$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

2 comments:

  1. That only makes sense really. Post-Madoff, people want to see a large established fund with a long track record. Can't blame them.

    ReplyDelete
  2. Thanks for writing such a good article, I stumbled onto your blog and read a few post. I like your style of writing...
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