The role of capital introductions in the growth of the hedge fund industry
The Hedge Fund Industry has topped USD 1 trillion, with some studies suggesting there is approximately USD 1.15 trillion in assets globally (Source: Tremont Asset Flows Report, First Quarter 2006).
The 2005 Deutsche Bank Alternative Investor Survey, polling over 1000 global investor respondents which manage USD 645 billion in AUM, revealed that the regional breakdown of hedge fund assets is approximately: US 62%, Europe 26%, Asia Pacific 10%, and 2% other. The breakdown of the alternative investor community, in terms of AUM, is shown in the following chart.
The overwhelming demand by the alternatives investor community for much of 2005, and into 2006, continues to be Emerging Markets (BRIC), Asia Pacific and Europe. From a strategy perspective, long/short, event driven, and multi strategy continue to be popular. A newcomer to 2006, which experienced slight outflows in 2005, is 'global macro'.
Lastly there is a trend towards the merging of the public and private equity worlds, into 'hybrid funds'. This remains the domain of the larger hedge fund players and private equity funds who can structure special liquidity terms for this non- traditional asset class.
Focusing on the growth of the Asian Hedge Fund space we have seen assets soar to about USD 115 billion, this is a growth rate of 50% per annum over the last six years. (Source: Asia Hedge Vol. 6 Issue 5 February 2006). Comparing this, by percentages, to the Global Hedge Fund Industry, the Asian Hedge Fund percentage has gone from a little over 2% of the total industry assets (approximately USD 500 million in 2000, Source HFR Industry Report Q1 2006) to approximately 10% of the total industry assets (USD 1.15 trillion, Source: Tremont Asset Flows Report, First Quarter 2006). While the Global Hedge Fund industry has doubled in 5 years, the Asian portion has grown by over 800%.
Not only has Asia Pacific experienced an explosive growth in terms of Asia product that has been traded, there has also been a shift in the profile of the Asia Pacific investor community. The Japanese community, although still influential (15% of assets), does not have the dominant 25% market share they had 2 years ago. Australian participation has grown from 11% to 26% of the overall pie, surpassing all. The US (19%) and the UK (19%) continue to be significant players in the Asia Pacific space (Source: AsiaHedge Roundtable Discussion 2006)
Finally, the global hedge fund manager universe has grown commensurate with the increase in assets of the industry. There are over 8,100 hedge fund managers, a rise of 100% in the last 5 years and over 4150 FOFs (SFS Hedge Fund Database Survey). The bulk of hedge fund assets are controlled by the largest hedge funds, and it is becoming increasingly difficult for small managers to raise capital. There is indeed a 'barbell' effect that is being experienced in the institutionalisation of the market place.
To insure survival, managers must get big faster and offer more product. The small single manager strategy is increasingly finding it harder to compete. At the centre of the explosion of this industry in terms of assets and new participants is the Capital Introduction Group.
What is Capital Introduction?
Capital Introduction is a courtesy service investment banks offer which facilitates investor introductions with hedge fund clients. It is traditionally a non revenue generating service (some prime brokers have models, 'free' and 'for fee'). The service is meant to be a 'complement' to the hedge fund's in-house marketing group, such as giving a manager access to investor communities that are different to their core strengths. (Regions or Types of Investors). It is not a distribution service as is typical to the long only business and the third party marketing community. Capital Introduction groups can also provide guidance on marketing materials and best practices for structures of funds. However, it is not a replacement to an internal marketer or compliance and legal specialist.
Where do Capital Introduction Groups fit in the Hedge Fund Industry?
Capital Introduction is an integral part of the industry. Initially, its primary function was helping hedge fund managers and investors find each other in an opaque cottage industry. Today, it is the information highway connecting the three communities who drive the future of the industry. Those communities are:
a) the hedge fund manager,
b) the product factory (banks), and
c) the investor.
Hedge fund managers continue to search the spectrum of investment tools to create alpha for their portfolios. There are new funds starting from established investment managers as well as new start- ups every week. Deutsche Bank (the factory) and other banks are creating financial instruments to help the manager (as well as investor) express their alpha views. The alternative investor community continues to grow and so do their demands as retail and institutional investors continue to diversify away from traditional asset classes.
How does DB deal with this data research exercise?
DB follows a three-pronged strategy for gathering and maintaining information on the complex world of alternatives:
- We have increased our interaction with Deutsche Bank's global network to better identify the alternatives investor universe. We utilise traditional Deutsche Bank dealing desks, namely Structured Products, Asset Management, Private Wealth Management and Investment Banking.
- Creation of market research tools, such as the DB Alternative Asset Survey. This is Deutsche Bank's Hedge Fund Capital Group survey of over 1000 hedge fund investors, representing 650 investors globally. We estimate this represents nearly two-thirds of the trillion dollars invested in the hedge fund industry
- Constant global meetings to stay abreast of current investor initiatives as well as culling new entrants to the alternatives investment community and new initiatives amongst existing investors.
Responsibilities of the Hedge Fund Manager in the Capital Introduction Process
The manager must be process-driven in terms of investment style as well as the investor process.
Communication: Raising capital requires frequent follow-up and communicating your message to investors in a clear concise manner. Investors like to create a bond with their managers and understand how they react to various scenarios. Infrequent communication is detrimental to that trust. It is important to communicate to the outside world when you have poor performance than waiting until there is a positive performance cycle.Investors understand that a manager needs to monitor the investment process, but they don't understand complete silence. Remember there are over 8100 funds to choose from. Someone is willing to take your place.
Stick to your style: Style drift is an issue for many hedge fund managers. When a hedge fund manager's style is not performing, there is a temptation to drift.
Don't chase high performing sectors that do no lie within your strategy. Investors now have the access to research tools and data that will allow them to track this drift. This will undermine their trust in your investment process.
Pay attention to infrastructure and human capital: The investor community has now become more sophisticated and their requirements have changed as well. No longer can you expect an investment without proper infrastructure-human or other wise. Responsibilities of the Investor in the Capital Introduction Process Due diligence- Capital introduction groups perform 'basic'due diligence functions, but do not provide an extensive due diligence service.
Tracking managers: Capital Introduction groups have access to myriads of data, contacts and information but the service is not a replacement for investor's research. An investor must have 'in-house' capabilities to analyze hedge fund manager risk and perform substantial due diligence queries. Once communication with a manager is established, it is the onus of the investor to stay up to date with the manager.
Future of Capital Introduction
Capital Introductions, historically and in many cases today, lie inside the Equity Prime Brokerage (PB) arm of investment banks as a soft service to help clients raise assets. At Deutsche Bank, we are building on this for the future. Deutsche Bank has re-branded our team as the Hedge Fund Capital Group (HFCG). The Hedge Fund Capital Group, lies at the center of the hedge fund information superhighway between all assets classes of the Deutsche Bank network and the investor community. We now service many groups inside of Deutsche Bank (FX, Credit, and Emerging Markets to name a few). We are not resting on 'Best IN Class'laurels for traditional capital introduction. The sophistication of the hedge fund industry is evolving and the Hedge Fund Capital Group at Deutsche Bank is rising to meet the challenge.
This article was originally published in Asian Investor Magazine
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