Transparency key to building relationships

In these times of uncertainty, startup and emerging managers are turning to their partners, consultants and service providers for support and guidance. Max Hayden (pictured), global head of prime brokerage sales at IG Prime, sat down with three respected, experienced COOs now providing outsourced services, to underscore the opportunities, challenges and considerations this group of managers are facing. Paul Gary Reynolds, founder of Covalent, Chude Chidi-Ofong, co-founder of Montague Square Advisors and Paul Clement, founder of Clement Advisory answer Hayden’s questions.

What are the key considerations for emerging and startup managers in the current environment? 

Outlining the current environment, Paul Gary Reynolds, believes the barriers to entry to the hedge fund world are reducing: “Historically the barriers were getting higher due to regulation and compliance. However, now, with the support of sophisticated service partners, they’ve come down.”

In this highly competitive landscape therefore, it is critical for emerging and startup managers to eloquently communicate their unique selling point. “They need to be specific about what differentiates their fund to all the others available in the market,” Reynolds notes.

Chude Chidi-Ofong, on the other hand thinks launching a fund has been getting progressively more difficult: “Whether it’s regulation, investor expectations, fee pressures….the bar is being raised all the time.”

According to Paul Clement, cost should play a significant role in a startup manager’s considerations: “When portfolio managers look to start their own funds, they may quickly realise how much is actually involved, in terms of cost and administration.” This is especially relevant to those professionals leaving a large firm, where many of the operational aspects were taken care of by others.

How can new and emerging managers build the intimate relationships in a virtual environment? 

As the world shifted to remote working, building relationships with potential clients has become more difficult. In Chidi-Ofong’s words: “In light of Covid, things are harder. The rigour of the due diligence isn’t going to get any less. If anything, because they can’t meet managers face to face, investors are going to want more information. This means it’s more difficult to get to know the investors and, correspondingly, for the investors to get to know the investment teams.”

Reynolds argues the increase in compliance requirements has also contributed to this: “The increase in compliance has forced investors and managers into more of a professional relationship. Compliance has dictated that managers cannot have intimate relationships with clients in case it looks like a form of inducement.”

However, the relationship between managers and investors needs to be based on trust, integrity and performance. “A strong relationship is built over time; it doesn’t happen overnight,” stresses Reynolds, “It happens through strong, consistent communication via multiple mediums, which includes email, Zoom and face to face meetings. Managers also need to ensure all other elements such as their website, portfolio managers, fact sheets, newsletters, are all sending the same message.”

If all these channels provide investors with high quality, consistent messaging, then over time, the trust will be built and the firm’s integrity will show through. Chidi-Ofong highlights the key characteristic which can support managers in their efforts in this regard: “Although building those relationships may be harder, especially for startups, if they follow the principle of transparency, they’ll be fine.” He cites an example of an investor redeeming a better performing fund because it was less transparent than others during times of stress.

Clement outlines the work he carries out with managers to help provide this transparency: “I support managers in setting up the proper processes, get these very well documented and make sure they have detailed operating manuals. These need to include flow diagrams to make the processes clear and straightforward for people to understand.”

This not only helps the managers communicate with their clients and potential investors, but also provides support from a business continuity perspective in the absence of key professionals within the business.

Essentially, emerging managers crave opportunities to engage with investors and in Chidi-Ofong’s view, they can turn the current state of affairs to their advantage: “With Covid, managers have a reason to actively engage with investors. They’re in contact more often and can potentially offer more of the portfolio manager’s time. It’s a fine line between distracting the manager from managing the portfolio and engaging with investors.”

One of the additional pressures startup managers face in this virtual space is building a strong firm culture. Chidi-Ofong points out: “Some of the larger investors place a huge premium on culture so embedding this sense of belonging and team cohesion is a massive issue.”

What solutions are available to help startups operate at maximum efficiency? 

Although remote working has created some challenges, it has also brought new opportunities. Clement comments: “This pandemic has really shown a business can run as normal, working remotely. Therefore, it’s given managers a lot more comfort around outsourcing a lot of work.”

Reynolds discusses the outsourced relationships startup managers need to put in place: “The most strategic partnership managers can have is with their compliance hosting platform. The way this operates from an infrastructure perspective is critical. There are many well-established technology providers who do amazing front-to-back, cloud-based hosted software solutions and they shouldn’t underestimate the importance of this.”

The managers’ need for a broad ecosystem of support is being felt acutely. Chidi-Ofong highlights: “To a larger extent, managers are asking us to use our pre-existing relationships with lawyers, software vendors, auditors etc. However, although investors might expect startups to get their systems right straight away, I sometimes advise clients that they can tell investors they are evolving their processes as they go along.”

Chidi-Ofong warns that the desire to get things right from a systems perspective could lead to impatience and wrong decisions: “If you have an unlimited budget you can build an amazing engine on day one, but in reality, this situation is unlikely. What startups need to focus on is scalability. There are many vendors for them to choose from, which is why they need guidance to try and implement a scalable system which works for their particular firm.”

Clement further underscores the importance of working with the right providers: “I’ve seen people try to set up their IT as cheaply as possible, but there is room for gaps and errors in that approach. When selecting providers, managers need to make sure they select the right ones.”

He also outlines considerations startups need to make in terms of their relationship with prime brokers: “These managers often don’t meet the minimum requirements demanded by the larger prime brokerage firms so they need to find other solutions. Working with smaller, more nimble firms works very well in these situations.”

Do you agree there have been more “spin out startups” compared to “brand new startups? Will this trend continue?

Reynolds remarks on the rise in the number of startups spinning out from larger shops: “I’ve seen many more spin outs in the last six to nine months. It’s partly driven by the due diligence process being quicker if there is some history there. Also, many companies have been changing their strategy or their focus, in reaction to the shifting markets. This is driving many more spin-out firms.”

He adds regulation also plays a role in entities being set up separately: “If you’re moving some of your asset managers overseas, spinning out that business might be more effective from an expenses perspective.”

“Pedigree is also key,” notes Chidi-Ofong, “A manager from an established shop often has a leg up over someone who, though very smart, hasn’t had the opportunity to demonstrate a track record. They potentially have investors who already know them, giving them a better chance of success.” This is even more relevant in a virtual environment where partners like prime brokers could vouch for managers who the investors have never met.

Chidi-Ofong continues: “Covid has exacerbated allocators’ desire to give money to managers coming from established firms. If you get some level of positive affirmation from the manager’s previous firm, then it helps. Thinking about the psychology of allocators, it is much easier to allocate to someone coming out of a spin out.”

Also, in Clement’s view: “Investors are more eager to invest in small to medium-sized managers now. They have been showing a preference for smaller, more niche teams.” This also could be driven by performance expectations, given returns sometimes dip when a fund gets to a certain size.

He believes the future is positive for startup managers: “They have a lot more choice in terms of their set-up and the service providers they can work with, which means they can get better results. Also, investors should be allocating a bit more on the hedge fund side. So, as long as the managers can keep hold of their performance, then the outlook is good.”

Hayden, at IG Prime concludes: “Thank you for contributing your insight and observations on this market sector and the challenges it is facing. Despite the difficulties arising from world events it is fascinating to see how the established hedge fund community is succeeding. Also specifically, how new entrants are adapting by taking advantage of the mature infrastructure which has been developed for this community. With more versatile and accessible technology, coupled with the acceptance and availability of more outsourced services designed for the smaller hedge fund it is encouraging for the future of new businesses.” 

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Max Hayden, Global Head of Prime Brokerage Sales, IG Prime
Max Hayden has over 30 years of experience in the prime brokerage field. He recently joined IG from ITI Capital where he was CEO and prior to that Max was MD of PB at BCS Global Markets, a Russian-based specialist broker. For the majority of his career, Max was at BAML where he performed a number of leadership roles in Prime Brokerage and Equity Financing.