Raising capital is an essential first step to launching a hedge fund. But what sort of track record is required and where should you look to attract capital? Find out below as we describe the challenges – and the potential solutions – that characterise this process.
Launching a hedge fund is more challenging than starting an enterprise in many other sectors, simply due to the initial costs involved, the need for a track record that will attract investors, and the regulatory hurdles, which will vary from one geographic market to another. Indeed, according to Hedgeweek, raising investor assets remains the biggest challenge facing hedge fund managers. The organisation points to data showing that 82% of emerging managers cite securing investments as their top hurdle, while 62% of established hedge funds share this
‘primary pain point’.1
Even before drawing up a business plan, it is important to understand the experience required to gain the interest of investors. According to an IG Prime survey of 507 leading UK hedge fund managers, published in our report on Raising Capital for New Hedge Funds, investors often decide on whether to invest capital based on the skill of a hedge fund manager behind a new fund and the years they have spent working on an existing fund.
In your experience, how many years should you be working in an existing fund before launching your own ?
The report also found that 41% of the hedge fund managers surveyed believe new managers should have returns of between 2.0% and 2.99% from work with previous funds. Investors often compare a manager’s history of returns to that of a competing manager who has used the same investment strategy, to see how they measure up.2 A hedge fund manager’s track record also goes a long way towards building investors’ confidence in their abilities and showing that the investment strategies they’ve used in the past have been successful.
The next step, if you think you have the requisite experience and return record, is to recruit a credible team of experienced professionals. Key staffing functions will include legal and compliance, investor relations, technology, and fundraising. The last of these will include responsibility for generating strategies to raise capital. Fundraising staff should have established relationships and expertise in institutional dynamics.
When selecting investors, the main choice will be between High Net Worth Individuals (HNWIs) and institutions, such as pension funds. The particular characteristics and requirements of institutional investors can make it more difficult to raise capital from them than from HNWIs. For example, pension funds have long-term horizons, require stable returns and may demand that investments align with their Environmental, Social and Governance (ESG) objectives. Hedgeweek argues that family offices might provide a more flexible source of institutional capital than pension funds, given the former’s greater inclination to take on some portfolio risk.3
There are various ways of attracting the attention of potential investors. Prime brokers, for example, act as the middlemen between hedge funds and two key counterparties: commercial banks (which may also be prime brokers) with the cash to provide loans for margin purposes, and institutional investors (such as pension funds) with large equity holdings that can be lent to hedge funds for the purpose of short-selling. Prime brokerages also host small group seminars where it is possible to meet potential investors.
IG Prime’s report on Raising Capital for New Hedge Funds also points out that using LinkedIn is a popular marketing strategy adopted by hedge fund managers. The advantages of the platform include that it offers hyper-specific targeting opportunities such as focusing on individuals by job title, place of work and location. Fund databases and websites are other popular options.
Hedgeweek says that personal connections – friends, family members, close business colleagues and similar ties – often provide an initial investor base. It adds that gaining early capital commitments from those in proximity or relationship circles provides credibility, which is helpful when seeking investments from institutions.
In IG Prime’s survey, hedge fund managers listed communication and presentation skills as their preferred way to sell themselves to potential investors. However, Dan Sondhelm, CEO of Sondhelm Partners, told Hedgeweek that ‘too often, funds fail to clearly convey their unique selling points and differentiators in a compelling way’.
Sondheim said that managers should specify how they achieve outperformance through truly distinguished philosophy, proprietary models, niche exposures, defensive posturing, etc., and that they should:
‘Be explicit in addressing how you augment or diversify an overall portfolio, whether through maximum upside capture potential, Sharpe ratios, mitigating drawdowns and volatility in stress periods, or providing continuity of returns through various market cycles.’ 4
In conclusion, managers need to deliver a compelling pitch that aligns with institutions’ preferences for steady returns and robust risk management. That, along with a consistent record of returns, an experienced team, and institutional-grade infrastructure, can help emerging managers meet this challenge.
Sources
1 https://www.hedgeweek.com/navigating-the-hurdles-of-raising-capital-for-hedge-funds/
2 https://www.investopedia.com/articles/investing/040915/how-start-hedge-fund-uk.asp
3 https://www.hedgeweek.com/navigating-the-hurdles-of-raising-capital-for-hedge-funds/
4 https://www.hedgeweek.com/navigating-the-hurdles-of-raising-capital-for-hedge-funds/
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