In the News – Are There Any Investors Left?

The International Herald Tribune recently reported:

“The gilded age of hedge funds is losing its luster. The funds, pools of fast money that defined the era of Wall Street hyper-wealth, are in the throes of an unprecedented shakeout.”

Even in the good times, raising capital was the most difficult part for most emerging managers. So is it possible for the emerging manager to succeed today? We interview 3 experts in the emerging manager space to find out:

Is the hedge fund industry over?

JD – It’s certainly not in its demise. Every industry goes through cycles, with a washing out of excess capacity and poor managers. However, our industry is relatively new that this is our first experience of it. Any increased regulatory transparency and oversight could undermine the pace of any recovery.

RW – During this crisis, every day that traditional capital sources remain dry, private corporations begin to adapt to seeking from alternative sources. When the economy does recover, hedge funds will be there first, and will profit the most.

JM – We are hearing a lot about the funds that are down right now but approx 25% of funds are posting positive performance. We need to remember that Paul Tudor Jones made $100m during the 1987 crash, and Citadel was born in 1991 during the last recession. There will be similar stories this time around and we will undoubtedly see a new class of superstars emerge.

FM – We are seeing a pause for breath whilst the industry rethinks how it will manage risk. As the permitted risk profiles for institutional proprietary trading desks change, we will see individuals leaving and setting up new funds using their own seed capital.

Is it still possible for new emerging managers to launch or raise capital?

JD – There has been a circling of wagons for traditional seed investors with the general consensus being that no allocations will be made for the remainder of 2008. However, there is a great deal of money sitting on the sidelines to be redeployed. When this happens, new launches and emerging managers will benefit.

RW – Seed capital is currently in high demand, with literally hundreds of investment groups looking right now, and only three or four handfuls will receive it.

JM – I don’t think much is going to happen before the end of this year; there is just too much risk out there to put any money to work. But it will recover in time and when it does, those managers that kept their heads and didn’t panic will reap the rewards.

FM – There is a lot of uncertainty at the moment with the Presidential election, changes in industry regulations, and possible legal action against CEO’s. Capital will sit on the sidelines until some of these areas have been clarified.

What are the best sources of new capital to target?

JD – Institutions have become far friendlier to emerging managers, with an increasing number committing capital to the space and using consultants to establish their platforms.

RW – A seed investor is a vote of confidence by an outside firm. However, money at all costs should be avoided. Ensure that you aren’t tied down by stringent terms that impact your investment process.

JM – Managers should be wide open to accepting all potential sources of new capital. Take capital from anywhere you can get it, be it friends and family, endowments, fund of funds, etc. This is not the time to be selective and automatically assume money is hot.

FM – Fund of funds, large family offices, and offshore institutions all have money sitting on the sidelines and will all be looking to allocate, but not until next year.

What is the most important thing for a manager to focus on?

JD – Whilst clearly important, performance is not the only variable of the equation. Focus also needs to be paid to qualitative aspects such as: a well rounded business model, quality service providers, front and middle office support, and going multi-prime as a business objective.

RW – You should aim to build a deeply experienced team, understandable and repeatable investment process, solid returns, good portfolio risk controls, and a sound business behind all of this.

JM – Risk management, risk management, risk management. How are you going to control what you do and how you do it? Even in future years, investors will focus on how managers handled the events of Q4 of 2008 as a basis on which to assess and make allocation decisions.

FM – Transparency will be critical going forward. Managers must be able to communicate a clear strategy with their client base, and investors will want to understand that strategy. We will likely see a new era of single strategy focused funds.

What are the easiest strategies to sell to investors?

JD – The temporary regulatory changes i.e. short selling rule has made some strategies, such as long/short, a hard sell. However, there is still interest in commodities and managed futures, multi-strategy, global macro and private equity.

RW – Strategies with a distinct information advantage, which is easy to understand, and have not lost more than 3% in 2008, are still in demand.

JM – Some strategies may have had their day, such as credit and quants. However, any asset based lending, CTA’s on the short side, and some directional strategies still appear interesting to investors.

FM – The best strategies will depend on the market. If we continue to see significant volatility, then the smaller nimble managers who actively trade will likely benefit. It is hard to see how very large funds can effectively deploy their capital in these markets.

Any other advice?

JD – Don’t rely too much on producing performance, and spend time marketing. If you produce the numbers, the investors won’t just come knocking on your door. Develop an in-house marketing model and combine with professional marketers and capital raisers. Don’t put all of your eggs in one basket!

RW – Keep faith in your business, there are still many hedge funds in positive territory right now.

JM – Be passionate, stay the course, and ensure that you have good risk management procedures. If you can show that you are uncorrelated to all of the other managers who are currently losing big, then this will form the building blocks for future capital raising when normality returns.

FM – Ensure that you have a detailed strategy and can explain how it will work. Ensure that your infrastructure is sound, with appropriate trading systems, operational staff, and service providers such as prime brokers and fund administrators.

Jacques P. DeRouen (JD), is a Founder and Managing Director of Pinnacle Alternative Investments LLC which provides business strategy and marketing consultant services to emerging managers.

Richard Wilson (RW) is an independent consultant to the industry, founder of Hedge Fund Group, and Editor of www.hedgefundblogger.com .

John McGowan (JM) is a Managing Director of Alternative Asset Investment Management LLC which provides capital introduction services to emerging managers.

Frank Magnani (FM) is a Managing Director of SIP Online which provides trading and operational services to single and multi-primed hedge funds.