Launching your fund on a proper platform
By Steve Bernstein, CEO, SinoPac Solutions and Services
Published: 15 December 2014
So you’ve heard the siren’s song – you’re thinking of starting a hedge fund. You’re not alone. More than 800 new funds launched globally in 2013, including 71 in Asia. Clearly, in spite of mounting regulatory barriers, the idea of launching and running one’s own fund still has a lot of appeal among investment professionals.
You’ve got the talent and experience, some capital and some prospective investors, and the commitment that the endeavor requires. Now, you face a crucial decision. Should you try and launch a fund on your own or should you sign on with an established asset management platform?
There are many compelling reasons to consider an established platform as the better path for a start-up fund. The first is economics. The costs of creating a legal entity and building out the infrastructure to support a fund – licensing, attorneys’ fees, compliance, technology, office space, staff – can add up quickly. In the general opinion of market professionals, a new hedge fund needs to raise about $50 million to break even. And trying to do things on the cheap – particularly where technology is concerned – is a recipe for disaster down the road. The market has shown to be unforgiving of funds that lack a strong operational backbone.
With an established platform, you could be up and running with as little as $5 or $10 million. A proper platform serving multiple managers should have the scale to provide all the infrastructure and middle- and back-office services that larger, more established funds are accustomed to, regardless of your size.
Economics, however, are only one factor. Even if you have plenty of investment capital to start, the platform route allows you to focus on investing, and leave the administrative tasks to experts who perform them for a living.
Think of all the master chefs who have started their own restaurants. If they become too focused on cleaning the restrooms and repairing the fixtures, the restaurant will not likely succeed. The chef needs to focus on the food, and leave the rest to others. The same can be said of fund managers. Time spent on administration and operations is time spent away from what really matters, namely identifying opportunities in the market, raising money and investing it effectively. Distractions from that focus could well be reflected in performance.
The freedom to focus on investing is what really makes the platform proposition compelling for start-up, small and medium-sized funds. Not all platforms, however, are alike – quite the contrary. They can vary widely in services and capabilities. Some firms that bill themselves as platforms have significant gaps in their offerings. Others may be no more than hedge funds looking for partners to scale their operations. That is why it is important to do your due diligence, know what to look for and what questions to ask when talking to platform providers.
The pillars of a proper platform
What constitutes a proper platform? The two most important pillars are people and technology.
Who are the people looking after your business? What is the depth of their experience? Where have they worked before? Do they know what you need, perhaps even before you do? You’re entering into an important, everyday relationship. You’ll want to work with people whose resumés and credentials inspire confidence that they know what they are doing.
It is equally important that the platform offers a strong technology infrastructure, built around state-of-the-art systems, with a high level of automation and integration to enable straight-through processing and help mitigate your operational risk. Be wary of any firm that says they have built their own in-house fund accounting or middle-office system. Homegrown systems often raise questions about support, upgrades, scalability, and integration with industry-standard technology, and may pose operational risks if these issues are not adequately addressed.
For your crucial applications – fund and investor accounting, trade order management, and clearing and settlement – look for proven, brand-name technology that is well known and widely used in the industry. The infrastructure needs to be highly scalable to accommodate escalating transaction volume and asset growth. And it needs to be able to support complex fund structures and multi-currency, multi-asset class strategies. Most importantly, the systems should be backed by global service and support organizations with deep bench strength, and kept up to date with regularly scheduled enhancements and upgrades. Moreover, they should have a roadmap to the future, in which cloud-based services and mobile accessibility are expected to become the norm.
The practical, everyday benefits of such an infrastructure are optimal efficiency, data integrity, and risk management. There is another important benefit, however, that should not be minimized: the signal you send to investors. Institutional investors now account for the majority of money flowing into alternative investment strategies. Institutions and their consultants perform rigorous, ongoing due diligence on fund managers, with operations a key focus of their inquiries. Furthermore, they are becoming increasingly tech-savvy. In order to tap into this critical source of funding, you will need to be on a platform that can stand up to the most intense scrutiny.
The importance of superior technology cannot be overemphasized – and the risks of sub-par technology should not be underestimated. Funds in the billions of dollars have been known to fail, not because of bad trades or market forces beyond their control, but because of inadequate infrastructure and poor administration.
Another important part of the technology equation is a solid disaster recovery and business continuity program. You should ask any prospective platform provider how they plan to protect your fund and investor data – meaning your business – in the event of a natural or man-made disaster.
As you review a platform provider’s service offerings, it is important to know which services are performed in-house and which are being outsourced. It’s not uncommon to have fairly narrow, standardized services farmed out to specialists. However, certain aspects of your business – risk management, for example – are too important to be taken outside. Find out how much is being outsourced and decide for yourself how that fits with your comfort level.
Beyond that, what is the provider willing and able to do to help you launch successfully and stay afloat? Do they provide capital introduction services? Do they have connections with qualified and engaged investors? Will they go so far as to help you prepare your pitchbooks and presentations? Those kinds of questions should be on your checklist. Anything less falls short of “full service”.
Now, if the platform proposition is so appealing, why isn’t everybody doing it? Some managers may feel they are giving up a measure of independence – even though they are branding the fund, setting the strategy, raising the money and making the decisions. Considering the cost advantages for a small or medium-sized fund, it seems a small price to pay.
A more legitimate concern is that some platforms make it difficult to leave. Nobody starts small with the intention of staying small. What happens when you reach a threshold where your fund is sufficiently profitable to cover much of your overhead? You should know the answer going in. Ask any prospective provider what their off-boarding practices and policies are. Make sure you can still have access to fund administration services without having to give up a cut of your management or performance fees. The right provider should be willing to work with you when it makes sense to break or at least loosen the ties.
The proper platform, one that handles not only your fund administration but also your business administration, should ultimately give you a better chance of gaining traction and attracting capital. It allows you the time you need to travel and meet investors. It provides the technology infrastructure with the risk controls that investors expect. And it provides a level of support that allows you to focus on analyzing opportunities and making decisions – the very reasons you decided to launch a fund in the first place.