Hedge Fund Marketing: Know the Edge

Date: Sunday, November 18, 2007
Author: Jacob Bunge

CHICAGO (HedgeWorld.com)—Philip Halpern spent years managing billions of dollars in assets for institutions like the University of Chicago, the California Institute of Technology and the Washington State Investment Board. In that time he oversaw plenty of allocations to investment managers who came in with a succinct presentation that illustrated their strategy and how they planned to execute it.

But Mr. Halpern, now a private investor, also had the misfortune of enduring meetings that illustrated exactly what not to do. At a Nov. 9 luncheon organized by Cole Partners LLC, he recounted a few of these: managers fudging the facts on where they went to school, partners getting into a fight with one another prior to the meeting and firms sending one of their attractive female employees to the meeting, instead of someone familiar with the strategy.

"Many of these things may seem obvious and second nature," Mr. Halpern said, "but I spent about 25 years managing institutional portfolios, and met with I don't know how many managers, and the things I've seen are just sort of outrageous."

Many of the current or soon-to-be startup hedge fund managers in the audience that day may have struck out on their own in part because they want to be their own boss. Hearing Mr. Halpern's stories from the trenches, though, they might do well to treat each meeting with a potential investor as an interview for a job.

Talk about your successes, he said, but it's also important to talk about your failures, that you understand why they happened and learned from them. Credentials and experience are important, and it helps immensely to have other respected investors onboard to vouch for you. Have your pitch down, but don't get stuck on a script—listen and respond to your audience. Be able to outline your investment philosophy and the edge that makes your strategy compelling and different. Oh, and the performance has to be there too.

Mr. Halpern said he looked for follow-through, the ability for managers to build out what they have planned. For young firms, having a chief operational officer and systems in place is important for this. Knowing the audience is important too—the allocation process at endowments tends to be very different than at pension plans, and managers should know if there will be only one meeting or several.

It isn't fair to hold small, startup asset managers to the standard of a JP Morgan Chase & Co. or another massive firm that comes in with reams of crisp, neat documents, Mr. Halpern said, adding that sloppy errors like grammatical mistakes in the manager's literature can be deadly. "If you make that kind of error, what errors are you making on trades?" he said.

Brad Cole, president and chief executive of Cole Partners, a third-party marketing firm and broker-dealer that also runs a natural resources fund of funds, encouraged managers to think of themselves as the "sell side" in meetings with potential investors, who represent the "buy side." Third-party marketers like his firm operate somewhere in the middle, critiquing the manager's marketing plan and how it is best applied.

Mr. Cole urged managers starting the fund-raising process to be critical of everything—the market sector, how the strategy works within that sector, how the competitors operate and how the firm itself will operate, whether the manager is content with a couple of Bloomberg terminals in a basement or is out to conquer the world.

Seed capital providers are one possible avenue, he said, though these arrangements come with a hefty price tag that usually entails big cuts of the hedge fund's fees and an expensive buyout in the future. "As a marketer I should be opposed to these guys," Mr. Cole said, "but we see some good there." In a highly competitive environment, he said, they can provide structure, working capital and credibility, getting a fledgling fund past the first few steps of being a small manager. "But be prepared for sticker shock," he warned.

The capital introduction services offered by prime brokers is another venue, though Mr. Cole said that managers ought to approach these introductions more as presenting information than selling, and follow-up is critical. Friend and family assets, the launching pad of many would-be professional investors, provides little credibility with institutional investors, who will largely discount track records built this way, he said.

Third-party marketing firms like Cole Partners usually don't get paid unless an allocation is made, at which point the marketer will take a portion of the management and performance fees on the assets the marketer brought in. When entering a relationship with a marketer, Mr. Cole said it's crucial to spell out the terms of the contract—what the marketer will do, the time period of the contract and the geographic area the marketer will cover.

The marketer ought to evaluate the firm's marketing plan, keep track of which investors have been contacted, and where the manager's time is best spent. In the meantime, the manager should develop various versions of his pitch—a 60-minute version, a 30-minute version, a 10-minute panel presentation version, and a one-minute elevator ride version. "This all comes out of your marketing plan," Mr. Cole said.

Potential investors aren't the only ones looking for reassurance when a hedge fund starts marketing itself. Rian Akey, vice president and chief operating officer of Cole Partners, detailed the due diligence process the firm goes through when considering a new client for its third-party marketing services. Mr. Akey said he looks for an understanding of the firm's edge, the manager's background and experience, and a sense of the firm's existing marketing abilities. Performance is a factor, but huge returns can sometimes be a little off-putting—Mr. Akey said he looks for something a little more realistic that can be sustained year in and year out.

From an operational standpoint, Cole Partners will review the organization and personnel, looking to see who's handling money and if there are any convoluted structures or extra entities that don't make sense. Technology infrastructure is examined, as is the legal history of the firm and its principals. Past litigation is not an automatic deal-breaker for Cole Partners, but Mr. Akey said it may help identify repeated patterns of small issues.

The due diligence process also digs into hedge funds' pricing and risk policies, with special attention paid to the execution of the fund's strategy—how many people are involved, who has discretion and how long it takes before a trade actually goes through. Mr. Akey compared it to the children's game of telephone, and noted that at some firms a trade goes through so many people that when it's finally executed it may not resemble the trade that was originally thought up.