion to require only eight or ten people to undertake this task. And given performance of, say 10% a year and the norm in fees - 2% pa management and 10% performance fee on net new highs - the fund will be producing some USD 30 million a year in gross revenues. However this cake, if sliced, represents a good chunk of change.
Compare this to a fund where, say, half the shares are in external public hands -where dividends need to be paid and where if the fund managers' incomes become too high (and these, of course, will now have to be declared via the formal publication of accounts) issues of corporate governance can be called into play. I would argue that such a structure risks leaking talent and, in some senses risks becoming a victim of its own success.
The Best Deal
Today, after the collapse of the dot.com/IT boom, I would argue that investment management, particularly alternative investment management, is the best legal way for a talented individual to make extraordinary amounts of money. (It may be worth recording here that according to the US press, George Soros was paid - and note the word 'paid' this is not about fluctuating stock values - USD 1.6 billion dollars in 1996 and then again in 1997). For this reason alone, I believe that what some have described as a flow of managers seeking to go public, will never be more than a trickle. You know, the world's biggest traditional manager, Fidelity, never felt the need to be anything more than privately owned.
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