Hedge funds must do more to foster collaboration with LPs
November looks like it could be a superb month for equity-focused hedge funds on the back of Biden’s presidential victory and the three Covid vaccine announcements. And with hedge funds up over 5 per cent YTD, November’s turbo boost could see 2020 ending on a high note.
This should be welcome relief to newer hedge funds keen to demonstrate to investors that they have the magic touch to active stock picking, and that their investment process is both robust and repeatable. In that regard, for those ending 2020 with a two-year track record, next year could prove pivotal to securing serious institutional dollars.
Emerging managers have to grasp this opportunity, especially as first generation managers such as John Paulson, David Tepper convert to family offices. York Capital Management announced this week that they would largely be retreating from hedge fund investing while earlier this year, Landsdowne Partners confirmed it was shutting its flagship fund to focus on long-only investing and start-up businesses.
The number of fund closures still exceeds that of fund launches, however, as Hedgeweek reported back in June. Even against a more favourable market backdrop, raising capital to build a viable, sustainable business remains brutishly difficult. Having a good track record is vital, but what else can newer managers do to catch investors’ attention?
One argument is that hedge funds simply do not focus enough on developing a spirit of collaboration with investors, as one tends to see in private equity where no LP request is deemed irrelevant or ‘too much’. Investors are treated as equal partners. They feel valued.
Is that truly the case in the hedge fund industry? Yes, these are shorter-term investment vehicles, so one might expect a different dynamic, but as emerging managers burn the midnight oil to generate alpha, there is perhaps an oversight on some of the softer factors that play a key role in building a business, such as top-notch client communication.
“Hedge funds haven’t had the best decade. There was a sense among professional investors that it wasn’t a very collaborative sector, it was very closed off and it was hard to know exactly what was in the fund. Managers were quite slow to open up. Some of the larger names have learned from this and have become more investor facing: actively talking to investors, keeping them in the loop on portfolio developments, explaining what the portfolio managers are thinking ahead of time.
“The better hedge funds have developed more of a trusted relationship with their clients. Previously, it was more of a transactional relationship – you allocate your money and that’s that. There was nothing to build on,” comments Charlotte Thorne (pictured) of Capital Generation Partners (CapGen).
Thorne is one of the three founding partners of CapGen, an independent, private investment office established in 2006 to manage the investment needs of some of the world’s wealthiest families. Its two other founding partners are Khaled Said and Ian Barnard.
From the get-go, the focus was to build entirely bespoke investment portfolios for its family office clients, on an individual basis, selecting from the very best fund managers available (including private equity and real estate).
“We felt there was something missing at the time, which was institutional-quality investment for UHNW clients combined with exceptional service. A lot of the time, most of the market starts with a product, which then gets sold to investors. We wanted to turn that around, by building a business that firstly focuses on service, before designing institutional portfolios. You can’t do that if you start off with a product-focused mindset.
“Even when you’re representing a significant private pool of capital, what you’re shown by the established industry is the same product that gets shown to HNW and even retail clients. There’s very little discrimination in the sector and when you’ve got hundreds of millions to invest, 1) you should be presented with the very best investment opportunities at a decent price, and 2) you should expect to receive exceptional quality service,” suggests Thorne.
For today’s emerging manager, it is arguable that client service and communication – skills that are not the normal purview of portfolio managers – are becoming equally as important as performance. Those who are willing to dedicate resources to fostering LP collaboration – even if it’s only with a couple of small investors – might find they are able to catch the attention of larger investors.
“What we want is greater transparency,” asserts Thorne. “Managers who are willing to pick up the phone and explain why things might have gone awry in the portfolio. We want honesty. We feel as investors we can offer long-term capital that won’t be pulled at the first whiff of underperformance. In return, what we would like to see is our hedge fund relationships truly develop over time. That doesn’t mean getting involved in any portfolio decisions, it’s more about having collaborative discussions and managers trusting us to talk about why a trade didn’t work well.
“Our investment committee carefully assesses any interaction issues that might arise; i.e. our analyst calls up with an enquiry and receives short shrift…that will absolutely factor in to our decision making. Arguably, it is those kind of issues that the investment committee discusses more than what are sometimes temporary performance-related issues.”
It is not very sexy or intellectually compelling for new hedge funds to dedicate time to sharpening their communication skills but it is undoubtedly one reason why so many funds fail to become successful over the long term, even if performance hasn’t been bad.
What today’s new generation needs to ask themselves is: “Do I have the appetite to address all of the challenges that come with running a business?” If all someone wants to do is run a portfolio, set up a managed account and keep it simple. Don’t even try to compete with bigger name players if there is no strategic plan to build truly meaningful relationships with investors, some of whom might not allocate for two, three years or more.
Those who are committed to client service, while also focusing on exceptional portfolio management, will at least give themselves the best possible chance to becoming the next Julian Robertson or Ken Griffin.
“The smart start-ups today, I think, have observed the importance of client communication and see it as a way to gain traction,” says Thorne.
“We do have some smaller funds on our buy list but we would use those in a very specific way. Unless they’ve been incubated within a larger group, or have spun out and are very savvy about what investors need, smaller managers are going to struggle in the current climate.”
Investors like Dixon Boardman’s Optima Asset Management are feeling very upbeat on 2021 and view the current market as a “new golden age” for hedge funds. Unfortunately, if emerging hedge funds take investors too lightly, and aren’t willing to treat them as equal partners, they will fail to not only attract capital but retain it, and fund liquidations will continue at pace.
Next time you get a call from an investor, even if you’re on the wrong side of the market, give them the royal treatment. It could make all the difference.