By Donald A. Steinbrugge, CFA, Managing Partner Agecroft Partners
Many small to mid-sized hedge funds become frustrated because their firm’s assets under management are not growing and they believe the market is biased against them based on their asset size. They are constantly hearing that a majority of assets are flowing to the largest hedge funds despite evidence that shows smaller hedge funds have significantly out performed larger funds over time. Frequently they hear that once they get to a certain asset size, it will be much easier to raise assets. However, that is not necessarily true. Agecroft Partners believes that momentum in asset growth is more important to being successful in raising hedge fund assets for small and medium sized hedge funds than the current asset size of the organization.
The reason for this is that most hedge fund investors put much more weight on what happens to a hedge fund after the initial meeting than on the historical track record. For example, the performance generated by the hedge fund in the 12 months after the initial meeting is of equal importance to an investor as the previous ten year historical track record.
After an initial meeting with a hedge fund, an investor continues their due diligence process by monitoring how the hedge fund does. This typically takes at least six months to several years, although the process can be truncated if the investor initiated the first meeting. During this period the investors will read the monthly/quarterly letters, follow performance, and also keep track of trends in assets under management.
If a firm is not growing despite a continued strong track record, investors will be reluctant to invest because they believe there must be a reason why other investors are not investing in the fund. As a result of this phenomenon, success in asset raising is much more likely for a fund that has grown from $100 million to $300 million over the past year than a $1 billion hedge funds that has had no asset growth. In addition, raising assets for hedge funds is not a linear process, but is exponential as more and more investors make investments.
Three Components Necessary To Raise Capital
This brings us to the question: Why are so many hedge funds having difficultly gaining momentum in their asset raising activities and what can be done to enhance their capabilities? With ten thousand competitors in the hedge fund industry, in order to be successful in raising assets, hedge funds need to have a high quality product offering, be able to articulate the differential advantages of their product offering across each of the evaluation factors investors use to select hedge funds, and have a high quality sales strategy. A weakness in any of these three components can cause assets to stagnate or decline.
Let’s start by assuming a hedge fund has a high quality fund offering and a strong marketing message. These are very big assumptions because most hedge funds do a poor job of articulating their differential advantages. The number one mistake most high quality small to mid-sized hedge funds make is not dedicating enough resources to their sales effort to create asset growth momentum. Many hedge funds either have only one full time sales person or sales is handled on a part time basis by the portfolio manager, COO or president of the firm. It is very difficult for one person to effectively penetrate the market because a successful sales strategy requires a large volume of qualified, high quality meetings, along with a tailored follow up strategy for each prospect based on their needs.
A large number of qualified, high quality meetings are important for two reasons. The first reason is to create a “market buzz” or to strengthen a firms brand in the market place. In reality, the hedge fund community is very small where many of the large hedge fund investors frequently share hedge fund ideas among themselves. It gives an investor comfort when they hear the same hedge fund idea mentioned from multiple sources. This also creates reverse inquiry where the close rate is much higher. The second reason is that raising assets is highly correlated to the number of qualified, high quality meetings a firm does. It typically requires contacting five to ten investors for each qualified, high quality meeting and the close ratios on these tends to be 5% to 10% over time. In order to get momentum in the market place, a hedge fund needs to be meeting with well over 200 different investors per year not including conferences and cap-intro events.
The ideal structure of a successful sales strategy is to isolate the portfolio manager as much as possible from the sales process by employing a “product specialist’ who is highly technical, well versed in describing the process, able to go into detail about the portfolio and has the ability to answer a vast majority of questions from the potential investor. This person needs to act and sound like a portfolio manager, not a sales person. This allows the portfolio manager to focus most of his/her time on the portfolio, and to only get involved at later stages of the sales process. A product specialist should work closely with a sales team or a third party marketing firm, who has relationships with a broad set of investors with whom they would arrange qualified, high quality meetings, travel with the product specialist, and implement the appropriate follow up strategy for each prospect.
In summary, there are many variables which impact a hedge fund’s success in raising assets. The purpose of this article is to isolate these variables in order to highlight the often over looked concept of asset growth momentum. You can learn more about what is important to effectively grow a hedge fund firm by joining Agecroft Partners and other industry experts at Hedgeopolis New York on November 4th, 2013.