Much is made in the mainstream media of the supposed greed and avarice of hedge fund managers but as a recent Emerging Managers survey, compiled by boutique prime broker GPP in partnership with AIMA reveals, the opposite is true.
Far from looking to exploit investors with sky-high performance fees, the survey finds that the average figure is 15.37 per cent for funds that launched one to three years ago. Moreover, some 77 per cent of survey respondents said that performance fees in their flagship fund over the next 12 months would remain unchanged.
This level of pragmatism often gets overlooked, and suggests that emerging managers are careful about setting unrealistic expectations.
The survey finds that funds with five year-plus track records can command a slightly higher performance fee, 16.67 per cent, compared to those that have launched in the last 12 months, 14.74 per cent.
The trick is how to build a successful business for many years to come.
Increasing head count is one to achieve this, with over 80 per cent of survey respondents confirming that they plan to increase staff numbers by 10 to 50 per cent over the coming year.
In the early years, one would expect managers to hire more aggressively to build out the team. Incrementally, this number falls over the years. Not every manager, however, will want to hire large numbers of internal staff. What is interesting, and reassuring to start-ups, is that 92 per cent of investors have no issue investing with those who opt to launch their fund on regulatory hosted platforms.
“If you look at growth phases, the average start-up fund – any fund that has launched in the last 12 months – based on the survey, had USD30 million of AUM. In the second stage of growth, from one to three years, that AUM jumps to USD115 million and after three years the AUM keeps on rising, to an average of USD180 million after five years. It pays to therefore stay in the game,” comments Sean Capstick (pictured), Head of Prime Brokerage, GPP.
Phillip Chapple is COO at London-based Monterone Partners. He says that a hedge fund with a team of 10 people might not think that getting to USD180 million by Year 5 is very profitable.
“What you tend to find is that when there’s a lot of volatility, certain strategies get hit by the markets (and might take them longer to build AUM). During certain parts of the market cycle, it might be nearly impossible to get a macro fund going, or other times during the market cycle when it might be difficult for systematic funds or long/short equity funds. The market cycles over the last couple of years have been different to anything I’ve seen in the industry.
“The growth numbers, from an average AUM perspective, could therefore be obscuring the fact that some managers grow substantially after Year 3. Most would expect to be higher than USD180 after five years, in my view.”
Growth has a momentum component to it as well. There is a relatively small pool of investors willing to invest in managers at the outset. As the manager’s AUM grows, the pool of investors deepens.
“One aspect the survey doesn’t take into account is which investor base is interested in different strategies. For example, if you have a long-term strategy that interests US endowments, in the early stages it is going to be really tough for the manager because they need a track record, they need size. By comparison, if you are targeting fund-of-funds, you are more likely to access capital quicker,” says Chapple.
The survey finds that 91 per cent of managers regard their fund strategy as the most important differentiator, followed by talent within the firm. Fund board composition was regarded as the least important aspect of promoting the fund in the marketplace.
“The other factor that I see becoming important is risk management; reacting to the markets,” says Chapple. For investors, this is a proof of concept (for the strategy). If the market is whipsawing, how do you handle that? That is a real measure of how well the strategy works.”
If you don’t have the pedigree of talent, or a strategy that investors can understand, quite frankly they won’t be interested in understanding how you manage risk, “but if you do, they will certainly be interested in risk management when they start to do a deeper dive.
“You’re going to be on a stronger wicket if the strategy is delivering what it says it should,” suggests Chapple.
Some 50 per cent of respondents use the classic Cayman offshore structure for their flagship fund. Although the majority (60 per cent) do not plan on launching new structures to diversify their investor base over the next 12 months, those that do appear to favour UCITS structures to market into Europe. “This makes sense, given the appeal of this structure to European institutions,” adds Capstick.
For the average start-up, Chapple believes it is not the breakeven figure that is the primary focus but rather how many years a manager has to fund the business before they can start to attract significant assets.
“Each strategy is so different. For example, Monterone Partners is a high conviction strategy, which means we don’t need to have a large amount of infrastructure compared to say a systematic strategy. Our breakeven is quite a bit lower even than the USD86 million figure cited in the survey.
“Then again, for other start-ups and emerging managers, because of the amount of IT and manpower needed to trade, the breakeven figure can be as high as USD150 million,” says Chapple.
He does agree that breakeven numbers, in general, have fallen, because the market has changed.
“It takes a lot longer to build a hedge fund business than it used to, just because investors want to see proof of concept. They want to see that you are up and running and building a good track record before allocating,” concludes Chapple.
