Hedge Fund Third Party Marketing Industry is Seeing Strong Growth in Demand

Donald A. Steinbrugge, Managing Member of Agecroft Partners, LLC has written what I consider to be an excellent piece on Third Party Marketing and the state of this industry.  Please see article and link to the source on HedgeCo.Net below:

New York (HedgeCo.net) – After a tumultuous three years the hedge fund Third Party Marketing (TPM) industry is seeing very strong growth in demand from both hedge funds and investors, although this growth is not shared evenly across the estimated 500 firms in the industry due to a wide difference in the quality and reputation of TPM firms. Addressed below are reasons for the increase in demand for TPMs, the benefits of the top TPMs to investors and hedge fund managers, what has transpired in the TPM industry over the past three years and the quality difference among TPM firms in the industry.
Why the Recent Increase in Demand
The third party marketing industry is seeing strong growth in demand from hedge funds because most net flows into the hedge fund business have been concentrated in a small percentage of firms with the strongest brands. From the 4th quarter of 2008 through 2010, the definition of strongest brand meant the largest hedge funds with assets greater than $5 billion, where performance was a secondary consideration. Beginning in 2011, a small percentage of small and mid-sized hedge funds were able to break away from the crowd by building strong brands, which led them to successfully compete with their larger peers. A high quality product offering and strong historical returns are not enough for smaller mangers to attract capital. They also need to effectively communicate what their differential advantages are in order for investors to have a positive perception of the fund. In addition, they need an effective sales and marketing strategy. This is a great environment for TPMs, because there are a significant number of high quality funds that are having difficulty raising assets. Many of these managers are looking for marketing help because they realize that high-quality marketing is a critical element of a hedge fund’s long term survival.
From the standpoint of investors, the number of hedge funds has grown substantially over the years, to the extent that some investors are contacted by hundreds of managers a week. The top third party marketing firms act as a filter for high quality managers and make it easier for investors to evaluate the managers. In addition, many high quality firms are difficult to find since they do not show up in hedge fund databases.
Benefits the Top TPMs Provide to Investors
TPM services are complimentary to investors: fees are not typically paid by the investor or by the fund. They are paid by the hedge fund organization.
Screening of the hedge fund manager universe. With an estimated eight thousand hedge funds and an opaque market, it can be difficult to identify the highest quality hedge funds. The best TPMs spend significant time analyzing hedge fund databases, trade journals, and leveraging various industry relationships to identify a broad universe of managers. This universe is then narrowed down by utilizing both quantitative and qualitative screens. TPM firms then perform extensive due diligence on the top funds before making the decision to represent a hedge fund. In some cases, TPMs represent less than 1% of the firms on which they perform due diligence. If one of the firms they are representing becomes less marketable for any reason, they have the option to stop representing that organization. In-house marketers do not have this option; they need to either continue to sell the fund or find another job.

Easier to evaluate mangers. Investors don’t like wasting time with managers that are unable to effectively communicate what they do. A good TPM will help its manager consistently deliver a concise and linear marketing message that identifies the differential advantages across each of the evaluation factors investors used to select hedge funds.

TPMs can offer consulting advice relative to what strategies they think will outperform given current valuation levels and the economic environment, identify trends they are seeing among similar investors, and pinpoint where the money is going. TPMs are in a unique position since they are both doing research on hedge funds across a broad range of strategies and speaking with thousands of investors about how their assets are allocated and what strategies they currently prioritize.
TPMs are required to be licensed and regulated by the Financial Industry Regulatory Authority (FINRA). These firms are heavily regulated and are required to undergo periodic reviews by the regulatory bodies for compliance. Not all hedge funds are regulated, and their internal sales people in many cases are not licensed. As it now stands, third-party marketers face a much higher degree of regulatory scrutiny than hedge funds that have not registered with the SEC.
Benefits the Top 3PMs Provide to Hedge Fund Managers
A. Immediate enhancement of brand. Some of the top TPMs can add instant credibility to a hedge fund when they take them on as a client. This is achieved when investors have consistently been shown high quality funds by the TPM, which causes them to have a high regard for their hedge fund research process. This is similar to the credibility received by a new fund when launched by an existing high-quality hedge fund.
B. Consulting advice – This includes analyzing the fund offering based on the evaluation factors that investors use to select hedge funds and offering advice to improve any weaknesses. Strong TPMs are able to review all marketing materials and oral presentations to assure a consistently delivered, concise and linear marketing message that identifies the differential advantages across each of the evaluation factors investors use to select hedge funds. Finally, TPMs can provide marketing and sales consulting advice that identifies which type of investors the fund should be focused on, which conferences they should attend, and as a result of the new JOBS act, whether or not they should develop a publicity or advertising strategy.
C. Access to investors – Most of the major TPM firms have a large rolodex of investors and often have very strong professional relationships. Due to the multiple strategies they represent, TPM firms have the ability to meet with investors much more frequently than internal hedge fund marketers. This gives the TPM the ability to significantly increase the number of high quality meetings for a hedge fund manager and allows for better feedback and follow up from those investors.
D. Economics – Building out an internal sales force with top-quality talent can cost several million dollars, and the compensation associated with this effort remains in place regardless of how effectively assets are raised. TPMs typically are only compensated if they raise assets. If these assets are from investors the hedge fund would not have acquired on their own, then there is no cost to the hedge fund because they are receiving a majority of the fee income they would not normally have received. In addition, if the TPM can bring in assets 6 months earlier than the hedge fund would have on their own, than the increase in fee income is often enough to offset the TPM’s fee.
E. Increased probability of success – Raising assets in the hedge fund industry is not a linear process, but exponential. Part of the reason for this is that investors do not like investing in funds that are not growing. Asset-raising success gives other investors confidence to make an investment.
What Transpired Over the Past 3 Years?
Before 2008 the third party marketing industry flourished and helped many emerging managers to become some of the largest hedge funds in the industry today. This was a period of rapid expansion for the industry when it was relatively easy to raise assets for a fund and asset flows were diversified over a large number of hedge funds. It was also during this time, due to low barriers to entry, that the number of third party marketing firms expanded significantly and attracted some unprofessional and unethical individuals to the industry. This had a negative impact on some investors’ perception of third party marketers, similar to the general public’s perception of the hedge fund industry, due to a few bad apples.
From 2008 to 2011 the TPM industry was devastated for three primary reasons. To quote Thomas Paine, “these are the times that try men’s souls.” First, TPM fee revenue and asset base declined along with the rest of the hedge fund industry. Second, from the 4th quarter of 2008 through 2010, hedge fund net flows dropped off an estimated 95% from their peak and only slowly improved over this time period. The environment was even worse for hedge funds with less than $5 billion in AUM, which were a majority of the hedge funds that TPMs represent.
The final issue had to do with the public pension fund scandal led by the New York State Common Fund that was plagued with internal corruption. An official associated with the fund created a TPM firm in order to illegally get paid off by alternative investment managers for getting hired. Despite the fact that traditional hedge fund TPMs were completely innocent and most not allowed to meet with the fund since at that time they only invested in hedge fund of funds, the State of NY proceeded to blame the TPM industry in order to deflect criticism away from their own structural flaws. They first tried to get other public pension funds to ban TPMs and, when that strategy failed, they lobbied the SEC to ban TPMs. This proposed legislation was both prejudiced and insulting to the institutional quality TPM firms. During the comment period of the proposed legislation, the response from many of the leading public pension funds, who recognized the value added by the top TPM firms, was overwhelmingly in favor of the TPM industry. As a result, the ultimate “pay to play” legislation that was passed actually benefited the top third party marketing firms by leveling the playing field and making everyone play by the same rules. The new legislation applied to all asset management, alternative investment and TPM firms equally. As a result, TPMs are able to call on public funds with the exception of State pension funds in 3 states that have all had internal unethical behavior. During this time period the Third Party Marketing Association has proactively developed ethical guidelines for its members to abide by. As mentioned earlier, the top tier TPMs that made it through this period are seeing a significant increase in demand and fund flows.
Major Differences in the Quality Within the TPM Industry
Similar to the hedge fund industry, there is a significant difference in quality across the estimated 500+ firms within the TPM industry. The top TPM firms receive a disproportionate amount of attention because they have developed strong brands that enhance the credibility of the managers they represent in the marketplace. This has been achieved by those third party marketing firms that are perceived by the market as being of institutional quality, having strong investment and product knowledge, high integrity, deep consideration for the best interest of the investor and only representing the highest quality hedge funds in the industry.
Investors should differentiate between institutional quality TPMs that consistently represent high-quality hedge funds versus the lower quality organizations. For hedge funds, it is vital to hire the highest quality TPM firm possible, because it will have a major impact on how people perceive their firm. Hedge funds should use multiple factors when selecting a TPM firm, including: firm reputation, depth and quality of sales team, industry knowledge, investment knowledge, assets raised, and geographic and investor segment specialties.
Donald A. Steinbrugge, CFA
Managing Member
Agecroft Partners, LLC
103 Canterbury RD
Richmond, VA 23221

Proposed FINRA Rule 5123: Enhanced Investor Protection or Unnecessary Regulatory Burden?

Originally proposed on October 5, 2011, FINRA Rule 5123 (the “Rule”) would, if adopted, significantly increase the regulatory burden on certain issuers, such as private funds, and FINRA members involved in the private placement of securities such as third party marketers, placement agents, solicitors and finders and may encourage issuers to rely on the services of unregistered intermediaries to facilitate introductions to accredited investors. Additional, the Rule has been criticized on the basis that it departs from established practice in the realm of private placements by mandating the disclosure of specific information to investors. In particular, the Rule would require FINRA members who offer and sell private securities through the dissemination of a disclosure document, such as a private placement memoranda (“PPM”) or term sheet, to provide each solicited investor who is an accredited investor the following information prior to sale of such securities: (i) the anticipated use of the offering proceeds, (iii) the amount and type of offering expenses, and (iii) the amount and type of compensation provided to sponsors, finders, consultants and members and their associated persons in connection with the offering.  And within 15 calendar days of the date of first sale, each member would be required to file such PPM or term sheet with FINRA along with any material amendment to these documents within 15 days of such occurrence.

In response to comments submitted by various industry participants, on January 20, 2012, the SEC proposed a variety of amendments and clarifications to the draft Rule including: (i) removal of any reference implying that FINRA would review or sign-off on the offering documents before they are sold, (ii)  exemption of “institutional accounts”, “qualified purchasers”  and “investment companies”, among others, and (iii) exemption of certain offerings including those made under 4(1), 4(3) and 4(4) of the Securities Act of ‘33.

Despite the SEC’s attempt to address certain of these initial comments, the Rule continues to generate significant opposition from industry players on a number of grounds. Some of the most salient of these concerns are outlined below:   

a.       The Rule conflicts with the statutory framework for private placements long-established under Section 4(2) of the Securities Act of 1933 which, under SEC interpretation, does not proscribe any particular type of information an issuer must disclosure in the course of a Reg. D private offering. The Rule departs from the this long standing practice by requiring issuers to disclose specific information to investors regarding the offering, information akin to certain disclosures required in a registered offering.

b.      Since much, if not all, information required to be filed under the proposed Rule is already required to be provided under an issuer’s SEC filed and publically available Form D, which must also be filed within 15 days of the first private sale, it is unclear what additional transparency the Rule would provide the market post-sale.

c.       The Rule is likely to significantly inhibit the capital formation process especially for smaller funds and issuers, the placement agents that serve them and the retail accredited investors they solicit. The heightened regulatory oversight, administrative burden and compliance costs will disproportionately affect smaller market players and inhibit their ability to reach the accredited investor who make of the bulk of their investors. Additionally, the past several years have seen the introduction of a variety of new regulatory obligations on FINRA members including registration as "municipal advisers" with the MSRB and compliance with certain "pay to play" rules. Taking the cumulative increase of these compliance requirements into consideration, many smaller FINRA registered broker-dealer may be squeezed out of business.

d.      The Rule is also likely to have the unintended effect of encouraging issuers to pursue relationships with unlicensed agents not subject to the regulatory scrutiny and compliance costs imposed on registered FINRA members. Required to comply with these additional compliance obligations and costs, FINRA members will be placed at a further competitive disadvantage in to unlicensed brokers conducting business illicitly.  As FINRA and the SEC has acknowledged, since there are few resources available to pursue the hundreds, or even thousands, of finders and solicitors doing business on an unregistered basis, these entities operate with virtual impunity, and for all practical purposes, there is unlikely to be penalties for the private funds and issuers using their services.

e.      The Rule also does not specify the penalties a member firm would be subject to in the event of an unintentional late or incomplete filing or non-compliance with filing requirements. If such oversight were not part of a pattern of non-compliance, would it be considered administrative in nature or subject to more serious sanctions as a consequence of being an 'investment related' instance of non-compliance?

f.        Lastly, the Rule is likely to shift a degree of liability from issuers to placement agents in so far as member firms are required to provide "best practices" level disclosure and due diligence prior to accepting subscriptions from private placement investors. The Rule could potentially impose strict liability on member firms for information supplied by issuers over which they have little, if any, ability to verify accuracy.

Given these concerns, it remains unclear whether the SEC will ultimately approve Rule 5123. Perhaps as an indication that the agency is taking a particularly close look at the ramifications of the Rule, the SEC has requested additional comments on its potential impact on investors purchasing private securities through broker-dealers, the potential burden on members resulting from compliance requirements, and the potential impact on the capital formation process and on competition.  

The blog entry above was written by Simon Riveles from the Riveles Law Group in NYC.  The website for Riveles Law Group is www.riveleslawgroup.com.   If you are looking for legal counsel regarding hedge funds, their establishment, or securities laws generally, then I certainly recommend contacting either myself or Simon directly.  Be sure to tell him you read his article on www.capitalintroduction.com.

If you have an opinion on current hedge fund marketing/capital introduction rules or regulation, or tips on how hedge funds can further their own marketing efforts, please submit your article to support@capitalintroduction.com.

Are You Ready To Advertise Your Hedge Fund?

It finally happened.  The powers that be in the hedge fund world have convinced Congress, the Senate, and in a few days, the President of the United States that by allowing hedge funds to advertise,  hedge funds will in turn create jobs.  Pure Genius.  We knew hedgies were smart, so to give elected officials hope that something, anything, will create jobs and not cost the American people a dime...SOLD!

Say hello to the JOBS act, which stands for, Jumpstart Our Business Startups Act. "This legislation is intended to help start-ups raise capital and go public, and is positioned as a bill with bipartisan support aimed at making it easier for small businesses to find investors early and to continue to grow in the public markets by lowering some of the bureaucratic barriers. It also promotes "crowd-funding,” a mechanism by which entrepreneurs can raise up to $1 million online from individual investors with minimal financial disclosure." (I took part of this definition from an article somewhere)  But most important of all, it lifts the almost 80 year old ban on hedge fund advertising

This is a monumental change in the way hedge funds will now be able to market themselves.  Some colorful ideas are in articles like this one: http://blogs.wsj.com/deals/2012/03/28/jobs-bill-opens-door-to-hedgie-advertising/.  

Now frankly, while it is fun to think about the possibility of firms like Paulson & Co. and D.E. Shaw naming stadium after themselves, (narcissists!) in my opinion, the biggest beneficiaries of this rule change will be the emerging hedge fund managers.  Emerging managers, those with under 50mm in assets and less than 5 year track records, consistently have the hardest time getting their message out to the investor community despite consistently outperforming the billion dollar plus managers.  The reasons why they have a hard time raising assets are fairly simple.  The largest reason being, institutional investors have been slow to adopt emerging manager investing.  Other reasons include investors not wanting to be too large of a percentage of total fund AUM, restrictions on any fund with less than 3 year track record, certain pedigree requirements and also select service provider requirements.  I believe this bias away from emerging manager investing is changing, however, with the proliferation of separately managed accounts because more institutions are willing to make an investment with an emerging manager (with a great track record of course) due the high degree of transparency and liquidity the SMA structure provides.  Now the problem is, how does an emerging manager get in front of institutions?  By advertising of course! Prior to the JOBS act, there were/are (at the time I am writing this) very few ways a small manager can get in front of investors.  Some of the only ways are through friends and family, existing contacts and colleagues, hedge fund databases (like my own, HedgeCo.Net), investor conferences and small RIA introductions.  I would say third party marketers/broker dealers, but there are very few, if any 3pm shops that take on new or sub 50mm funds. I also might say capital introduction groups at the Prime Brokers or Mini Prime Brokers, but they don't ever provide service to smaller funds (regardless of what they tell you!)  So advertising is frankly one of the only ways that talented managers can get their strategies in front of thousands, dare I say millions, of people within a reasonable time frame at a cost that more than likely won't break their budget.  This is truly a game changer for those fund managers who have great track records and no marketing connections.

As someone who owns a firm that raises capital for funds, runs a hedge fund, and also is a publisher, I think I have various takes on the way the rule will effect the industry.  For one, I think advertising may kill a lot of the low end third party marketers.  Funds have to pay a marketer a percentage of their fees for the life of client, but if they advertise, they only have to pay a one-time fee.  They can also immediately quantify what their cost per client is and continually optimize their campaigns to bring that cost down.  For smaller funds (say with a $10,000 marketing budget for example), I am not sure how else they would be able to get their message in front of the same amount of investors.   Tickets to a traditional hedge fund conference, a few client dinners, and plane tickets and hotels for a couple of people easily tops that figure.  Then, you can assume the fund probably only meets a hundred people if they are lucky; ten of which are investors, and two of those are interested in looking at emerging mangers.  Not a great use of resources.  Now instead imagine going to an agency and saying, “I have $10,000.  I would like to have my fund performance and strategy information pop up when anyone on a hedge fund database searches for an aggressive growth hedge fund under 25mm.”For $10,000 I can have that done one thousand times.  To me, that sounds like a much more targeted approach.  At the high end of the range however, I don't think advertising will ever replace marketers that are capable of bringing in hundreds of millions of dollars per fund that they market.  There is still something to be said for solid relationships and the trust built around them.

As a publisher of a hedge fund database and new site, I am incredibly excited about what the future holds.  Right now, in order to get on to our database at HedgeCo.Net, you must first fill out all your personal financial information online, then get a call from one of our representatives to verbally verify the information you posted.  Then, and only then, can you finally get on to the secure section of the website that has all of the hedge fund data.  This is a fairly onerous process to just be able to see some hedge fund performance, but it is currently what is required by the SEC.  Once the advertising ban is lifted, we can ease the registration burden and allow a whole new group of investors to view hedge fund data on HedgeCo.Net. As a result, I could not be happier about the opportunity.  Also, as a firm that obviously sells advertisements, we could not be in a better place to take advantage of the opportunity to provide hedge fund managers the targeted exposure they need through our various advertising products.  HedgeCo also owns the Hedge Fund Ad Network, the first advertising network focused exclusively on the hedge fund industry.  Our team of expert advertising professionals will help our hedge fund clients optimize their advertising budget and get their information in front of the maximum amount of potential investors for their funds.  We already have started pre-booking advertising for hedge fund clients and have space available on the top two hedge fund databases, hedge fund blogs and news sites, and thousands of other financial related websites and print publications.  If you are interested in learning more about our advertising services, please email Andrew Rapoport at arapp@hedgeco.net

As someone that runs a hedge fund, the ability for me to be able to tell the world about our strategy, what makes us unique, our returns, etc. excites the hell out of me.  I can't even tell you the name of my fund on this website right now, how much assets we have, who our staff is, nothing!  I literally cannot wait to tell the investor community by the millions what we do. 

So in summary, I believe one of the bigger beneficiaries of the JOBS act will be the emerging hedge fund manager.  At a time where institutions are getting warmer to being invested with emerging managers, these managers now will have a way to finally introduce their fund via advertising to a larger group of these investors, whereas before they might have never had the opportunity.

 Next topic on this subject - Will advertising lead to increased fraud and regulation within the hedge fund industry, or will it actually help to put standardized procedures in place? 

Feel free to comment on this article or the future topic below.

$100 Million Question

As a member of the Capital Introduction team at HedgeCo Securities, I spend the better part of my day on the phone, playing matchmaker to hedge fund managers and investors.  We start first by initiating a dialogue with the investor in order to gain understanding of their various investment parameters.  When and where appropriate, we introduce them to a suitable product (namely, one of the funds offered through our broker-dealer).

Over the past couple of years, one of the more noteworthy trends I have seen has involved the “$100 Million Question”.  Simply put, I have observed that the vast majority of pension plans, endowments, foundations, and funds of funds (not to mention a growing number of high net worth and family office investors) refuse to even consider investing in hedge funds with less than $100 million in AUM.  In my experience marketing various hedge fund products, growing your fund’s assets beyond the $100 million AUM plateau signifies not just a noteworthy achievement in fund raising but as a catalyst of sorts, opening your fund’s floodgates to a sea of external allocators.  From my experience, there are three root causes for this AUM-inspired trend.

First and foremost, most allocators are constrained by their own size.  Often time, I hear from institutional allocators who stipulate in their bylaws that no single investment can represent more than a certain percentage of the targeted fund’s overall assets.  For example, imagine you are the manager of a $200 million fund of funds (FoF) that initially allocates $10 million per new managers.  If your bylaws state that any allocation cannot exceed 10% of the desired fund’s AUM, then your investable universe is strictly limited to funds with reported AUM north of $100 million.  In other words, if a fund has yet to reach $100 million, you cannot consider it, let alone invest in it.  As an institutional allocator, your time and money is better-spent conducting diligence on funds that have already achieved this 'critical mass.'

The second reason I believe investors adhere to the “$100 Million Question” boils down to business risk.  One common refrain that investors have shared with me is that once a fund approaches $100 million in AUM, they feel that the fund is better-positioned to withstand daily market and liquidity events.  In my experience, fund managers normally rely upon their own capital, seed investors, high net worth, and family office capital to supply the bulk of the fund’s first $100 million in AUM, or what is often referred to as ‘hot’ or ‘relationship money.’  Historically, these allocators are much more likely to stay committed to the fund during any market downturns or rough patches, helping reassure potential outside investors.  Along the same lines, this asset base helps to ensure that the fund can maintain a solid infrastructure.  By infrastructure, I am referring to the fund's engagement of top flight service providers (administrator, auditor, legal counsel), as well as the staffing of a support or back office team.  All of these pieces lend themselves to attracting additional institutional capital.

Last, eclipsing the $100 million AUM barrier signifies a shift in investor perception in my opinion. Once managers have surpassed $100 million in AUM, the perception is that they know what they are doing (of course, reasonable minds could argue that point).  Money starts to chase money.  Reaching the $100 million AUM sweet spot is like winning your first tournament on the PGA Tour.  While reaching the mark may not guarantee future success, it legitimizes your place on tour.  That big shiny trophy on your mantle very well may lend to your odds for success down the road.

Given the post-Madoff/Lehman/Oh-Eight world in which we live, one major trend I have observed is that potential allocators are much more stringent with their due diligence.  For the emerging manager, that means stomaching the “$100 Million Question” when the investors ask.  However, rather than treating this potential road block in a negative light, you can use it to zero in on the investors who will consider allocating to a fund of your size, giving you a much more targeted approach to marketing. After all, in this business, your time is arguably your greatest resource.    

Dave Reynolds

Separately Managed Accounts - Blessing or Curse Part 2

In my last post, I discussed the benefits of Separately Managed Accounts (SMA’s) for Investors.  So, the next step is to talk about some of the drawbacks.  The first problem you run into is the larger minimum investment size in order to obtain an SMA over a traditional LP investment.  There’s not a hard and fast rule, but typically the minimum investment for an SMA is roughly five times larger than the minimum investment into the actual fund structure. 

Second, sometimes too much transparency and liquidity can actually be a bad thing.  You might be asking yourself how I could say that after I have been touting the importance of transparency and liquidity over the past few years.  Imagine an investor who is seeing intra-month volatility two or three times greater than the monthly volatility he is used to seeing.  Or imagine if his portfolio was down ten percent intra-month.  Investors with a quick trigger finger might close out too soon on a manager and miss the upside after seeing the negative performance.  Investors may not understand the strategic position of the portfolio manager, who might even be expecting intra-month drawdowns.  In fact, many option strategies do consistently drawdown leading up to expiration before going positive as options expire worthless, and many managers might be down 5 to 10 percent in the first half of a month and up that same amount in the second half.

Lastly, many strategies might be negatively affected by the SMA structure, and the fund manager might feel encumbered by using the investor’s broker.   He may not have access to the research he needs with the new broker.  He might trade hard-to-borrow stocks that aren’t readily available with one prime broker and prefers to utilize a multi-prime broker model.  And, of course, some assets can’t be traded Parri-Passu in different accounts. 

So, we know not all funds are appropriate for SMA’s, but not all funds are willing to take on SMA’s either.  Many of the larger, more established managers don’t want to deal with SMA’s, and quite frankly, don’t have to.  Actually, it is much easier to have an investor in the fund as opposed to in an SMA; that’s why they invented hedge funds in the first place!  After speaking with Brent Gillette over at Investment Law Group, he mentioned that legally a manager will have more fiduciary responsibilities and thus more exposed to liability.  Brent also pointed out that the performance fees in an SMA are subject to ordinary income taxes as opposed to capital gains taxes for a fund’s performance fee.  Also, some fund managers are very “secretive” about their strategies and wouldn’t be willing to let investors see live trading in the account. 

While some fund managers avoid SMA’s, let’s talk about the recent increase in the use of Separately Managed Accounts.  As the financial markets melted down in 2008 and investors were pulling out money as faster than Elin Woods at a divorce hearing, fund managers began to find out how hard it can be to raise assets.  The power in the industry shifted in the favor of investors, and many fund managers were willing to bend to investor demands.  Also, as technology has improved, prime brokers are more equipped to handle the logistics of SMA’s. 

So, now that fund managers are taking on SMA’s, let’s discuss how they benefit from Separately Managed Accounts.  The obvious reason for taking on SMA’s is attracting investor capital.  SMA’s allow the investor more control and can ease his mind about committing capital to a fund manager.  Also, smaller managers now have access to institutional capital that was normally only available to large and established managers due to SMA’s.  For instance, a $2 billion pension isn’t going to want to allocate less than $50 million to any one fund manager.  There are due diligence and human capital costs in making allocations, and anything smaller than $50 million isn’t worth it (I wish I had that problem).  Well, $50 million funds are not going to bring in $50 million allocations.  Typically, institutional investors only want to be, at max, 10% of the fund’s AUM.   But, they will allocate via an SMA.  Also, institutional investors prefer Separately Managed Accounts since they severely reduce the chance of fraud. 

Yet another benefit for a fund manager that allows SMA’s is the ability to actually grow their fund.  That's right, I said "grow their fund."   Increased ‘strategy’ assets under management in a Separately Managed Account increase the manager’s credibility.  This is the snowball effect of raising assets.  Increasing AUM makes the fund more attractive to other investors and will lead to other allocations.  Once the fund manager has raised a decent amount of assets under management through SMA's, investors will start to care less about the total fund AUM.  Specifically if the manager raises their minimum further for future SMA's or cuts out the offering of SMA's entirely, thereby making a fund investment the only way to get involved with the strategy.

So in summary, are SMA's a blessing or curse to today's hedge fund industry?  In my opinion, there is no doubt they are a blessing.

Separately Managed Accounts - Blessing or Curse? Part 1

More than ever, I am seeing investors utilize separately managed accounts as opposed to direct hedge fund investments.  The question however remains, is this a benefit for hedge fund managers, or will it lead to the death of the traditional hedge fund structure?

First, for those unfamiliar with the term 'separately managed accounts' (SMA), an SMA is basically a brokerage account that is held in the investor's name as opposed to the fund's name, and is not intertwined or co-mingled in any way with the fund (separate).   The fund manager is typically the 'sub-advisor' for the account, and has limited power to simply trade the account, and not make any withdrawals or money transfers.  The sub-advisors are typically paid on a quarterly basis (a bonus for fund managers that normally take fees annually) and usually get paid the same fees they would with their hedge fund.  The SMA is typically traded the exact same way as the hedge fund, with no time or selection bias, essentially Parri-Passu (hand in hand/equal footing) if the strategy allows.   There are certain strategies where this is simply impossible, and therefore SMA's are simply not appropriate and fund investments or pooled vehicles are the only proper way to allocate and diversify the portfolio.

Now that we understand what an separately managed account is, let's talk about the benefits.  Assume strategy permits SMA's of course.

For the investor, utilizing SMA's is a much more effective method of allocating.  SMA's allow the investor benefits like:
  • Transparency
  • Liquidity
  • Decreased Costs (no admin/audit/other fees bringing down returns)
  • Ability to properly weight their overall portfolios
  • Ability to individually leverage accounts and tweak exposure
  • Choice of custodian 
  • Control over commission/finance costs 
  • Prohibit/Severely Inhibit fraud from occurring
These benefits are huge in my opinion.  An investor can shut a manager down and liquidate their account at anytime if they see things like position concentration or 'style drift'.  They can utilize software to monitor all their accounts at one time and quantitative tools that help them effectively manage their risk moment by moment.  They can use notional exposure from one account to fund another and actually (for once) get back the ability to leverage their hedge fund holdings. (key for fund of funds, a dying breed that needs any edge possible to produce additional alpha) Investor's can hire their own administrators if they even deem them necessary, and not have to share in expensive audit bills. They can't steal any money from the account, OR post fake returns, because the investor gets all the statements! I can keep going....

Obviously all these factors are compelling reasons to invest via SMA, but of course, there usually is a catch.  In this case, the catch is often that in order to obtain a managed account from an established fund manager, you have to have a minimum investment of anywhere from five to fifty million dollars.  So, as amazing as the benefits of an SMA structure are as opposed to a traditional fund investment, usually only the institutional or super wealthy family office types are able to meet the minimums required to establish the accounts.

I will continue with the potential problems for an investor with the SMA structure and why the structure will not work for all products in my next post.  In addition, I will discuss the benefits/caveats for fund managers that allow the use of SMA's, and I will conclude with whether I think SMA's will be death of the traditional fund investment, or instead be the tool that helps bring trillions of additional capital into alternative investment managers coffers.  

Quick housekeeping item, I have been away from writing on the blog for far too long!  When I started writing my capital introduction blog the hedge fund marketing/capital introduction industry was still thawing, and so it gave me some time to express my thoughts and share my experience with the public.  However as an active marketer and manager one of the larger capital introduction teams in the industry, once the ice did thaw, we found there were still plenty of sweet smelling flowers available underneath.  As a result, myself and my team have been extremely busy raising assets almost exclusively for emerging managers over the past year, and I am proud to say from experience that money has definitely returned to the alternative space.  We have had tremendous success over the past year and as a result, it has severely impacted the time I had available to write on Cap Intro blog.  That said, I am making a conscious effort to try to write at least a few entries a week going forward.  I have a ton of new topics that have been bouncing around in my head for months that I must share.  So get ready for some new entries shortly and thanks for your patience and continued reading and following of www.capitalintroduction.com.

New Registration Requirements for Investment Advisors

On, July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act").  The Act has several potential impacts on those within the investment management community.  This article is an attempt to explain the important aspects and the impact this new legislation will have on Investment Advisers.

Unless otherwise stated, any changes in law discussed herein generally are effective July 21, 2011.


  1. If you manage any separately managed accounts and have assets under management ("AUM") in excess of $100MM, then you must register with the SEC (even if you only have one account /client).
  2. If you have separate accounts and AUM of $25MM - $100MM, then you must register with your home state unless exempt under state law, in which case you must register with the SEC.*
  3. If your only clients are investment funds and you have AUM of more than $150MM, then you must register with the SEC. 
  4. If you are a non-U.S. adviser with any separate accounts, or with fund assets over $150MM, then you generally must register with the SEC UNLESS you have (1) no place of business in the U.S.; (2) less than $25MM in AUM from U.S. clients and U.S. fund investors; (3) fewer than 15 U.S. clients and fund investors; and (4) do not hold yourself out generally to the public in the U.S. as an adviser.
  5. If you have AUM of less than $25MM or are exempt from SEC registration, then you must be registered or find an exemption in any state where you have a place of business or more than 5 clients.*
  6. If you are a "Family office" or an adviser solely to one or more "venture capital funds"  (both terms to be defined), then you are exempt from SEC registration.

*It is not clear what state exemptions may change as a result of the Act.


You must immediately amend your fund subscription agreement's definition of accredited investors to exclude primary residence from an investor's net worth.  For now, this change seems to apply only to new investors or additional subscriptions from existing investors with no need to expel any existing investors.  This change is effective immediately and requires your prompt attention.

If you are a registered investment adviser ("RIA") and charge performance fees/allocations to any investor in a 3(c)(1) fund, you will need to amend to adjust for inflation the "qualified client" certification obtained from each client/fund investor next year.


You may need to register with the National Futures Association ("NFA") as a Commodity Pool Operator (CPO) if (1) you buy commodities and currently rely on an exemption based on margin and notional exposure percentage limitations because you will now need to include any swaps when determining compliance with such limitations, or (2) you are defined as a "major swap participant" when new rules are adopted.

You may need to report (1) pre-enactment swaps if applicable regulators issue related interim rules, and (2) future swaps which are not accepted for clearing.


A.  Reporting:  If you manage funds (whether or not you are a RIA), you WILL be required to maintain records and file reports to the SEC.

Such reports will include a description of funds':

  1. amount of AUM
  2. use of leverage, including off-balance sheet leverage
  3. counterparty credit risk exposure
  4. trading and investment positions
  5. valuation policies and procedures
  6. types of assets held
  7. side letters
  8. trading practices
  9. any other information that the SEC deems to be “necessary or appropriate

B.  Custody:  Future rules under the Act may require RIAs to take further steps to safeguard client assets.

C.  The "Volcker" Rule:  If you are affiliated with a bank, then you generally must not engage in proprietary trading activities 
or sponsoring or investing in a hedge fund, private equity fund or similar entity.

D.  "Bad Boy" Provisions:  If further rules are adopted, then you will be disqualified from using Rule 506 Regulation D offerings if your firm or principals have engaged in certain improper conduct in the past.

E.  Securities Lending:  Within two years, the SEC will promulgate rules designed to raise the transparency of information available to investors with respect to the loan or borrowing of securities.

F.  Shorting and Arbitrage:  The SEC may adopt further reporting rules and restrictions on such activities pursuant to the Act.

G.  Mandatory Arbitration:  The SEC may adopt rules and regulations restricting or prohibiting the use of mandatory arbitration agreements by advisers.

Welcome to the Hedge Fund Capital Introduction Blog

Hedge Fund Capital Introduction can be a crucial component to a hedge fund's growth. Most bulge bracket prime brokers offer some form of capital introduction for their larger clients but finding a solid capital introduction program for smaller clients presents a challenge. This site is designed to discuss recent events and updates within the hedge fund marketing/capital introduction space. All contributors with beneficial knowledge are urged to participate.

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