The phrase, “Penny wise and pound foolish” immediately came to mind as I began my outline for this piece. When I researched its origins I discovered it wasn’t attributed to Benjamin Franklin as many people assume, but to the Oxford scholar and mathematician, Robert Burton whose 900-page tome The Anatomy of Melancholies was first published in 1621 (yes, 401 years ago). Burton apparently threw himself into this work as a form of therapy to manage his own chronic depression. So what does “penny wise and pound foolish” have to do with launching a hedge fund? I believe a lot.
So you’re getting closer to the official launch of your fund… good for you! In the grand scheme of things, the barriers to entry for launching a new hedge fund are relatively low but that doesn’t mean it’s easy. After months of interviewing you’ve now lined up service providers, your offering documents are finalized and you’ve been talking to countless numbers of investors, some of whom have committed to coming in for Day 1. Of course you and your team have been staying on top of the market and are chomping at the bit to actually start investing. It’s mid-month – what’s the harm of jumping in right now??
Before you take that last big leap, consider taking a deep breath instead and review this checklist. Your legal team and/or CFO should have brought most of these points to your attention, but as a long-time marketer I’m surprised how often I see the same miss-steps by new fund managers. And that’s why “Penny wise pound foolish” comes to mind, at least for a couple of these.
- Establishing a Master-feeder with a 3c7 fund on Day 1 is worth every one of your pennies. Maybe you’ve got just a handful of investors and limited AUM so it’s easy to rationalize just launching a 3c1 fund… the reality is you need to be thinking LONGER term. It’s worth every penny (and let’s be realistic, I really mean dollars) to get that 3c7 fund launched on Day 1 alongside your 3c1 fund (even if it’s just your own money.) This is key because a 3c7 fund’s Day 1 track record can be more broadly shared/marketed to a wider investor base down the road. A 3c1 track record alone ultimately limits your distribution abilities.
- Spend the money hiring established service providers with name recognition. Name brands go a long way in establishing your own reputation and ability to run a business. It also signals that you have your investors’ best interests at heart. And perhaps you are just too small to go with some of the “big guns” right out of the starting gate, that’s okay, just make sure your service provider choices are well thought out and thoroughly due diligenced. Investors are cognizant that there are “best in class” providers for all sizes of manager.
- Your Personal Account does not a track record make. Sorry to burst your bubble, but you’re going to need an audited track record if you’re serious about attracting institutional investors. This is why launching a 3c7 fund can make all the difference in the world. A 3c7 structure allows you to include your previous track record in your marketing materials. This assumes two things: (1) the strategy is substantially similar to what you are currently managing and (2) if it is a carve-out from a prior firm you have been granted permission. Make sure you have consulted with your own legal counsel and compliance team before including this information.
- Think long and hard before you fill your marketing materials with adjectives you can’t justify. As a manager you currently have more leeway than outside marketers with what you can include in your marketing materials, but the SEC’s rules continue to evolve so be careful with your choice of words. Is your long/short strategy really “unique”? Are you absolutely “the best”? Is your research process or portfolio construction truly “proprietary”?
- Your Tearsheet speaks volumes in communicating your fund’s strategy, absolute/relative performance, and terms – consistency of message is key. Make sure you are using industry standard benchmarks that realistically measure your fund’s performance, NOT generalized benchmarks that make your fund “look good”. Your performance should always be shown on a net basis and your terms should be reasonable and relative given your fund’s strategy and its liquidity. And footnotes… don’t think you can massage your data with a “the devil is in the detail” series of footnotes – FYI, investors really read them!
- And with regard to the previous two points – please note the SEC’s November 4, 2022 deadline to be in compliance with the Investment Adviser marketing rule. To further complicate your already complicated hedge fund business, be aware that the SEC has imposed a deadline of November 4, 2022 to be in full compliance with amendments under the Investment Advisers Act of 1940 that update rules governing investment adviser marketing. The amendments create a single rule that replaces the current advertising and cash solicitation rules, Rule 206(4)-1 and Rule 206(4)-3.
- Day 1 tracking of monthly data saves time down the road. Maybe you don’t have any institutional investors… yet. Your hands are already full juggling the current demands of the fund, but wait, the operative word in the last sentence is “yet”. When you do get the attention of institutional investors you can expect a thorough scrubbing of your data. Take the time to track your portfolio’s key data points from Day 1. This includes exposures, attribution, sector allocation, market capitalization data, etc. It is time well spent and will save precious hours in the future. And for you systematic traders out there, save yourself future aggravation by tracking your DAILY data. It WILL be requested. Who knows, you might learn something new about your portfolio.
- An Advisory Board can be a positive attribute IF the individuals are providing real value-add to the fund. But if your Advisory Board is just fluff whose sole purpose is to build out an infrastructure chart, don’t bother, investors’ ability to see through smoke and mirrors has been honed through years of experience.
- Jumping the gun and launching mid-month – Go ahead if you really want to, or need to, just know there will always be a footnote attached to that first data point of performance reflecting that your chosen benchmarks and your partial month fund performance cannot be accurately compared.
The points we have shared come from years of marketing experience. I think it is safe to say that the earlier they are taken to heart the less chance you’ll find yourself reading The Anatomy of Melancholies or worse yet, writing its next edition!
