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Hedge funds and the costs of raising assets

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Last week London ground to a halt. Tube drivers went on strike for 24 hours. Chaos ensued as city workers jumped on their bikes, hailed cabs or, worse, squeezed onto the next available bus to get to the office.

It is perhaps fitting, therefore, that just days before the strike Hedgeweek went to visit Murano Systems, a company who likes to think of itself as a matchmaker for hedge funds and institutional investors. Like London, the hedge fund industry, which now boasts anywhere up to 14,000 hedge funds, has bottlenecked into one almighty traffic jam.

Murano exists to help allocators plot a route through this traffic by introducing them to managers that fit the right profile. Think of it as the hedge fund equivalent to Crossrail.

“In the mid-2000s when I was doing roadshows I could get about five meetings a day,” recalls Ole Rollag (pictured), Managing Principal at Murano. “Today, when we speak to managers and ask them how long it takes to do roadshows they say it takes two to three weeks depending on the fund. It’s become mind numbingly difficult and the reason for that is because allocators simply have too much to do.”

Whenever an allocator visits Murano’s office on New Bond Street in London, Rollag and his team always ask how much manager traffic they receive and the fact is, they are bombarded on a daily basis with anywhere from 10 to 20 calls and 300 emails. Cutting through that noise has become nigh on impossible.

“What this industry hasn’t done a good job of is trying to better understand the mindset of the allocator. Why does an allocator buy what they buy? Let’s say you’re a fund manager that trades Japanese warrants. You could be the best Japanese warrants fund manager in the world, but if you don’t know how to position the fund or understand what allocators are looking for, then you’re going to have a very difficult time,” says Rollag.

Although hedge fund managers don’t want to hear it, the reality is they no longer have an aura of intrigue or invincibility. They aren’t special. They are lemmings, not white Siberian tigers, and as such they need to work damn hard to get the attention of the right allocators. Just as any successful restaurant needs to be easily accessible – by having good transport links – Murano works with fund managers to help their business development become more efficient and cost-effective.

Time and again, new fund managers come to market with dollar signs in their eyes. They fixate on an AUM target with scant regard to how to properly run the business side of things. This is the difference between what makes a good manager and a great manager.

It’s no coincidence that when Paul Ruddock established Lansdowne Partners with Steven Heinz in 1998 there was a clear separation between investment management and business development; Ruddock used his expertise in equity research, sales and trading to build long-term institutional relationships. It is now one of Europe’s highest regarded hedge fund managers.

“If you have zero AUM growth, you’re never going to run a successful hedge fund management business. You don’t just need to have an excellent product. You also need to be able to sell it. Very few managers are able to do this. If you look at the equation of success, it is AUM x Mgt Fee & Performance Fees = X,” says Rollag, who continues:

“Our managers fall into three categories: emerging managers, where we act as a proxy for client services; managers running esoteric strategies, who want to connect to specialist investors; and large managers, who understand that we are an efficiency play.”

It is not only fund manager numbers that have ballooned this century. Increasing numbers of institutional investors are turning to hedge funds as they seek protection against traditional asset class volatility. Ten years ago, having a list of 1,000 investors was considered a big deal. Not any more. Murano’s database alone has 31,000 investors and counting.

This is making the whole process of asset raising a much more costly exercise. By Murano’s estimations, prospecting costs largely derive from three sources:

  • Conferences
  • In-house prospecting
  • Third party marketing

The singular objective is to get the first meeting with an allocator. According to Murano, the cost of attending conferences can reach up to USD40,000 per ticket, whilst using third party marketing can be as much as USD80,000 per ticket.

By stepping into the breach and providing a more focused, considered approach that involves liaising closely with allocators to understand exactly what their investment needs are, Murano’s team is able to compile quantitative reports that can slice through the front-loaded prospecting costs to the tune of approximately USD10,000 per ticket.

The obvious question at this juncture is, “How exactly is this possible?”

One of the central cogs in the Murano process is delivering a 40 to 60 per cent success rate in securing the first meeting on the back of the reports it generates for managers. The trick is to ask the right questions to allocators, with which to then generate meaningful reports.

The volume of reports that a manager receives will vary depending on the fund strategy. Esoteric strategies such as the Japanese warrants example might only result in one report every one to two weeks. More vanilla strategies, such as long/short equities and global macro, would typically result in two to four reports per week, provided the fund has a minimum of USD100 million and a three-year track record.

“If we are doing our job correctly, 40 to 60 per cent of those reports turn into meetings. If they don’t, we need to consult with the manager to work out why: there are a lot of different variables – it could be we aren’t asking the right questions, the service isn’t being used optimally (not following up from the first email correspondence), maybe the emails they are sending are too long, and so on. There is a fair amount of coaching involved. If professional athletes need it, why should fund managers be any different?” comments Rollag.

All things being equal, provided managers take the right steps to secure the first meeting, they have a 5 to 10 per cent chance of getting a ticket. In other words, for every 20 meetings the manager should expect to receive an allocation. This is based on metrics that Murano has been able to build on the success of the asset raising process since it was established five years ago.

This helps to explain where the USD10K cost per ticket comes from. 

The following breakdown serves to illustrate, based on a straightforward long/short equity strategy:

Manager X receives 4 reports per week for 50 weeks = 200 reports

Based on a 40 per cent conversion rate = 80 meetings

At a 5 per cent closing rate = 4 tickets per year

Murano annual costs = USD40K

Therefore, price per ticket = USD10K

Right now, there are 70 managers in the Murano network. Rollag believes that the optimal number, in terms of capacity, is 125 managers, which they are on track to reach. Of particular importance is guarding against having managers over-represented in any single asset class.

“It’s up to us to find managers where there’s demand. If we don’t have a fund strategy that an allocator is looking for…well, that’s the end of the conversation. We have most hedge fund strategies covered in our network and we’re seeing demand for global macro and event-driven strategies in particular, at the moment.

Murano essentially operates on behalf of the manager by occupying the middle ground. The whole edifice is built on understanding precisely what allocators are looking for, understanding their needs, “and if we think there is the basis of a solid conversation to be had, we’ll send the information over to the appropriate fund manager. We have no involvement whatsoever in the sales process; it’s entirely the fund manager’s decision to approach that allocator or not,” explains Rollag.

One can think of Murano as being something akin to a diplomat at a cocktail party. As Rollag points out: “We’re trying to make the whole process more polite, more genteel by helping both the managers and the allocators at the same time. We’re helping to break the ice, as it were.”

This need to connect more effectively with the right allocators is underpinned by the fact that institutional investors are paying much greater attention to the AUM and track record of a manager.

According to Rollag, when speaking to allocators he finds that they typically ascribe 20 per cent importance to fund performance when screening managers, the other 80 per cent being operational considerations, business growth plans and so on.

“Whatever a manager’s edge might be, it all comes back to having empathy with the allocator,” stresses Rollag. “Trying to understand, from an allocator’s perspective, why they should invest in their fund. There are a lot of nuances to this process, but it’s not as if it is top secret; it’s just that nobody has ever bothered to ask.”

One of the biggest problems of being a small fund is that oftentimes they are under-capitalised. This can be overcome by paying heed to long-term business development and by presenting a bigger vision to prospective investors. Allocators aren’t necessarily discouraged from investing in small funds, provided they have assurances that the manager is focused, not just on generating alpha, but on making their business a genuine success.

The disconnect with allocators is that fund managers typically fall into the trap of saying, ‘Well look at our performance record, it’s great.’ The point is, allocators are looking for more than that.

“I liken this to stock picking. If you’re going to buy Google you don’t do so because it has performed well in the past, you buy it because you think the business drivers are going to be positive moving forward; increased revenues, earnings growth, etc. For any investor considering a manager, the key drivers are not just past performance but also understanding the reasons for how and why the manager is making money – and under what circumstances.

“You’ve got to tailor the product specifically to what allocators want; that includes liquidity, legal structure and oftentimes if a manager ticks those boxes they’ll get an allocation, particularly if it is in a strategy that is difficult to access,” explains Rollag.  

The aim here is for Murano to help managers move away from the cold calling, carpet bomb approach to getting in front of allocators; to reverse the sales process by taking a measured stance that elicits their needs and desires.

“At the end of the day, we have the methodology in place to reach out to allocators, listen to what they want, and decide whether it is worthwhile putting them in touch with the managers on our network,” concludes Rollag. 

Like London’s commuters, no institutional allocator enjoys hedge fund congestion. It’s time for managers to start plotting a smarter route. 

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