“Know who you are”: Confronting the challenges facing start-up hedge funds

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David Horton, Anchin

Emerging hedge funds must tread with caution in the face of increasingly complex operational infrastructure as their businesses gather pace and raise assets, speakers at Hedgeweek’s fourth annual HedgeweekLIVE North America Emerging Managers Summit said on Wednesday.

The opening panel of the two-day summit examined the battalion of legal and fund structuring considerations confronting start-up firms today.

Moderating the panel, David Horton (pictured), partner at Anchin, said it is vital for fledgling managers to know who they are before they can begin their fund launch process and develop their fund structures.

“Understanding who you are and what you bring to the marketplace is of paramount importance,” observed Michael Fastert, chief operating officer and chief legal officer at TIG Advisors. “Every geographic region and investor base likes something different. You want to be as inclusive as possible and raise as many assets as possible, but there are certain strategies that are favoured in some jurisdictions and some that are not.”

Nicholas Miller, senior associate at Seward & Kissel concurred, underlining the importance of keeping things simple during the initial planning stages, rather than attempting to launch a broad range of fee classes across an assortment of liquidity terms.

“When managers try to be everything to everyone, they end up being nothing to no-one,” Miller told the panel. “That doesn’t work on the fundraising front – it’s much better to have a clearer idea of your core competencies and your strengths. Build your firm and fund around that.”

Justin Savage, partner at Ogier, said a key benefit of having an offshore Cayman vehicle from day one is that it is able to come to market quickly. 

“We are structuring their gameplan for one to five years down the road,” Fastert added. “One of the places we start is certainly that Cayman master feeder – it gives that optionality and that flexibility that you crave in a jurisdiction that has well-settled laws and parameters.”

Speakers also discussed the importance of carving out a durable track record to attract investor attention, and weighed up the pros and cons of a start-up manager establishing a separately managed account (SMA) versus a fund vehicle in its initial stages.

Miller acknowledged there were trade-offs between the two. “One efficient and effective way to build a track record is to utilise an SMA especially if you really only have a handful or strong targets and no critical mass,” he observed.

Fastert added that while starting off with an SMA initially may be more simple for certain managers, things could get complex further down the line as firms grow and decide to add multiple accounts and launch commingled funds, complicating the back and middle office functions.

“All of this requires an operational infrastructure going forward,” Fastert said, adding that managed accounts put “different lenses” on compared to flagship fund investors.

“Once you get there it’s more of a complex operational set-up, and I would caution and advise that once you go down that road of having private funds and managed accounts here and there, there will likely be different parameters they are run with.”

Using top-tier service providers is also crucial, and will pay dividends going forward, speakers said, providing institutional investors with a degree of confidence when start-up funds make an initial marketing approach.

Savage said strong service providers will offer clarity over what issues may potentially tie managers’ hands further down the line as start-ups focus on bringing in big-ticket allocations.

Miller spoke of the importance of matching portfolio liquidity and fund structure.

“When something turns in the market and folks head for the door, you can get into some severe fiduciary issues,” he explained.  “It’s easy for me as legal – I’m not the one pounding that pavement trying to raise money - but as much as you can try to have a mindset of where you have a thoughtful narrative and story about the terms.” 

Fastert meanwhile suggested that building the legal structure is just as important as building the portfolio, and warned of the perils of portfolio managers getting “bogged down” in compliance and audit issues during the start-up process. He indicated that having a trusted number two, whether a second person in-house or an outside advisor you can lean on will go a long way towards assisting growth quicker.