Navigating a challenging environment and rising to success
By A Paris – The European hedge fund industry ended the year with USD486 billion in assets under management. The largest portion of these funds were domiciled in the Cayman Islands. Luxembourg was the next most prevalent jurisdiction, which highlights one of the key decisions start-up hedge funds need to make ahead of launch – that of domiciliation.
Despite experiencing outflows over the course of 2019 and navigating a challenging capital raising environment, last year saw the number of launches in the European hedge fund market outpace the number of closures for the first time since 2014, according to data from Eurekahedge.
A matter of jurisdiction
When looking to launch a fund, aspiring hedge fund managers need to choose whether to structure their fund offshore or within a UCITS wrapper. Before the introduction of the Alternative Investment Fund Managers Directive (AIFMD), most hedge funds were established as offshore structures. The advent of the AIFMD however has led to an increased number of managers considering onshore jurisdictions such as Luxembourg and Ireland.
Shane Coveney, partner at Dillon Eustace says: “A key determinant in deciding where to set up a hedge fund structure will be tied to where the promoter of the hedge fund foresees asset raising being most effective….Should the asset raising and investor base be located in Europe, it is common for start-up hedge fund managers to establish structures within the EU and seek to avail of the EU wide marketing passport which is provided under AIFMD and the UCITS regime.”
According to Sam McMurray, Vice President at Cowen, offshore structures remain popular: “In our experience, 95% of the European allocators we talk to are offshore investors first and foremost… Cayman remains the most popular offshore jurisdiction, although we see increasing demand for onshore ICAV structures in Ireland that have the ability to take US and non-US money via feeders.”
He adds how UCITS platforms are also looking for exciting, under the radar emerging opportunities out of the US, which is where the firm spends most of its time on the UCITS front.
Different investor types
However they are structured, hedge funds need to have the ability to onboard different investor types as they scale up. “The key for most funds is having flexibility in structure (typically via feeders) to look at different investor types,” notes Lawrence Obertelli, Director at Cowen.
For example, when a fund plans to target a mix of foreign investors or tax-exempt US entities, an offshore structure is generally preferable. Setting up an onshore fund seeking to raise assets from such investors will simply not work.
Whether the target investors are family offices, sovereign wealth funds or pension funds also makes a difference. Each type of institutional investor has different needs and risk thresholds while also having to abide by varying regulations themselves. Start-up hedge funds need to be highly cognisant of their target client group while also keeping their set up flexible to accommodate others as they grow.
Joris Groot, Business Development Manager Europe at Circle Partners adds: “You need to take that [having the flexibility to cater for different investor types] into account in your business plan. What we see as a result are Master-Feeder structures with feeders onshore or vice versa, to accommodate both onshore European investors and offshore investors. People are looking into multi-domiciled structures or in some parallel structures as well – running a similar fund for onshore European investors as well as for people who would like to invest offshore.”
Outsourcing and speed
Until around 10 years ago, starting or launching a hedge fund was an arduous, expensive process which took months to complete. The dawn of service providers helped alleviate this burden, resulting in a much quicker time-to-market.
Andrew Fundell at GC Partners comments: “Our job is to help get funds to market earlier. The more we can help with the day to day running of their investments, the more they can focus on what they want to be doing, which is creating alpha.”
In a report, the Alternative Investment Management Association highlights the important role outsourcing plays in the journey of a start-up hedge fund: “The more staff directly employed, the greater the cost — in both direct and indirect terms (office space, supplies, management, etc). Using external resources, although somewhat costly, negates the need to hire expensive staff to perform these functions and also eliminates the need for software licenses and a tail on staff costs.”
“Outsourcing certain functions can not only help funds to get to market quicker, but also ensure competency and expertise in certain areas. Taking on every function directly will take a huge amount of time, but there is also a potential knowledge gap in specialist areas. By outsourcing certain functions to specialist providers in those areas the fund should be able to save time, costs and also ensure they can call on experts,” Fundell adds. An example of this is in the area of share class hedging; most funds would just use their custodian bank, but the question is whether this way, they are getting best execution in terms of pricing, and whether their custodian is monitoring hedge performance on the funds’ behalf intra month.
According to Colin Bridges, Director at Cowen, the two key roles an emerging hedge fund needs to fill are those of its chief operating officer and the marketer. “Managers should be very clear in their minds when exactly these roles will feature,” he says.
Malcolm Goddard, COO of Zetland Capital Partners explains: “An experienced COO will save both time and money; will have the necessary connections and will recognise where the bear-traps are. Having another person take on COO responsibilities frees up bandwidth to focus on marketing and portfolio management; so, if you get the right person, it will be the best money you’ll have spent.”
The role of the COO is also shifting as regulatory scrutiny has been rising and increased transparency is being demanded. In a statement, Jayesh Punater, founder and CEO of Gravitas, outlines some of the additional dimensions of responsibility hedge fund COOs are taking on.
“COOs are now at the forefront of managing firm culture and values. With the advent of millennials entering the workplace, culture and values have become an important stake for recruiting and retaining valuable talent. COOs are typically entrusted to screen for these values and culture traits in new recruits while also promoting them within the firm.
“They are also often responsible for navigating professional development in new ways that are effective and resonate with top-tier talent. Instead of traditional incentives such as compensation and title changes, COOs must promote new learning opportunities and individual growth among top talent, hence maximising their contributions and development within the firm,” Punater explains.
He also believes COOs are having a larger impact on client-facing marketing activities. This further emphasises the importance of the marketer.
The Hedge Fund Marketing Association points out how marketing concerns are often given the short shrift when a fund is on the launch pad. However, as one of the basic functions of a new fund is to raise capital, pushing marketing aside makes little sense. “Thousands of hedge funds are in competition with each other for capital investment, which makes marketing an extremely important focal point for any hedge fund, particularly start-ups, because they lack a record of performance,” the association says.