Since the financial crisis of 2008-09, the environment for start-up fund managers has become increasingly difficult, and a perception has been generated that the barriers to entry are high. Many traders and analysts who might have considered taking the plunge, have shied away from the prospect of managing their own investment businesses.
Conventional wisdom now holds that a manager should be able to bring a documented three year track record and over US$ 100 million in commitments to the table before he will be seriously considered by service providers, let alone investors.
So, for starters, let us address a few of those myths.
1. "Investors will not look at start up funds!"
Wrong. From many conversations with investors over the last three years, I can categorically say that investors will look at early stage managers. This includes even the biggest of the sovereign wealth managers. There may be more strings attached to their participation, especially if they are taking on the sometimes considerable risk of being a large shareholder in an illiquid fund. But then they deserve to drive a harder bargain than they might with a billion dollar fund manager.I have regularly had conversations with investors who are seeking funds with imaginative strategies, funds that do something different. The asset class might still be highly vanilla, like index derivatives or US equities, but if the approach is something they have not seen before, and if they can see the diversification benefits of the strategy, then you have a case.
In addition, there are specialist firms of consultants who can help smaller managers raise money from capital pools, particularly from the private wealth industry and family offices. These advisers have established networks of relationships with smaller investors, and can facilitate the early stage growth of funds. They will also be able to 'kick the tires' on a new investment strategy, and provide valuable feedback on whether a particular fund will generate interest. Such advisers can be of great help in building a fund up from early stage to $100 million, at which point it is possible to generate more institutional interest.
2. "The increased regulatory burden placed on hedge funds is a barrier to entry!"
The world has changed considerably since 2008, especially for alternative fund managers. Whether the blame for the financial crisis was properly allocated is now a historical debating point. Managers launching funds in today's climate have frequently complained about the burden regulatory challenges represent, and the enormous costs their businesses now face.Yes, regulation is more demanding than it used to be, but smaller fund managers are often being led into advisory relationships that are not suited for businesses of their scale. Many regulations are targeted at large scale or retail funds, designed to protect consumers or to protect the financial system itself. Exceptions are made for smaller funds and for those at a growth stage. In addition, pre-authorised platforms and solutions exist that can help funds receive fast track regulatory approval for distribution.
From an advisory perspective, early stage fund managers do not need to appoint blue chip compliance and legal advice: there are a variety of cost-effective alternatives available, if time is taken to shop around. If I were representing, say, a large scale launch of $500 million, I would appoint different service providers than a start up with $10 million. Investment managers are not always told this, and can be shocked at the bill attached to such advice.
3. "You have to have worked at a Wall Street investment bank to be seriously considered!"
Traditionally, many hedge fund managers had established track records either with Wall Street firms or with blue chip fund investment management outfits. Many started out as analysts, migrated to the status of portfolio managers, and finally started their own businesses. This was the traditional, well-beaten path to becoming a hedge fund super star.We are now seeing probably the last generation of banking prop traders exiting Wall Street banks to start funds. The Dodd Frank Act in the US has heavily curtailed the trading activity banks can carry out for their own profit. Lack of big bonuses, and restrictions on how those bonuses are paid (i.e. NOT in cash), has meant many successful traders have left to start their own funds or join hedge funds.
However, further to my point above, investors remain interested in something different, something with serious diversification benefits or evidence of consistent alpha-generative qualities. In a 20 year career in the funds industry, I've seen some highly imaginative investment strategies. Not all of these were successful, but many were managed by individuals from less than conventional backgrounds, and frequently with expertise earned in another industry, including academia. It is also obvious that there are other entities than banks that manage investments - look at the trading desks of big energy companies, for example. Just because you don't have Goldman Sachs on your CV does not mean you cannot be a successful investment manager.
4. "Service providers are too expensive!"
Service providers will look too expensive if you are a start up manager seeking to launch with blue chip advisors. To quote one prime broker I know, they are "reassuringly expensive." The key to success in your first 18 months is making sure your budget and running costs are not swallowed by this. It means using providers who can support you at the start up stage, and who recognise the operational challenges faced by early stage managers. We are in an environment now where many service providers are not averse to firing clients after a year or so, if they are not gathering assets fast enough. Don't let it be you.The key to success here is doing your homework, or using an advisor who has the right relationships and connections within the industry to fit your business to the service providers that are right for you. I will explore this theme further in a future post, but suffice to say, the initial operational framework you adopt for your fund is critical to its early stage success. Appointing the best may not necessarily be the way forward, as you could cripple yourself with fees before your fund has had a chance to blossom.
If you have are already trading or managing money in small quantities and considering a third party fund launch, do get in touch - stuart@hawksmoorpartners.com
