A recent survey by Preqin revealed that 60 per cent of hedge funds have less than USD100 million in AUM and that only 5 per cent of hedge fund flows go to funds operating below that AUM level.
There are now approximately 15,000 hedge funds in the industry, meaning investors are being bombarded by different funds every single day and thousands over the course of a year. They probably meet with 200 or so, engage in follow-up meetings with around 40 and allocate to two or three.
As such, there is one certainty that US start-ups can be sure of when launching their new fund: the ability to raise capital is exceptionally difficult and competitive.
So what can start-ups do to put themselves in the best possible position to succeed? Reaching out to their appointed Prime Broker(s) will help to a certain extent, provided they have a capital introductions team in place, but this should only be done as part of a wider, strategic marketing and distribution strategy.
Don Steinbrugge (pictured) is the founder of Agecroft Partners, a prominent, award-winning third party marketing firm located in Richmond, Virginia. He says that managers need to excel in three areas:
• Quality of product
• Quality of message
• Distribution strategy
A manager's fund will make the first screen as a high quality product by investors if performance is strong, however their due diligence process goes much further than that. Investors will also consider factors such as: organisational structure, the quality and make-up of the investment team, the investment process, risk controls, appointed service providers and fund terms.
"Secondly, they have to have a refined marketing message that clearly articulates their differential advantages across each of the evaluation factors investors use to select a hedge fund. The message must be concise, linear and consistently delivered. One of the biggest problems is that fund managers do a bad job of communicating their point of differentiation to investors and the investor's perception of their fund falls below reality. This results in a manager doing countless meetings with investors yet failing to secure capital," says Steinbrugge.
The third component of raising assets is the marketing strategy. This requires reaching out to a wide selection of investors and setting up qualified meetings. It also requires making sure that the manager has the right follow-up strategy in place for each prospect. Building momentum in asset growth is more important than asset size, says Steinbrugge.
"I'd much rather represent a hedge fund that is going from USD50 million to USD175 million than one that has been at USD800 million for the last few years."
He says that new managers shouldn't hit the market until they are certain they have a product that is competitive and that their marketing message is well refined as first impressions are vital.
"Part of the challenge is identifying in the first place who to call on. There's no definitive list of investors that a manager can refer to. It takes a lot of hard work building out that list. The more prospects that a manager can identify the more meetings they are going to get with investors that are interested in their strategy," adds Steinbrugge.
Thomas S Kreitler is a managing director and leads the hedge fund/public market strategies fundraising team at Eaton Partners, which works with some of the largest pension funds, endowments and insurance companies. Kreitler has a deep understanding of what institutional investors look for when investing in hedge funds, and whilst the majority of its hedge fund clients are well established managers with solid track records he is able to share some important insights for any start-up manager to consider.
The first criteria an investor will consider is that the fund manager can provide clear evidence of alpha generation; this can also include a performance track record if the start-up manager previously worked at a hedge fund manager and ran a percentage of the firm's AUM.
Secondly, whatever the strategy is, it should be focused on a clear, robust market opportunity – for example, the prolonged price dispersion and inefficiency within a market sector. Typically, institutional investors will already be well versed in the opportunity and potentially interested in making an allocation.
"Thirdly, the group's strategy needs to be highly differentiated. It can't just be a standard trading strategy that looks like countless others in the marketplace. At Eaton, we tend to work with managers in more niche strategies who demonstrate a clear expertise in their chosen area. These could be sector-focused strategies that provide a unique set of market exposures to the investor.
"Fourthly, the principals of the firm need to have significant personal investments in the fund. Investors are not inclined to invest with someone who does not have significant skin in the game – it raises questions about the manager's conviction in the investment strategy and their level of commitment," explains Kreitler.
The concept of establishing a brand is relevant but should not be an immediate consideration for new managers; rather, it should be part of the long-term business plan. Nobody can build a brand overnight. In the first two years of operating, investors are going to place more stock on the criteria cited above. A manager who might have a fantastic website, lots of good thought-leadership papers and a strong social media presence yet can't articulate their strategy concisely is going to face an uphill task.
"Branding, in my view, shouldn't be a priority for a start-up manager. I wouldn't recommend that they allocate limited resources to branding at an early capital raising stage," says Kreitler.
Investment edge
Without question, a manager's marketing materials have to clearly articulate their investment edge. They should be high caliber, well written materials that reflect the core attributes of the hedge fund. After all, the presentation deck will act as a roadmap for those meeting the prospective investor so the more complete and rehearsed it is the better the presentation will be.
"Oftentimes, managers like to talk about their latest great trade; that may be okay for the second meeting but not the initial meeting. When making that first presentation and introduction to an investor, the manager needs to give a broad overview of the business, including the background of the principals and their investment edge. If it gets to the point that there's interest in a more granular discussion that's fine but a proper relationship and rapport needs to be established before the manager starts getting too detailed.
"Managers should aim to discuss how they built the business, and their plans for growth that are consistent with optimal performance. If they do a poor job of highlighting what their value-add is as a fund manager, they're not going to make it through the starting gate," asserts Kreitler.
Patience is a virtue
The cycle of going from an initial investor meeting to securing investment dollars can be a long one, especially if the manager is targeting institutional investors. As such, it is advisable to prioritise prospects. Identify those most interested in the fund and think about what will help them in their decision making process.
Investors might provide positive feedback after a meeting, but they'll likely be seeing another manager or two later that day, another couple the next day and so on. As the days turn into months, managers should ensure that investors are regularly contacted. This requires putting proper processes in place to do follow-up emails, answering additional questions or points of clarification. The manager will need to be proactive because an investor will quickly forget about them.
"It is important to follow up with investors and understand what the next step in their due diligence process is. If not, the positive initial impression you made will get diluted by all the other meetings that investor will be having with other managers," says Steinbrugge. "Also, think about the nature of the investor. Some investors are interested in all types of strategies, whilst others have very specific requirements. If you're a CTA and you're approaching a FoHF manager that has a preference for long/short equity managers, you're going to be wasting your time."
At Eaton Partners, Kreitler says that the average sales cycle from initial meeting to allocation can take anywhere from 12 to 24 months or longer. "Our research reveals that the typical fund raising process requires an average of 42 touch points; meetings, emails, phone calls etc. Additionally, over 25 per cent of investors who have invested with the managers we work with initially said `No'. This demonstrates that perseverance pays off."
Experience counts
Make sure it's a product specialist going out to do the first meetings with investors rather than the portfolio manager. It's imperative that they speak exactly like the portfolio manager, however.
Also, whoever that product specialist is, don't hire them as a junior member of staff. That person is going to have a major impact on how an investor views the hedge fund. They will impact the brand so they should be well-polished, extremely knowledgeable people. A junior inexperienced staffer will not command any credibility.
Then, if the meeting goes well, the founding partner or portfolio manager (if they are two different people) should attend the second or third meeting with the investor to give them a clearer picture of the firm.
"I think it's hard for just one individual to represent the firm and penetrate the market as they build a brand. Yet at the same time, investors will be looking at the firm's AUM month to month and if your AUM is not growing investors will be reluctant to allocate. If it is growing, they tend to jump on the bandwagon. So by penetrating the marketplace, delivering a good product and a good presentation, this will help to build a brand. Ultimately success breeds success in the hedge fund industry," concludes Steinbrugge.
