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Picking up from our last newsletter, where we discuss “Why you will come to regret launching your new hedge fund on any day other than the 1st of the month – and other practical things to consider”, our next natural course of discussion is: At what point do you have enough performance to put on your marketing hat?
There are many more factors that move in concert with performance to determine whether a fund is “ready for prime time”. It’s like a string section without the full orchestra – it sounds good as a standalone, but you want to have a full orchestra to have the best overall performance possible for your audience.
Let’s look at the emerging manager classification and its performance further. We would first classify two types of emerging managers, “newly formed” and “ready to market”.
Newly formed – Newly formed hedge funds – including start-ups and spin-outs – are emerging managers. Most emerging managers may have newly formed funds but they most likely have a lot of experience which got them there, usually managing capital in their area of expertise for other established managers. They have worked themselves up through the ranks – performed well and want to move forward to the logical next step in their career – having their own fund.
Ready to Market Fund – what defines ready to market?
First – a ready to market fund manager will have built a track record of 2-3 years. In addition to the length of track record and proper private placement 3(c)1 or 3(c)7 or master feeder fund structure, one important factor certainly considered by potential investors is how large the fund AUM is. There is a big difference between managing $25 million and $100 million.
Although there is not one conventional definition of an “emerging ready to market fund” when it comes to AUM – numbers such as under $100m AUM, or under $250m AUM, or even under $500m AUM have been used. In addition, some larger pensions can even consider managers under $10bn AUM to be “emerging”. It all depends on the type of investor you are trying to attract. According to eVestment and, based on historical investing patterns, announced mandates, RFPs and our direct experience, family offices generally lean towards the lower end of the AUM spectrum (under $100m) while institutions scale and lean toward the upper ends and typically will want to see a longer fund track record of at least 3 years.
As a newly formed fund, you are always marketing to grow your assets that help your fund pay for your operating costs while you serve your current investor base and develop a solid track record and business model. We are going to cover all of these points in this article.
Things you must consider as an emerging manager launch include:
A newly formed fund should take into consideration the above points as they build their track record and AUM to move toward the “Ready to Market” next step. Most newly formed funds will initially rely on “friends and family” capital along with their own capital to launch their fund and investors will want to see a portfolio manager have most of their liquid net worth invested in the fund. Investors will also want to be assured that the manager is well capitalized with at least 2-3 years of operating costs.
Ideally, if a new fund can start with assets in excess of $10-20 million this will allow them to start reasonably and trade a long/short equity or credit fund. Other more boutique strategies may require a larger minimum fund size to accurately trade and represent the strategy you as a new fund manager are trading. You must keep this in mind.
Make sure you consider the appropriate fund structure for the investor base you want to attract. Are you structuring your fund so that you can attract the right type of investors when you are at the “Ready to Market” stage? If you can, you should consider a master feeder structure from day one. This will allow you to accommodate all types of investors as you and your investor base/assets grow. This should be a meeting with your counsel where you clearly state your goals so that they can help you realize them and so you are aware of costs, etc.
Keep all of your performance analytics up to date so your potential investor base will have timely access to this data. If you cannot provide items such as attribution and exposure on a quick turnaround, potential investors will not take you seriously as a credible fund manager whose objective is to grow towards having a well-rounded institutional investor base and moving to the next level of being “Ready to Market”.
As a newly formed fund your primary investor target will be HNW/family offices. Utilize your network where you can in addition to your current investors and other prospects to make sure you are keeping them up to date on your performance/progress. There may be some smaller foundations/wealth management firms that will keep you on their radar. Establish a professional system for consistent monthly distribution of your performance information that is easily expandable and who tracks for you who is looking at those distributions so you can follow up with those prospects in a timely manner. Our firm, 5th Rock Fund Development has all of the tools to help you with this task.
Work on entering your performance and AUM data in hedge fund databases. You will get exposure by putting yourself out there. Good performance with reasonably sized small AUM will draw attention. One example of this would be eVestment. They allow emerging funds to enter and maintain their track records for free. This will also calculate “industry standard” performance analytics for you and allow you to assign a comparative performance index.
Make sure you have a complete due diligence questionnaire updated at least quarterly. Utilize formats like AIMA (Alternative Investment Manage Association) which is widely known and accepted by many investors as the gold standard in both guidance and sound practices in the alternative fund industry.
Make sure your performance is independently certified and/or audited. If you are not quite ready to bear the costs of a full audit, you can have an independent accountant prepare a summary and verify your historical performance and provide a report which will usually include return calculation methodology and other relevant information. If possible, try to utilize the GIPS (Global Investment Performance Standards) in the report as, down the road, many institutional investors will have due diligence processes require that performance be calculated in accordance with GIPS.
The goal of all of the above, is to provide guidance that will prepare your emerging fund as a “Ready to Market” fund from day one as your performance track record grows. Investors will notice and will be more likely to consider taking a deeper dive if you are able to provide them with all of the necessary information to make an informed decision. Performance is the number one factor to get you noticed, but you must have a sustainable solid infrastructure to support your fund and your business goals.