Capital is the life blood of any business. If one reads many of the headlines in the hedge fund industry tout sheets, one could get the impression that there is an abundance of capital out there looking for the right hedge fund home. It is true that many pension funds, sovereign wealth funds and insurance companies are looking to increase their exposure to the alternative funds market. AUM for hedge funds rose to almost $4 trillion by the end of 2020. However, the lion share of these assets is managed by the largest managers.
While many allocators know that the best returns usually come from the smaller, emerging funds, most institutional investors are prohibited from investing with managers who have AUM below a certain minimum. So how can emerging funds raise capital?
Most start-ups will begin with friends and family capital. The most important thing is to start the fund with enough capital to generate a meaningful track record that can attract investors outside this limited circle. The sad fact is that three quarters of all start-ups will exhaust their network of friends and family within a year of launch. Due to limited financial and personnel resources, most managers are hard put to make the effort to market themselves. One solution exists in the choice of a prime broker.
Large, bank-backed prime brokers play a role in introducing managers to sources of capital. However, the big bulge-bracket primes will do very little for managers with less than $100 million in AUM. A market has developed for boutique primes who will work with managers with good track records and AUM of $10-25 million. This is forcing many managers to rethink their choice of service providers.
Many emerging managers will choose a broker that is more retail oriented because of a perceived lower commission rate or because they are used to a certain platform. The fact is, commission rates have come down so much that any miniscule difference between one firm and the next will not have a meaningful effect on manager performance, even for more active traders. The important thing to remember is to right-size yourself with all your service providers, from prime broker to fund administrator. The right provider will be worth far more to a manager in the long run for what they can bring to the table, even if they are not the “low cost” provider.
Some of the other important things managers must focus on to raise capital are:
- Communicate with your current roster of investors. Your quarterly partner letters can be your most effective marketing tool. Explain your thinking behind your largest positions, take credit for your good decisions but own your bad ones as well. Remember, the Baseball Hall of Fame is full of .300 hitters who make outs 7 out of 10 times. A portfolio manager has to have a much better batting average than .300, but don’t ignore your missteps. You won’t fool anyone by ignoring things that don’t work out as planned.
- Actively try and expand your network. Remember that your current investors have friends and family also. Do not be afraid to encourage your investors to talk to their contacts about you. Use social platforms like LinkedIn to build your brand. The old prohibition against advertising has been effectively lifted by the SEC, so use your website to let people know who you are.
- Have confidence in yourself and your process. While many hedge fund managers can be considered “type A” personalities there is often a reluctance to sell oneself. You cannot expect investors to believe in you if you do not believe in yourself.
- Have a sound and reliable infrastructure. Partner with the best service providers for your needs. All service providers will say they want to be your partner. Make sure they can walk the walk as well as they talk the talk.
- Understand that marketing is a full-time job. Set aside some time each day developing your strategy or implementing it.
When trying to raise capital, do not expect that a “one size fits all” policy will work. Be creative with your fee structure, especially for large potential investors. Many managers may hesitate to offer a significant piece of the general partner to a potential seed investor. Remember, 50% of a big number beats 100% of a small one every time.