Survey points to lack of investor interest in start-ups
A number of institutional investors acknowledged they have not invested in start-up or emerging hedge funds despite stating they would consider allocating into such firms.
A survey by Bougeville Consulting in conjunction with Global Prime Partners (GPP), a London-based boutique prime broker focused on emerging managers, said just 25% of investors had actually allocated into a smaller hedge fund, despite 70% telling the same survey last year they would be interested in providing capital to these managers.
Stringent concentration limits at investors, particularly wealth managers, appears to be the main factor behind this aversion to allocate to smaller firms, said the study. Fifteen per-cent of respondents said they had self-imposed concentration limits whereby they were loath to represent more than 10% or 20% of a fund’s total Assets under Management (AuM).
“Despite these somewhat disappointing numbers, we are finding that the investors that do invest in emerging hedge fund managers do provide the stickiest capital and are generally committed to the long-term successes of their investments,” said Marianne Scordel, founder of Bougeville Consulting in London and the study’s author.
A number of portfolio managers have, however, raised doubts as to whether they can run their businesses effectively – something which can diminish their ability to raise meaningful capital, the study added “One of the most important issues for investors is that portfolio managers who were managing money in-house also have to run a business when they start on their own. I strongly advise emerging managers appoint a quality operations team, which might cost a bit of money initially, but will pay off dividends down the line,” she added.
Nonetheless, early-stage allocators can be tough on hedge fund fees, which can stymie the ability of managers to invest in decent systems, staff and infrastructure. “Getting the balance right is very difficult for these managers. But a lot of the investors negotiating on fees are the ones writing the larger tickets as opposed to smaller allocations,” she said.
Fees overall have declined albeit marginally despite several years of underperformance. According to Goldman Sachs’ prime brokerage survey, a typical manager will charge a 1.65% management fee and an 18.3% performance fee. A J.P. Morgan Capital Introductions Group study revealed 70% of institutional investors expected fees to decline further this year, compared with 47% in 2012. However, a majority of investors, said the Goldman Sachs’ survey, still paid full or non-negotiated fees to their managers.
Hedge fund managers emerging from investment bank proprietary trading desks courtesy of the Volcker Rule have also faced a number of operational and business challenges, said the Bougeville/GPP study. Several high-profile spin outs have either shuttered as a number of star prop traders struggled to replicate their successes at investment banks within a hedge fund environment.
Another factor hindering these former prop traders from developing their hedge fund credentials is attributable to the reluctance of investment banks to provide investors with audited track records of their performance. “This historically has been an issue but is getting less so. The problem for managers is that when investors view these track records, they are unsure as to whether it is the individual trader or team generating those returns,” said Kevin LoPrimo, head of hedge fund services and equity finance at GPP.
The Bougeville/GPP survey also said investors were thoroughly reviewing the quality of managers’ service providers, although LoPrimo said they were not biased in favour of bulge-bracket or investment bank-backed fund administrators and prime brokers. “It is the quality of the service provider that is central not whether it has investment bank backing,” he said.
Regulatory compliance was top of investors’ agenda, the study added, but this should not come as a surprise given the plethora of global regulations that have come into effect or are due to be implemented. An area of particular concern surrounded the on-going confusion about what constitutes reverse solicitation under the Alternative Investment Fund Managers Directive (AIFMD) – interpretations of which seem to vary across the 28 EU member states.
The deluge of rules has also made investors more amenable to regulatory compliance outsourcing, the study continued. “In fact, some investors prefer the regulatory compliance work to be outsourced to a specialist provider as it can save on overheads and usually those providers will be better resourced. There are a number of boutique regulatory compliance providers out there which can handle this work,” highlighted Scordel.
Hedge fund documentation at emerging managers too was an area of concern with investors telling Bougeville Consulting and GPP that poorly drafted fact-sheets were a big issue. Corporate governance was touched upon in the study with half of respondents stating it was important to them. “I believe a lot of investors would like some sort of a global standard on corporate governance and such a blueprint would certainly help managers and investors alike,” said Scordel.