A start-up’s journey in any industry is not easy: it involves facing a series of challenges and hurdles. Those hurdles must be recognised, understood and then overcome.
As a measure of the industry, just under five hundred hedge funds manage approximately $2.8tn in assets. They contain only a little more than 10% of the industry in terms of number of firms but manage close to 90% of its assets. Much attention focuses on this club and firms close to attaining this status.
But what about the rest of the industry? Those estimated 3,000 firms, that run no more than $1billion in AUM, account for approximately $400bn AUM. In our paper, Alive & Kicking, published last year, we examined the universe of emerging managers (which we define as having AUM of up to $500m). Expanding on this work, this year’s paper looks at those firms that run no more than $1bn AUM and those that have made it into the billion-dollar club.
Through six key takeaways, this paper provides a road-map for all emerging and start-up managers seeking to build their firm to a billion-dollar business. In drawing on these takeaways, we sought feedback from both investors and managers alike.
Ultimately, what’s good for emerging managers also benefits the entire hedge fund industry. Investors value having the best choice possible; incumbent firms benefit from having their preconceptions challenged.
We hope that this paper is of use to both emerging managers who are in the process of growing their firms, but also of use to those who are considering launching a hedge fund.
Tom Kehoe CAIA, Global Head of Research, AIMA
Sean Capstick, Head of Prime Brokerage, GPP
Managing Director, Global Head of Research and Communications
Head of Prime Brokerage, GPP
‘Making it Big’ provides insights from larger managers who have blazed a trail in building a billion-dollar hedge fund business. The research examines their path to growth, providing a road map for all emerging and start-up managers as they make their way to $1bn AUM.
The work is informed by asset managers and industry allocators representing an estimated $500bn in total hedge fund AUM. Over 70% of manager respondents surveyed fall into the big six categories of investment strategies: equity long/short, global macro, fixed income credit, CTA/managed futures, event driven and multi-strategy.
We discovered that if managers aspire to be a billion-dollar business, they need to start life acting like a billion-dollar business: managers need to implement marketing and communications strategies that actually work and constantly keep the investor in mind. Being transparent, investing their own money in the fund and maintaining working capital levels are essential.
Deploy effective marketing
For emerging funds, investing in an effective marketing strategy can be seen as unnecessary until the fund is larger. Indeed, funds smaller than $100m AUM deviated most from the 11% average marketing spend of management fees. Funds managing between $100-$500m and those managing over $1bn all hire an in-house marketing specialist. Although this chicken and egg scenario can be problematic for managers, it was clear that investing in marketing is very important and this was further reiterated by the manager roundtable sessions, with firm advice to concentrate on marketing or hire a marketer early in the fund’s lifecycle.
Established funds appear to rely heavily on personal marketing and networks fundraising. Allocator responses confirmed the effectiveness of their personal networks for sourcing investments, and the importance of maintaining access to the manager during and after the investment process.
Allocators were shown to receive marketing content positively. By offering allocators transparency around the hedge fund strategy, approach to risk and correlation to the market, smaller funds could mitigate the effects of
a short track record.
Shoot for critical mass
Funds that successfully surpass $100m AUM open themselves up to a greater field of opportunities to receive capital investment, and the array of allocators who can invest in them increases. Seed funding was shown to provide an effective way of accelerating the growth of a smaller fund and allows the team to grow.
Have skin in the game
All allocator respondents demanded that the manager invest their own money in their funds. This was to offer certainty that they were investing alongside the manager, and that gains and losses would be felt by both parties.
Management fees are important, but align with your investors
The research analysed fee structures across five global regions and seven fund strategies. We found that some strategies are starting to feel the pressure, perhaps due to the emergence of an increasing variety of smart beta, risk premia style strategies with similar characteristics.
Managers and investors alike understand the importance of management fees to the day-to-day running of a fund and to cover costs. As such, they have remained relatively stable or have slightly increased for the majority of strategies.
The research suggests hedge fund managers are increasingly working to ensure that their fee arrangements are aligned to clients’ needs. Performance fees can be maintained at healthy levels by virtue of their alignment with potential investor benefits: responses revealed 80% of managers charge over 15% in performance fees.
Make every effort to underwrite your business for the immediate future
The possibility for a fund to breakeven with $86m AUM was a unique finding of last year’s Alive and Kicking research, and this overall average figure remains relatively static at $85m in the current results. New insight from funds with over $1bn AUM revealed that this number clearly grows as AUM grows: a requirement of $180m AUM to breakeven, offering useful intelligence for the future $1bn manager.
However, achieving breakeven does not happen after a defined period of time or after a critical event, as it is a moving target. Feedback from the larger, $1bn+ AUM managers who gave insights into the idiosyncrasies of their fund made salient the importance of having enough working capital to support two to three years of sub-scale AUM.
Know when to build a permanent team
Results revealed the importance of possessing particular senior in-house staff. The COO function appeared to be an inherently important role, being the least outsourced by all sizes of fund. Importantly, funds managing between $100-$500m and those managing over $1bn all hire an in-house marketing specialist.