Pulling Away from the Pack: Hedge Fund Best Practices

Date: Friday, June 4, 2010
Author: Hedgetracker.com

I attended the second annual SkyBridge Alternatives (SALT) Conference May 19-21 in Las Vegas, a fantastic opportunity to listen to global leaders and hear a "who's who" of speakers present investment ideas and strategies within the context of what's happening on the global economic scene. As a presenter on the opening panel, I talked about seizing growth opportunities in the marketplace by adhering to what I call "Merlin's Big 12 Hedge Fund Best Practices," and considering the minimum requirements -- both quantitative and qualitative -- necessary to be a successful hedge fund in today's environment.

Here they are: Merlin's Big 12 Hedge Fund Best Practices:
(1) Written compliance and employee trading policies with periodic attestation;
(2) Multiple levels of authority on cash movements with a minimum of two people controlling input, release and approvals;
(3) Written and consistent valuation policy by asset class;
(4) Sound technology and infrastructure with reliable back-up, disaster recovery and business continuity plan;
(5) Open architecture to handle multiple prime brokers, multiple custodians and managed accounts. Understand why you use these firms and the alpha they generate;
(6) Clear risk management methodology;
(7) Ability to prove best execution;
(8) High-quality audit, tax and legal representation;
(9) Sustainable third party administration with SAS 70 Type II;
(10) Dedicated operations manager, COO, CFO and CCO;
(11) Significant principal's money in the fund;
(12) Daily position and cash reconciliation.

You simply cannot retain institutional capital and you have no chance to get new capital if you can't check the box "yes," for each of these twelve. Insofar as minimum requirements to be a hedge fund today are concerned, the answer is not a number. It depends on strategy, investor type, leverage, location and many more variables.

No matter what size, success must include adherence to these minimums below:

The 4 Quantitative Minimums:
(1) Articulation of your Alpha and Beta vs. your custom benchmark. We see investors separating Alpha and Beta performance and allocating differently to it - they are paying for Alpha and demanding accurate measurement of it.

(2) Detailed asset allocation versus stock selection analytics (relative attribution).

(3) Intra-month exposure (as opposed to end-of-month snap shot) and over time for custom and flexible periods.

(4) Risk; not only mitigate and control for it, and articulate the traditional measurements, but also be able to take deeper dives into unintended risk - tail and hedging risk and more.

The 3 Qualitative Minimums:
1) Very clearly differentiated business. This means that you must:
- Articulate your edge and process
- Make your explanation of how you excel memorable, easy to follow and easy to understand.
Remember, impressed but confused investors do not invest. The Pitch Book must immediately get right to: Who you are -- What you are doing --How you get there

2) You need the capital, talent, commitment and staying power to persevere. Once you get to the inflection point on the hockey stick you must scale without creating too much burden on your investors

3) Managers must accept and tolerate deeper dives and requests for greater transparency from investors. Some will require a Board of Directors with and Agenda and Minutes. You will face more frequent and more customized requests for information from investors.

Funds that can meet these requirements will have an exciting opportunity to pull away from the pack.

Ron Suber is senior partner and head of global sales and marketing for Merlin Securities. He has more than 20 years of experience in sales, marketing and business development across the hedge fund, broker dealer and registered investment advisor industries.