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HFMWEEK
S P E C I A L
R E P O R T
H O W T O S TA R T A H E D G E
FUND IN THE US 2010
DISTRIBUTED WITH HFMWEEK JUNE 2010
ADMINISTRATION
Investors take control
LEGAL ISSUES
Advice on how to succesfully launch in the US
CORPORATE GOVERNANCE
The right solution for start-ups
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H O W T O S TA R T A H E D G E F U N D I N T H E U S 2 0 1 0
S
ince 2008, the face of the hedge fund industry has
changed dramatically, and there is no doubt that
this has affected the evolution of start-ups, as the
industry is witness to today. Not only has third-party
administration become a crucial component for the
inception and maintenance of any hedge fund, but
investor demands for transparency and reporting
requirements are shaping the terms on which
investments are formalised. While the tables have turned in favour of investor
control, giving them more power through heightened transparency and
regulation, it is clear that the changes the industry will endure, in a constantly
strengthening and evolving market, are not all over yet.
The events of recent years have led to the launch of any hedge fund being
riddled with a multiplicity of new and ever-evolving factors. Start-ups have
been resigned to facing and realising different considerations at the initial
stages, and this focus is of imperative worth to ensure long- or even shortterm success in most cases. Without such forward-planning, organisation and
structure, the risks in today’s climate, which is still reticent with regard to
investor comfort, will be too great to bear the weight of any new fund for long.
Planning for future technological requirements of any start-up will be one
of the key ways to reduce risk and ensure smooth running of a fund when it
begins to grow. Equally, full attention should be given by start up managers
to the type of investors they want to get on board; whether these investors
will be US-based will have a dramatic have an impact on how a fund is set up,
regardless of its location.
With these changes in mind, and a strong awareness of past years and the
changes that have evolved, managers will secure the best possible focus on
their fund. However, how the future lies in terms of the industry is neither
predictable nor quantifiable, and for success in the US, fund managers, most
importantly, will have to strive to be adaptable and attentive to the everchanging needs of the industry.
Ruth Gillbe
REPORT EDITOR
HEDGEFUNDMANAGER
HFMWEEK
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H F M W E E K . CO M 3
CONTENTS
06
ADMINISTRATION
POWER TO THE INVESTOR
16
John Godden of IGS Group discusses the possible challenges that
hedge fund managers face post the economic crisis now that power
has shifted from them to investors
08
ADMINISTRATION
SEARCHING FOR A FULL BUSINESS SOLUTION
18
LEGAL
FUND COUNSEL: WHAT YOU NEED TO KNOW
George Mazin of Dechert LLP’s Financial Services Group outlines
the questions hedge fund managers must ask when selecting
which law firm to work with
PORTFOLIO MANAGEMENT
TAKING CONTROL OF YOUR FUND
Frank Napolitani of Concept Capital discusses how, in light of the
recent stabilisation of the global financial markets, many portfolio
managers are looking to start their own funds
14
BEAT THE COMPETITION WITH FORWARD-THINKING
Vincent M Sarullo of Apex Fund Services advises fund managers
on how to have a robust infrastructure and a well-thought out
business plan to successfully establish themselves in the industry
Francis Rainsford of Viteos Fund Services gives his advice to
investment managers looking to start a hedge fund in the US
11
ALTERNATIVE INVESTMENT
21
ADMINISTRATION
PASSIONATE, PRECISE AND PERSISTENT
Steven Simmons of Lighthouse Prime Services explains how
ineffectual marketing can sink even the best funds, and that
starting a hedge fund can be likened to the day-to-day running of
a bed and breakfast – strong marketing is a must
LEGAL
READY FOR TAKEOFF
Launching a hedge fund in the US can be fraught with pitfalls,
which is why you need the best advice. Lance L Friedler of Sadis &
Goldberg LLP reveals his top tips for a successful launch
4 H F M W E E K . CO M
24
CORPORATE GOVERNANCE
FIND THE RIGHT SOLUTION FOR YOUR START-UP
Art Murphy of Linedata Services explores the strong regulation,
transparency and technology requirements that start-up fund
managers need to consider post the recent economic global crisis
FINANCIAL SERVICES
A top-ranked
legal advisor to the
investing world.
For more information, please contact:
Robert W. Helm
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Richard Horowitz
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George J. Mazin
+1 212 698 3570
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Kevin P. Scanlan
+1 212 649 8716
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Dechert is the law firm of choice for many of the world’s
largest hedge funds and emerging fund products seeking
comprehensive, cross-border service.
In the top tier for investment funds: hedge funds
Chambers Global
One of the top three onshore legal advisors globally
serving hedge funds
CogentHedge.com
“A powerhouse hedge funds practice”
The American Lawyer
“An outstanding reputation as the premier law firm for
hedge funds” (Chambers UK)
dechert.com
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POWE R TO TH E
IN V ESTO R
JOHN GODDEN OF IGS GROUP DISCUSSES THE POSSIBLE CHALLENGES THAT HEDGE FUND MANAGERS FACE POST
THE ECONOMIC CRISIS NOW THAT POWER HAS SHIFTED FROM THEM TO INVESTORS
A
John Godden
is a well-known
commentator and advisor
on hedge fund investing.
He is chief executive
officer of IGS Group, one
of the corporate partners
of MAG. Godden has been
involved in the design and
construction of several
leading managed account
platforms.
n often vocalised view in the aftermath
of the hedge fund community’s collective darkest hour in late 2008 has been
that the barriers to entry into the world
of the hedge fund manager had become
much too low for its own health, or indeed,
that of the investors. The resultant frenzy of regulator,
political and press focus on the sector has had an impact on how hedge funds are perceived which has, in
turn, altered the way that they are set up and run. Arguably, it has taken much of the past year for the investor
community to make up its mind on what are the key
factors to look for when putting money to work with
hedge fund managers.
The good news of course is that investors are coming
back to the sector, so what new challenges, if any, does
a new hedge fund starting up now face as a result of this
new paradigm?
INVESTOR FOCUS
What is apparent is a fundamental shift in the balance of
power away from the hedge fund
manager and towards the investor.
Planning the launch of any new
fund venture must therefore focus
on the demands of the investor in
a much more direct way than was
traditionally the case. The design
of the fund infrastructure, the integration with the regulatory framework within Europe and the key
terms such as liquidity, information flow and fee structure need to
be clearly fair to the investor first
and not merely pampering to the
needs of the fund manager.
Arguably, investor power was
overplayed in the period immediately post-2008 as a reaction
against investors being stung by
fund-gating being seen as a device used to preserve manager fees rather than to protect the collective investor.
The developing investor sentiment now seems to support a sensible tension between what is good for the
manager and what makes sense to the investor. After all,
it is in the investor’s interests that the hedge fund management company is appropriately resourced to fulfil its
role and has a stable economic base to provide for the
functions required to run a fund successfully.
Some of the pressures facing established hedge fund
managers provide very good insight into what demands
investors are likely to make of new managers. There are
two big themes facing hedge fund managers at this time
and, surprisingly, fees are not one of them. The first is
the issue of separating asset governance from trading
management, a practice that is utterly normal in traditional asset management, the second is that of using
fund structures that are easy to invest in, are inside an
onshore regulatory regime and are clear on taxation –
the European Ucits III being the current darling of this
area for investors across both Europe and Asia.
CHANGING ROLE OF THE HEDGE FUND MANAGER
Investor demands for the separation of control over valuation issues, limitation of changes to investment policy
and independent risk control have led to a much greater
role for administrators and custodians reducing the role
of the hedge fund manager to that of ‘trading advisor.’
The label of managed account, or segregated-managed
account is often attached to the highly developed version of such arrangements.
So, just how problematic are
these issues and what do they
mean to the new-start hedge
fund?
Given the fact that existing
hedge funds are being drawn to
set up Ucits III vehicles and managed accounts, should the newstart be looking to establish such
beasts at outset?
The traditional technique of
getting started in hedge-fund
land is to capitalise an LLP as
fund advisor with sufficient cash
to meet the fees for setting up a
Cayman fund vehicle most of
which will be devoted to getting
a law firm to write all the fund
documents, prospectus, sub/reds, IMAs, ISDAs, etc.
This would then be followed by obtaining commitment
from cornerstone investors of sufficient scale to not only
meet the minimum-fee levels of the administrator, the
auditor, the lawyers (again) and the prime brokers, but
also to provide sufficient potential fee-generating opportunities to keep leading practitioners in each of these
areas interested enough to support the new fund.
This then, provides an insight into the most significant
PLANNING THE LAUNCH OF
A NEW FUND VENTURE MUST
FOCUS ON THE DEMANDS
OF THE INVESTOR IN A MUCH
MORE DIRECT WAY THAN WAS
TRADITIONALLY THE CASE
”
A D M I N I S T R AT I O N
problem facing those establishing a new hedge fund –
how do you attract the high-quality, credit-max service
providers that investors care so much about? Is it possible to get the attention of the favoured prime brokers
(a much-reduced breed post-2008), one of the very
few top-tier AAA-rated custodians or a leading administrator if you are not either an existing institutional
investment management house or if you have $500m
or more seed-capital? This is by no means obvious. Not
only is the industry significantly capacity-restrained at
present with still limited balance from which to draw
leverage, but the fear of reputational contagion drives
a much more detailed look at new funds and a very
conservative stance limiting the number of yes’s.
It does appear then, that the service-provider community supporting the trading activities and infrastructure of the hedge fund industry, is in fact pretty
much as influential over who can start a hedge fund and
on what basis, as are the newly empowered investors.
One of the most powerful techniques that is gaining
significant momentum at this time is the use of ‘platforms’ as a mechanism to coral the greater scale of assets
of several hedge fund outfits such that it becomes more
compelling economically for the service providers.
We are seeing such platforms appear in a number
of forms from hotel-style entities that provide some
common trading and risk monitoring componentary
through to full-scale managed account platforms that
provide full ‘plug-and-play’ fund structures with common administration, prime brokerage and custody
services all of which benefits from the combined scale.
A SHIFT IN ECONOMICS
What this has done is to significantly alter the economics of setting up a fund. The new platform model
shifts the cost of set-up away from the new manager and
onto the platform sponsor who provides the prebuilt
infrastructure. This is then rebalanced by the platformsponsor receiving part of the annual management
fee that would normally go to the manager, this being
appropriate given the reduced burden, both financial
and practical, placed onto the fund manager.
So, will we now see new-start fund managers cutting straight to the new infrastructure world eschewing
the use of a flagship fund built from scratch and going
straight for a facility on a managed-account platform
and another on a Ucits III platform? The answer will
unfold over the next year as the influences of both the
investors and the service providers are expressed
through their support of such devices, or not. n
H F M W E E K . CO M 7
S e a rch in g for a f u l l
b u SineSS S o lu ti o n
fr ancis r ainsford of viteos fund services gives his advice to investment managers
looking to start a hedge fund in the us
S
Francis Rainsford
heads viteos’ global client
relationship management
function, providing valueadded services in the areas
of structuring, accounting,
tax and compliance matters.
considered an industry
expert, he frequently
speaks on matters relating
to technology, valuation,
fund administration and
regulatory compliance.
everal drivers are affecting the way in which
hedge funds look at the post-trade management of their portfolio. It is a foregone conclusion that fund managers will be required
to register with the US Securities and Exchange Commission (SEC) and other government agencies. Beyond registration, regulators will
require periodic and annual filings and will have the ability to audit the fund and management company’s books
and records. Managers will need to have internal control
documentation and a robust middle- and back-office infrastructure to meet the requirements associated with
government oversight of the industry.
For investors, performing detailed due diligence on
managers during the initial and ongoing investment in
the fund has become best practice. Alpha is no longer
the key element in the selection process, it is also about
the management company’s business plan around posttrade management of the portfolio. Investors also want
greater transparency into the administrator’s role in the
manager’s business. It is no longer ‘check the box’ when
it comes to whether a manager has
an administrator. Investors want
to see the processes and systems
being used by the administrator
and understand the services the
administrator performs on behalf
of the fund.
With greater focus on posttrade management of the portfolio, hedge fund managers are
evaluating their strategic business
plan and they are saying they need
to have a comprehensive solution
to manage trade processing, collateral management, compliance,
technology infrastructure and reporting to investors. With the increased pressure from investors to
reduce fees, the difficulty in raising
capital, the complexity of managing a business to support
pooled investment funds, separately managed accounts,
Undertakings for Collective Investment in Transferable
Securities (Ucits) and dealing with the business cycles
driving scale of operations, managers need an alternative
to building an in-house business solution. This raises the
bar for administrators to demonstrate they can add value
beyond just the core services of fund accounting and investor services.
one-stop shop
In today’s world, fund administrators need to augment
and complement a fund manager’s business. “At Viteos,
we present our offering as a ‘one-stop shop’ with the ability to unbundle our services to meet the specific requirements of our clients,” says Francis Rainsford, who heads
Viteos’ global client relationship management function.
He adds: “We work with clients who require our full
suite of services, as well as clients with unique business
needs. This may encompass providing support around
trade reconciliation, collateral management, security life
cycle reporting, risk management, compliance reporting and software implementation. More often than not
a conversation that starts with Viteos providing fund administration leads into discussions around a multitude
of roles Viteos can perform to augment and complement
a fund manager’s business.”
Viteos constructed its fund administration business
from the ground up, focusing on daily trade processing, reconciliation of trades and speed in executing its
service model. Rainsford notes the unique contribution
Viteos makes to the fund manager: “We were able to evaluate
the other fund administrators
and learn from their shortfalls,
bringing forth best thinking and
best practices to create a fund
administrator that offers hedge
funds a bespoke solution from
post-trade processing to net asset
value (NAV) and beyond.”
what is sometimes
forgotten about hedge
funds is that they are
entrepreneurial in
nature
technologic al b ack-up
Viteos’ platform is built around
Advent Geneva, the industry
standard for portfolio accounting. But it is not the fact they use
it which is impressive, it is what
they have done to it.
Instead of plug and play applications around Geneva,
Viteos took its best thinking and best practices a step
further by evaluating software applications and building
their own complement of products that are fully integrated between their applications and with Geneva.
Asttra is the engine wrapped around Geneva. Trades,
pricing and investment master data flows into Geneva
via Asttra, which is then used to pull the data out to create reports and data flow back to its clients. All of this is
”
8 h f m w e e k . co m
a d m i n i s t r at i o n
clients. Our clients look
at us as a trusted adviser
that can provide thought
leadership around their
business.”
performed in a real-time environment. Recon automates
trade, cash and position-reconciliation between the fund
manager and more than 40 different counterparties. Veda
performs the economic allocations and stores all investor documents, due diligence and statements. Rainsford
states: “Our commitment to improving the applications
around Geneva has resulted in a 90% straight-through
processing solution for fund administration.”
For Viteos, it is not just a great technology solution
that managers are look for in managing the post-trade
portfolio, it is the ability of administrators to present a
‘value-add proposition’ for the hedge fund on the business side.
Rainsford says: “Clients appreciate our superior platform but they appreciate even more our domain knowledge of financial products, trade processing competence,
fund accounting depth and fund/security structuring
knowledge. We take a consultative approach with our
ne w clients
It is clear that Viteos is
thinking about more than
just fund administration.
Speaking of Viteos’ approach to new clients,
Rainsford says: “When
we are introduced to a
new client we want to understand their business as
much as they want to understand ours. We are not
selling a ‘canned’ solution
to fund administration.
We look to demonstrate
that our platform will
meet not only their existing needs but also their
long-term needs.
“We want clients to
look beyond just fund
administration to all
the other operational
challenges they have in
launching their fund or
managing an existing one.
Clients appreciate that as
a fund administrator we
are thinking outside the
box. Each client engagement is a partnership and
our role is to meet the
specific business requirements of our clients.
“We apply our best
thinking to best practice
and the result is the total
client experience becomes one where there is a deep
understanding of their business goals and how we, as
part of the operations equation, help them succeed. Our
knowledge becomes their power.”
For managers today, it is not just about creating
alpha, it is about having a strategic business plan. Rainsford concludes: “Our clients look to Viteos to provide a
comprehensive and integrated set of business solutions
around their operations and reporting to investors. We
see our role as a strategic partner with our clients. What
is sometimes forgotten about hedge funds is they are
entrepreneurial in nature.
“Partnering with a service provider who is of the
same mindset enables a manager to do what they do
best creating alpha for their investors, knowing that
their administrator has their arms wrapped around the
manager’s business – applying best thinking to best
practices.” n
h f m w e e k . co m 9
H O W TO S TA R T A H E D G E F U N D I N T H E U S 2 0 1 0
TA KIN G CON TROL
OF YO U R F U N D
FRANK NAPOLITANI OF CONCEPT CAPITAL DISCUSSES HOW, IN LIGHT OF THE RECENT STABILISATION OF THE GLOBAL FINANCIAL MARKETS,
MANY PORTFOLIUO MANAGERS ARE LOOKING TO START THEIR OWN FUNDS
W
Since 1997, Frank
Napolitani has
worked as a hedge fund
analyst at a fund of funds,
portfolio manager allocating
to emerging hedge fund
managers for a US-based
family office, and is currently
in the Prime Services Group
for Concept Capital.
ith the stabilisation in world financial markets beginning last year, new
fund launches have increased since
the end of last summer. The redemptions that many of the largest global
hedge funds experienced following
the financial market meltdown resulted in a significant
contraction in the size of the trading portfolios of the underlying managers. In many cases, these underlying portfolio managers do not share in anything but a share of
the profitability of their trading portfolio. With a desire
for a larger percentage of the economics, the flexibility
to run the organisation the way they want and to control
their own destiny as catalysts, talented portfolio managers have been leaving larger hedge
fund complexes. Many of those
same portfolio managers decided
that they could start their own
fund(s), raise the same amount
of capital that they were recently
running at their former employer,
and control both the economics
and their own destiny. We’ll touch
on new launch topics below and
hopefully provide some insight as
to how you may be analysing your
prospects for launching a fund in
2010/2011.
As a small business, most operators will look to get as
much ‘bang for their proverbial buck’ and look to align
with service providers that have this mindset and business model. Knowing who those service providers are
and forging a partnership are often key to a fund manager’s success as he or she attempts to launch.
PICKING THE PRIMARY FUND SERVICE PROVIDERS
Like any important business decision, you’ll want to
work with service providers that understand your business plan and investment strategy, and a group that you
feel comfortable working with. Before picking any service provider, you’ll want to make sure the firm has name
brand recognition within the hedge fund community and
confirm their firm’s expertise in
dealing with hedge funds. The primary service providers you’ll look
to engage will be legal, accountant/auditor, fund administration
and prime brokerage. Further details on each are below:
Legal
Fund legal structure
• Fees
• Lock-ups
• Additions/Redemptions
• US-only or onshore/offshore,
master feeder
Firm legal documents
• File necessary entities in proper
jurisdictions (Delaware, the Caymans Islands/BVI for example)
• Draft operating agreements for
GP and investment management
co entities
• Draft employee contracts
• Draft compliance manual
• Draft business continuity and disaster recovery plan
Fund offering documents
• Offering
Offering memorandum, agreement of limited partnership and subscription documents
• Review marketing documents for accuracy against the PPM
• Review any tax or ERISA issues
AS A SMALL BUSINESS,
OPERATORS WILL LOOK TO GET
AS MUCH ‘BANG FOR THEIR
PROVERBIAL BUCK’ AND LOOK TO
ALIGN WITH SERVICE PROVIDERS
THAT HAVE THIS MINDSET AND
BUSINESS MODEL
DEVELOP A BUSINESS PLAN
It is imperative to develop a business plan describing why you (and
your partners) have the ability to
start and grow a successful alternative asset management firm.
With the continued institutionalisation of the industry,
simply taking a ‘cottage industry’ approach won’t cut it in
the current environment if your goal is to attract institutional capital and grow a scalable business.
In your business plan, you should touch on the following items:
• Executive summary
• General company description
• Products and services
• Marketing plan
• Operational plan
• Management and organisation
• Financial plan
• Start-up expenses and capitalisation
”
Accountant/auditor
• Annual audit
• Investor tax statements
• Tax preparation
• Certify the performance of the fund for investors
H F M W E E K . C O M 11
H O W TO S TA R T A H E D G E F U N D I N T H E U S 2 0 1 0
won’t have the same ‘coverage’ that they’ve grown accustomed to.
Emerging hedge fund managers are often constrained
from spending the necessary time to market their funds
due to the time necessary to manage their portfolio,
manage their organisation, and the limited resources
dictated by the smaller asset base they manage.
CAPITAL INTRODUCTION GROUPS/THIRD-PARTY MARKETERS
Because marketing and sales should be a full-time effort, the costs associated with internalising a dedicated marketing/investor-relations department at most
emerging managers are often prohibitive.
CAPITAL INTRODUCTION GROUPS
Although capital introduction groups can be a valuable
source of referrals, their mandates to make ongoing introductions for 50-500+ potential hedge fund clients is
often daunting and typically do not allow for a focused
effort on your organisation. You’ll often see ‘cap intro
events’ where 7-10 managers get 10-12 minutes to speak
in a ‘speed round’ of presentations to 75-100 investors.
After that it becomes a business-card swap. Spending
the time, effort and money to speak at these large events
without results are often a popular complaint by emerging hedge fund managers about their prime brokers.
FUND ADMINISTRATION
• Portfolio reporting
• Record-keeping for the fund
• MTD, QTD, YTD performance
• Liaise with auditors for audit
• Fund books and records
PRIME BROKER/CUSTODIAN
• Multi-asset class, multi-currency, multi-custodian
platform
• Stock loan
• Trading technology
• Middle/Back-office support
• Portfolio and risk reporting
• Infrastructure (office space, IT, etc)
• Capital introduction services
Current capital raising landscape for emerging managers
The performance of the S&P 500 (-38.5%) and hedge
fund research’s HFRI Fund Weighted Composite Index
(-18.3%) in 2008, the estimated number of hedge fund
closures in 2008/2009, and the anticipated fund closures in the first half of 2010, have caused the capital
introduction groups at the larger prime brokers to dramatically cut staff and the third-party marketing community has been cut dramatically.
For years, global hedge fund allocators relied on
capital introduction groups and/or placement agents
to make introductions to emerging, high-quality hedge
fund managers that they would not have found in databases or other public means. As global hedge fund allocators begin to re-allocate back into hedge funds, they
1 2 H F M W E E K . CO M
THIRD-PARTY MARKETERS
Engaging a high-quality, third-party marketing organisation is often the next progression for an emerging hedgefund manager. Third-party marketers will bear their own
operating expenses and market your fund to a mutually agreed upon, pre-determined investor demographic.
These organisations are paid on a ‘success-basis’ only
and will often receive either 20% of gross fees or a set
percentage of AUM for the life of the investment in the
fund. Because the number of global hedge fund allocators is very large, third-party marketers will often have a
specialty by concentrating on a geographic location (Europe, for example) and/or one particular demographic
of hedge fund allocator (family office, for example).
Emerging managers, due to their smaller asset base,
should concentrate on those allocators that either have
a concentration on allocating to emerging managers or
an investor demographic that is not prohibited by an investment committee/mandate from allocating to them.
Most often, the family office and emerging-manager focused fund of funds make the most sense.
The continued institutionalisation of the hedge fund
industry, along with the prospect of increased regulation are going to be key components in launching and
building a successful alternative asset-management
business. Gone are the days of ‘two guys and a Bloomberg’ as allocators are looking to invest with a highly talented, well-pedigreed investment team that can demonstrate a repeatable investment process along with
institutional-quality infrastructure and compliance.
The soon-to-be darling hedge funds of 2012-2013
are likely being launched right now as we’ve seen an
increase in the number of high-quality managers that
are currently in the pre-launch stage of starting their
funds today. n
Adapt&Thrive
igs group are a specialist advisory firm to the Alternative
Asset Industry and its’ investors. At this key time in the sector
we provide advice, support and resources to those needing
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19/02/2010 09:40
RE A DY FOR TA K EO F F
L AUNCHING A HEDGE FUND IN THE US CAN BE FR AUGHT WITH PITFALLS, WHICH IS WHY YOU NEED THE BEST ADVICE.
LANCE L FRIEDLER OF SADIS & GOLDBERG LLP REVEALS HIS TOP TIPS FOR A SUCCESSFUL L AUNCH
L
Lance L Friedler
is a partner at Sadis &
Goldberg LLP. He regularly
counsels clients on
structuring and forming
US and non-US private
investment funds, including
the investment manager
and general partner entities
to such funds. Friedler
also counsels investment
managers on registration
and ongoing compliance
issues with the SEC.
aunching a hedge fund in the US is a complicated business, which involves numerous considerations. A good starting point
is to consider the potential investor base
for the fund.
Investors can largely be divided into
three classes. If the investors are US taxable investors,
a US partnership or limited liability company structure generally works well. If the potential investors are
non-US based investors or US tax-exempt investors,
then launching a fund that is domiciled outside the
US, regardless of whether the investment manager is
based within or outside the US, generally works well.
According to Lance Friedler, a partner at Sadis &
Goldberg LLP, there are also many other issues to consider when launching a hedge fund, such as the fund’s
investment strategy, projected assets under management, service providers (such as auditors, administrators and prime brokers), internal personnel (such as
portfolio managers, compliance personnel and operational personnel) and risk management.
US TA X ABLE INVESTOR S
US taxable investors generally
invest in a US-based partnership or limited liability company
(LLC) for a number of reasons.
For example, if a partnership or
LLC holds the underlying fund
investments for more than one
year, the investor in the fund
will generally receive the benefit of capital gains tax treatment
when those investments are realised as the fund is considered a
‘pass-through’ entity for US tax
purposes.
In addition, in a typical hedge
fund structure, the investment
manager to the fund receives
two forms of compensation: a
management fee, which is typically 1-2% of the assets under
management, and a performance allocation, which is typically equal to 20% of
the net income of the fund after any prior losses in
the fund have been recovered. A US fund that is set
up as a partnership or an LLC typically structures the
SADIS & GOLDBERG LLP
Sadis & Goldberg LLP is a leading New York-based law firm focused on delivering sophisticated and creative legal solutions in a
highly professional manner. The firm is recognised for its financial
services practice that consists of representing several hundred
investment advisers and related investment entities (including
hedge funds, private equity funds and venture capital funds).
Similarly, the firm provides regulatory and compliance advice and
representation in connection with SEC enforcement proceedings.
Notwithstanding the emphasis on the financial services industry,
the firm also provides a full range of tax, litigation, regulatory, real
estate, intellectual property and corporate services to its clients.
performance allocation as an ‘allocation’ instead of a
‘fee’. As a result, the US taxable investor in the fund
is never deemed to receive the 20% of net income allocated to the investment manager and the investor
does not have to try to deduct the portion of the net
income allocated to the investment manager on his, her or its
tax return. If the performance allocation was structured as a ‘fee’,
the investor would be deemed
to have received the 20% of net
income paid to the investment
manager and would then need to
seek to deduct such amounts on
his, her or its tax return and such
amounts would likely be subject
to limits on deductibility.
The investment manager to
a hedge fund that is structured
as a limited partnership or LLC
will also likely benefit from receiving a performance allocation
instead of a fee as the investment
manager may get the benefit of
capital gains tax treatment on
the amounts allocated to it to the
extent the gains on the fund are
long-term capital gains.
ANYONE POTENTIALLY
CONSIDERING
LAUNCHING A FUND
NEEDS TO ENGAGE LEGAL
COUNSEL WHICH HAS A
TAX DEPARTMENT THAT
REGULARLY COUNSELS
CLIENTS ON SUCH
STRUCTURES
”
NON-US INVESTORS
Non-US investors and US tax-exempt investors typically invest in non-US funds domiciled in the Cay-
LEGAL
man Islands, British Virgin Islands (BVI), Bermuda or
other tax-favoured jurisdictions. Non-US investors do
not like to invest in vehicles that are based in the US
as they typically prefer to avoid any potential tax or
regulatory issues in the US.
However, as non-US funds can invest, without limitation, in the US securities markets, non-US investors
can access US securities markets by investing in a nonUS fund.
US tax-exempt investors typically prefer to invest
in a non-US fund set up as a corporation because if
the fund uses leverage (which means it buys securities on margin), a non-US fund set up as a corporation blocks the unrelated business taxable income
(UBTI) that would otherwise be taxable to the US
tax-exempt investor.
UBTI is a tax that is imposed on a US tax-exempt
investor that derives income from a source that is substantially unrelated to its tax-exempt status.
According to Friedler, tax considerations almost
always determine the ultimate structure of a hedge
fund and, as a result, anyone potentially considering
launching a fund needs to engage legal counsel which
has a tax department that regularly counsels clients on
such structures.
GE T TING ON-BOARD
For a hedge fund to fully begin operations, and to ensure investor confidence, a number of key service providers should be considered when setting up a fund.
For example, most US and non-US based funds have
an auditor, administrator and a prime broker.
According to Friedler, the choice of service providers is a significant part of the process that lawyers
at his firm address when speaking to potential and
new clients.
Typically, a few key service providers are needed.
An auditor is essential for the launch of a hedge fund
and an administrator is also becoming a necessity in
many cases. An administrator typically calculates the
net asset value of the fund, calculates the value of investors’ interests in the fund and helps to facilitate the
subscription and withdrawal process. n
BEAT THE COMPETITION
WITH FOWARD-THINKING
VINCENT M SARULLO OF APEX FUND SERVICES ADVISES FUND MANAGERS ON HOW THEY SHOULD ENSURE THEY HAVE A ROBUST
INFRASTRUCTURE AND A WELL-THOUGHT OUT BUSINESS PLAN TO SUCCESSFULLY ESTABLISH THEMSELVES IN THE INDUSTRY
A
Vincent M Sarullo
is managing director of Apex
Fund Services (US). Prior to
assuming this role, he was
chief financial officer and
chief compliance officer for
two private equity and one
SEC-registered investment
advisor that had a variety of
investment programmes.
lternative investment fund launches are on
the rise. Since Q3 2009, fund launches have
exceeded fund closures; with a net inflow
of capital in Q1 2010 exceeding $13.7bn.
Most of these launches have been $25m
or lower. While the number of launches
continues to increase, so does the competition for asset allocations. Positioning yourself as a well-organised
fund with a solid infrastructure, regardless of your size,
has been a key differentiator in securing assets.
Regardless of the industry in which you are establishing yourself, a sound, well-thought out business
plan is crucial. As you prepare to launch your fund,
potential investors and service providers need to understand your vision, which must include your investment strategy and proposed organisational structure.
Integral parts of this plan include your investment strategy and process, portfolio construction, risk management (both investment and operational) legal organisation or fund structure, and services providers. This
plan will be the roadmap that will guide you through
building your firm.
SEEING THE BIGGER PICTURE
Since managers are most comfortable with investment-related
topics, they often glaze over the
operations, fund structure and
service-provider aspects of their
plan. I often equate this to selling the tickets to the passengers
before building the ship and hiring the crew. You must take into
account other logistical considerations such as securing office
space, evaluating technology
(including telecom and order/
execution management systems)
and hiring support staff. Turn-key
start-up solutions could include
the use of a hedge fund hotel such as the one we work
with in London. Remember, lead times for launches
may be longer than anticipated and you don’t want
potential investors to sit cooling off while you are
putting these things in place.
Today, investors are conducting more thorough due
diligence on hedge fund managers, prior to investing.
This includes using outside counsel to review documents, consultants to perform background checks and
requiring managers to respond to frequent questionnaires. Having a well-documented investment programme, with policies and procedures in place, will
show your commitment to the success of your fund. It
is not enough to take a set of ‘off-the-shelf ’ documents
and adopt them as your own. Make sure your documents fit YOU. Not having policies and procedures
documented and in place is poor planning. Having
them and not following them is poor business.
Now that you have documented your vision, you need
to start surrounding yourself with a team of professionals
who have the expertise to execute your strategy.
CHOOSE YOUR PROVIDER WISELY
Whether you’re looking to create a single-fund platform or a cross-border structure, the rules to success
and longevity are the same. Service-provider selection
should be based on getting the best product or service,
while keeping costs in line, without sacrificing quality. This holds equally true for auditors, attorneys,
administrators, custodians, banks and prime brokers.
Can your service providers grow
with you to meet your needs or
more importantly, can they help
with growth in AUM, product
offerings and geographic coverage? This is an important consideration as changing providers is often viewed as a red flag
that issues may be present in the
organisation. Therefore, finding
the right providers at the onset
is crucial.
It is quite common for managers to align themselves with a law
firm when they are developing
their organisation. Concurrently, your administrator should be
brought on board to work closely with your attorneys. Being the
hub of your fund’s operation on an ongoing basis, your
administrator will provide valuable guidance on which
banks, brokers, custodians and auditors suit your
operational strategies making your business successful. Your administrator should be an extension of your
infrastructure, not a replacement for it. The services
your administrator provides are a direct benefit to your
investors, which is why they are charged directly to the
fund. Your administrator should be taking respons-
MANAGERS ARE EXPANDING
THEIR INVESTOR TARGET BASE
OUTSIDE THEIR BORDERS.
US MANAGERS ARE SEEKING
TO ATTRACT INVESTORS
IN EUROPE, ASIA AND THE
MIDDLE EAST AND VICE VERSA
”
A LT E R N AT I V E I N V E S T M E N T
ibility for processes that would otherwise take your
focus away from your prime directive which is raising
capital and overseeing the investment strategy. This is
what you receive a management fee for.
Managers are expanding their investor target base
outside their borders. US managers are seeking to attract investors in Europe, Asia and the Middle East and
vice versa. Having the ability to establish platforms to
bring their products to market in a timely and cost-effective manner is a key aspect to their success. Deciding
on where to set up your fund should be based on where
your investors feel most comfortable and that is usually
coupled with the reputation of that jurisdiction.
FUND STRUCTURES AVAILABLE
There are a number of options in the US and abroad
for your fund structure. In the US we have options
such as limited liability companies (LLC), segregated
portfolio companies (SPC) and the most recognised,
limited partnership (LP). These structures each have
their benefits, as far as flexibility with investor terms
and creditor-liability protection. Additionally, the use
of classes or separate series within the LP structure can
give the manager the ability to offer investors various
terms in their fund. Varied liquidity and fee structures,
without the use of side-letters, which have drawn much
attention and are frowned upon, can be developed.
Having the capability to offer multiple strategies to
investors under one ‘umbrella’ fund, creating or utilising an established SPC or a Series Limited Partnership
(SLP) can be highly effective. These entities, which
are sometimes referred to as protected cell entities,
segregate the assets and liabilities of different classes of
shares (for non-US funds) or series of limited partnership interests (for US funds) from each other and, the
general assets of the fund. By creating one ‘umbrella’
entity you can offer a number of distinctive investment
strategies or sub-funds. Each of these ‘cells’ or subfunds is offered through a supplement to the umbrella
fund. Each supplement details the specific terms of that
sub-fund. The flexibility this structure provides has
enabled Apex to offer US managers who wish to launch
an offshore fund a cell under our Apex Emerging Manager Platform. This cost-effective solution allows a new
or established manager to create and launch a fund, with
a lower amount of seed capital and, without the high
costs associated with structuring and managing a fund
without assistance.
Apex’s expansive, global network of service providers gives managers a team to trust while building a solid
foundation to launch their alternative investment fund.
We understand that the core requirements to launch an
alternate investment fund may be common regardless
of their geographic location but navigating local legal,
compliance and regulatory issues require in-region
expertise. Apex’s global presence enables us to develop
programmes that give managers the ability to get their
funds launched throughout the world. With extensive
industry expertise, innovative products and robust operating solutions, Apex has become internationally recognised as one of the world’s leading and fastest growing independent fund-administration businesses. n
FUN D COU N S E L : WH AT
YOU NE E D TO K N O W
GEORGE MAZIN OF DECHERT LLP’S FINANCIAL SERVICES GROUP OUTLINES THE QUESTIONS HEDGE FUND
MANAGERS MUST ASK WHEN SELECTING WHICH L AW FIRM TO WORK WITH
O
George Mazin
is a partner in Dechert LLP’s
financial services group.
He advises clients on the
structuring and restructuring
of domestic and offshore
private funds, private
placements of securities,
structured products, private
equity investing, and brokerdealer and investment
adviser compliance.
ne of the early decisions that hedge fund
managers must make when they decide
to launch a fund is to select a law firm to
prepare the fund’s offering documents.
Despite the importance of this decision, many managers are inexperienced
in selecting counsel. Here are some of the factors that
should be considered when making a decision:
• Experience – how extensive is the firm’s experience
in organising private funds? How deep is the bench
and which lawyers will be doing the work?
• Market intelligence – does the firm know what current terms are for competitive funds?
• Compliance expertise – in an industry that is increasingly becoming subject to greater regulation,
does the firm have the requisite experience in compliance matters?
• Geographic coverage – many funds invest globally
and seek to raise capital from investors around the
world. Does the law firm have the necessary geographic footprint to address these needs?
• Ancillary services – in addition to fund formation and
compliance expertise, managers will require advice in a
broad array of areas, including
tax, ERISA, derivatives, intellectual property and employment law. Does the law firm
have expertise in each of the
areas required by the manager?
While it is relatively easy to diligence these areas, there are several other considerations that
are at least as important, but are
perhaps more difficult to assess.
These include the following:
• Is the proposed attorney an
effective business adviser, or
merely a legal technician? Is the
attorney able to establish a good rapport with you?
• How responsive will the firm be in meeting deadlines and answering questions?
• Will services be provided in a timely and efficient
manner? Higher hourly rates need not mean that
the cost of delivering services will be higher than
lower cost but less experienced firms. Experienced
firms can often do the work more efficiently than a
firm that is learning ‘on your nickel’.
While fees are important, managers should take a
longer view and select a firm that will provide value and
be an effective partner with the manager in building
a business. Also, in comparing fee quotes from competing firms, make sure you are comparing ‘apples to
apples’. Do both quotes cover the same scope of work?
WHAT DO L AW YERS DO?
Often the perception of the manager, as a prospective
client, is that offering documents are simply boiler
plate, and preparing a set of documents requires little
more than filling in the blanks.
While the need to deliver legal services as efficiently as possible requires attorneys to strive to create more standardised documents, one size does not
fit all. Fund documents must be carefully tailored to
fit the investment strategy that will be employed by
the manager. Liquidity terms must match the duration
of the assets in the portfolio and risk factors must be
drafted in a manner which highlights the most relevant
risks and eliminates those that
are of limited relevance to the
strategy.
Before the drafting begins,
time must be spent developing the optimal fund structure.
Many factors should be taken
into account in doing so, including the desire to achieve the
greatest tax efficiency, considering the proposed investment
strategy and its impact on fund
structure, regulatory considerations and the needs and requirements of investors.
WHILE THE NEED TO
DELIVER LEGAL SERVICES
REQUIRES ATTORNEYS TO
STRIVE TO CREATE MORE
STANDARDISED
DOCUMENTS, ONE SIZE
DOES NOT FIT ALL
”
DE VELOPING FUND TER MS
Once the basic fund structure
has been developed, the remaining fund terms must
be established. Space does not permit an exhaustive
description of all issues which must be evaluated.
However, the following are some of the more important considerations:
• Parallel vs master/feeder structure: there are advantages and disadvantages to each approach. A
master/feeder structure is often favoured to simplify trade allocation and to be able to publish
LEGAL
•
•
•
•
consistent returns for both the
domestic and offshore feeders.
Offshore fund: is there a need
for an offshore fund and in which
jurisdiction should the offshore
fund be formed? Non-US investors and US tax exempt investors still prefer offshore vehicles.
While Cayman is still the jurisdiction of choice for most US
managers, it is not the only option and the European Alternative Investment Fund Managers
Directive is causing many managers to consider other jurisdictions, including Ireland and Luxembourg.
Regulatory exemptions: consideration must be given to navigating the exemptions available
under the Investment Company
Act, Securities Act and Commodity Exchange Act.
Management fees: the rate at which fees will be
charged must be determined as well as the frequency of payment.
Incentive fees: will a standard 20% incentive fee arrangement be used, or will the incentive fees reflect
some new terms emerging in the market?
EMERGING TER MS
• Use of hurdle rate.
• Multi-year performance period with clawback.
• Modified high-water mark.
• Reduced fee for longer term lock-up.
• Expenses. Certain expenses (such as legal fees, fees
payable to the administrator, audit fees and trading
expenses) are almost always charged to the fund.
Other types of expenses are up for grabs. How aggressive does the manager wish to be in shifting expenses to the fund. Possible categories of expenses
that might be charged to the fund (if properly disclosed) include risk management and order management software, insurance premiums, travel and
marketing expenses and compliance expenses.
• Liquidity – decisions concerning the restrictions
that will be imposed on investors who wish to withdraw their investment from the fund have become
the most contentious part of negotiating offering
documents with investors.
Consideration must be given to the following:
• How frequently will investors be able to withdraw
their capital?
• Will there be a lock-up period during which withdrawals are prohibited?
• Will withdrawals be permitted during the lock-up
period upon the payment of a fee (‘soft lock up’)?
• Should the amount of capital that may be withdrawn on any withdrawal date be limited by the
imposition of a gate. If so, should the gate be a fund
gate or an investor level gate?
IN COMPARING FEE QUOTES FROM COMPETING FIRMS,
MAKE SURE YOU ARE COMPARING ‘APPLES TO APPLES’
”
• Should the manager have the ability to fund withdrawals through distributions of securities?
• If securities cannot be readily distributed, should
the manager have the ability to create an SPV or
liquidating share class?
• Should the manager have the ability to suspend
withdrawals, and if so, under what circumstances?
• Investment limitations; purchase of illiquid assets.
While fund managers seek maximum flexibility to
modify their investment strategy to take advantage
of market opportunities, investors are increasingly
seeking to constrain this flexibility. Similarly, investors are reluctant to give the manager carte
blanche to purchase private or illiquid securities,
and have a strong negative reaction to the use of
side-pockets to manage the fund’s exposure to illiquid securities.
• Transparency; reporting. With investors demanding a high level of transparency, managers must determine the policies they will employ in providing
portfolio information and disclosing those polices
to investors.
The advice provided by counsel to managers is critical
in helping them make sound decisions in developing
the terms for their fund. Counsel will explain legal requirements, liability issues and market practice. The
goal should be to create a set of documents for a fund
that will be viewed favourably by investors, while still
appropriately protecting the manager. n
we practice law
but we live business
sadis & Goldberg represents over 500 hedge and private equity funds.
above all else, we value our client relationships. Our attorneys strive to provide excellent,
consistent, practical and efficient legal services. we distinguish ourselves from other law
firms by assisting our clients in the development of their businesses. this comprehensive
approach has often earned us recognition as one of the top five law firms in the u.s.
for our hedge fund practice. invest a few minutes to learn what our attorneys can do
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SadisGoldberg_203x273.indd 1
5/13/10 11:52 AM
PA SSIONATE , P REC I S E
A N D P E R S I STE N T
STEVEN SIMMONS OF LIGHTHOUSE PRIME SERVICES EXPLAINS HOW INEFFECTUAL MARKETING CAN SINK EVEN THE BEST FUNDS, AND
THAT STARTING A HEDGE FUND CAN BE LIKENED TO THE DAY-TO-DAY RUNNING OF A BED AND BREAKFAST – STRONG MARKETING IS A MUST
F
Steven Simmons
is a managing director and
head of Prime Services
Sales with Lighthouse
Prime Services, a division of
Lighthouse Financial Group,
LLC, a leading agency-only
brokerage and financial
services company based in
New York City.
requently when addressing larger hedge fund
audiences, I have used the analogy of starting
a hedge fund and running a bed and breakfast. In both cases, there is some romantic
notion that puts the process in motion – having accomplished enough in the first part
of a career, for example, as a sell-side trader or analyst,
it’s time to strike out on one’s own with the lure of freedom
from the corporate world and untold riches beckoning.
The reality is much less glamorous, and just as someone
in a bed and breakfast needs to make the beds and take
out the garbage, the hedge fund team needs to be able
to execute on all fronts: analysis, trade execution, risk
management and marketing, with marketing taking the
back seat more often than not. Unfortunately, poor or non-existent
marketing can sink a good fund
just as efficiently as poor performance can.
Being at the forefront of bringing investors and managers together, it’s easy to see where
good managers drop the ball.
Managers with poor performance
or non-existent marketing efforts
aside, let’s focus on those developing funds that should resonate
with investors – a solid pedigree,
infrastructure, and performance,
who still fall short of the investor’s radar.
When counseling new launches, I like to borrow from Barton
Biggs’ book Hedgehogging. He recounts his first forays into launching his fund, and the expectations that investors would be
knocking down his door with fists clenched with signed
cheques. Many managers need to be reminded that this
isn’t the reality; the current environment does not reward
complacency. Having broad relationships with numerous
institutional investors, there is one underlying mantra
that seems to unite them, and that is: “Give us a reason
NOT to invest with a specific manager”. When faced
with this kind of reality, it is incumbent to the developing
and established manager to have an effective marketing
programme in place. At Lighthouse Prime Services, we
have developed a simple, yet effective system for managers to reinforce and refine their marketing programme,
based around analysis of the 3 ‘Ps’ of fund marketing.
BE PASSIONATE
I have witnessed managers, when pressed about their
fund, offering a lacksadaisical, muddled response, to the
effect of “you know, traditional long/short, uh, decent
numbers etc”. I have seen an inability to recount specific
performance points, and proper benchmark relevance,
even for assets under management. This isn’t rocket science. If you cannot be passionate to the point of being
obsessed about your fund, then how can you expect an
investor to open their cheque book? Do you believe
enough in your own fund to have your own friends and
family’s money invested? If so, let it show. And hubris
should not be confused with passion – hubris and indifference are both punishable offences. We have seen
numerous managers put up excellent returns in 2008 and 2009,
who naturally expected investors
to flock to them. Many of them
took their foot off the marketing
pedal, and instead of piling on
the momentum, they ended up
getting lost in the shuffle. Some
of the most effective, and successful funds, have gone well beyond
the ‘elevator pitch’ to speak about
their fund with an almost religious
fervour. The essentials of the fund,
such as how it started, why it is
relevant now, and why it is salient
for the long run, comes out both
evenly and eloquently. Which
leads to the second ‘P’.
EXPLAINING WHY YOUR
LONG/SHORT DEEP-VALUE
EQUITY STRATEGY IS MORE
COMPELLING THAN THE OTHER
3,000 FUNDS IN YOUR SPACE
IS AN ABSOLUTE NECESSITY TO
YOUR FUND’S SURVIVAL
”
BE PRECISE
The most basic marketing tool, the
‘elevator pitch’, is an effective, 30-second presentation
that you give to a captive audience in an elevator (or any
other public space where you can spring it on an unsuspecting ‘qualified’ investor). Frequently these opportunities arise at conferences where numerous managers and
investors are milling about.
I recall one manager finding himself with the rare opportunity in an unexpected one-on-one with one of the
leading ‘PERS’ allocators. Watching from the sidelines,
I winced as I saw him feverishly scratching notes on paper, many of which were Greek equations. After a few
uncomfortable minutes, the allocator nodded and smiled
appropriately, and was on his way, shaking his head. The
fund manager came back to me frustrated saying that the
allocator ‘just didn’t get it’. We sat down and reviewed his
pitch, and subsequently, revised it.
The importance of delivering a concise, clear vision of
your fund’s strategy and relevance to investors cannot be
emphasised enough. The team at Lighthouse Prime Services works closely with our managers to hone their presentations – from the basic ‘elevator pitch’ to more elaborate presentations for extended meetings. Understanding
what your true ‘secret sauce’ is for creating alpha, and being able to elaborate that to others, is the most important
starting point for fund marketing. Often too much time
is spent discussing prior accomplishments or other nonsalient topics which are not the key selling points for the
fund. Excellent pedigree and previous accomplishments
are always beneficial, but for many of the relatively new
launches and developing managers, those are not the key
closing points that win the next meeting. Succinctly and
enthusiastically explaining why your long/short deepvalue equity strategy is more compelling than the other
3,000-plus funds in your space is more than just an art, it
is an absolute necessity to your fund’s survival.
BE PERSISTENT
Lighthouse Prime Services hosts numerous events
throughout the year that bring investors and fund managers together. During the strategy sessions before the
events, we work with managers to set expectation levels,
and then regroup afterward to map out the proper game
plan for following up and moving forward. Having the
investor’s ear and getting immediate feedback is extremely beneficial, and we utilise each of these opportunities
to relay both positive and negative feedback to the fund.
Our role is best suited to being a fund’s advocate, without
being a cheerleader; building on the feedback allows us
to work with the fund to craft a specific plan for following
up and maintaining contact.
Frequently, funds attend events, have several meetings
that seemingly go well, and nothing seems to materialise. Often, these funds become either disenfranchised
by the process, and fail to follow up sufficiently, rapidly
fading from the investor’s memory. Investors attending
our round table-style events have an excellent opportunity to meet with a broad range of managers, and many
of these first meetings have catapulted funds to the upper
echelons of consideration and funding. At the same time,
these investors also have hundreds of pitch books that are
also in consideration.
So how does a fund get to the next level? It’s simple:
stay on top of the process. Make sure that monthly numbers are being sent to the investors. Any updated pitch
books, awards, accolades, upcoming media interviews or
written articles all need to be brought to the investor’s
attention. If there are conferences, manager/investor
events or other opportunities to reunite in person with
the investor, take advantage of those situations. Utilise
your capital-introduction team or third-party marketer
to ensure they are working on your behalf as well.
While I’m not advocating stalking per se, I do believe
in the Malcolm X maxim of ‘by any means necessary’
when it comes to successfully staying in front of investors. It should be ever-present in your mind that the
typical investment cycle is a minimum of nine-to-12
months; the key is having the intestinal fortitude to see
the cycle through.
There is no clear cut panacea for a fund’s success
when it comes to marketing. Recognising the importance
of having a clear marketing vision out of the gate, and a
proper team both internally and externally, is paramount
to executing that vision. To avoid ‘economic Darwinism’ in the hedge fund world, you need to be your fund’s
biggest advocate; constantly refining your pitch, capitalising on opportunities provided by your prime broker’s
capital introduction or third-party marketing team, and
by staying in front of the investor at all times. With the
right blend of positive performance, precision marketing,
and a little bit of luck, you should be able to reap enough
success with your fund to buy that bed and breakfast
you always dreamed of...n
HEDGEFUNDM ANAGER
HFMWEEK
SUBSCRIPTIONS
HIGHLY COMME
NDED BUSINE SS
MAGAZ INE OF THE
YEAR 2009
THE BEST READ IN THE HEDGE FUND INDUSTRY
The long and the
short of it
www.hfmweek.com
Sector reverses last
year’s drop in AuA
and
ISSUE 186 27 May
closes in on April
2008
Hedge fund se
t growth
approaches as
record highs
EVERY WEEK YOUR WILL RECEIVE THE LATEST:
peak
THE HEDGE
FUND SECT
OR is edging
back towards
historic highs,
$2.44trn in Octob
HFMWeek’s latest
accord
er 2009, and 21%
Assets under Admin ing to 12 months, from
(AuA) Survey,
a record low for in the last
istration of $2.2trn
as the
recent times
.
of decline to climb industr y reverses a period
a massive 21%
The revival is testam
12 months and
over the last
ent to solid
post a total AuA
of nearly $2.7trn but also to fresh assets from investoperformance,
in April 2010.
returned to the
hedge fund sector rs, who have
Published in today’s
period of cautio
following a
magazine, the
total of single
usness
precise
. According to
manager assets,
the sur$2.657trn, puts vey’s respondents the industr y
the industr y just
has been able to
below its Novem
win a host of institu
and $200bn off
ber 2008 total
its $2.9trn record
ter due diligence, tional mandates through betin April 2008.
high, set back
wider move into increased transparency and a
new
The industry has
accounts and Ucits. products, such as managed
now enjoyed a
of growth, up 9%
in the last six monthfull year
The managed accoun
ts space
s, from of new
additions in recent has seen a number
months, includ
ing
Butterfield Fulcru
m’s new $1bn platSINGLE MAN
form Altinus, the
first from a hedge
NOV 2005 - APR AGER AuA GROWTH
fund administrator.
2010 (%)
Source: HFMWee
recent growth has In terms of Ucits,
k
European manag been sparked by
ers, but, accord
ing
to BNY Mellon’s
Marc Russell-Jones
more North Ameri
,
funds are showin ca-based hedge
expect to see a g interest. “We
$2.93tr n
$2.65tr n
substan
there [North Americ tial increase
a] in the coming
years,” he said.
Mergers and acquis
$2.19tr n
itions involving administrato
rs have also hit
the headlines
since HFMWeek’s
last survey. BNY
PNC in February Mellon acquired
for $2.31bn, while
Credit Suisse is
poised to buy Fortis
Bank Nederland’s
hedge
fund services unit, Prime
Fund Solutions.
number of private
A
also shown interes equity firms have
t
t.grif fiths@hfmweein the space.
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2010
FIND THE RIGHT SOLUTION
FOR YOUR START-UP
ART MURPHY OF LINEDATA SERVICES EXPLORES THE STRONG REGULATION, TRANSPARENCY AND TECHNOLOGY REQUIREMENTS THAT
START-UP FUND MANAGERS NEED TO CONSIDER POST THE RECENT GLOBAL ECONOMIC CRISIS
B
Art Murphy
joined Linedata Services in
2009 as senior manager
of business development
for Linedata’s hedge fund
business in North America,
working closely with new
and existing clients to
identify software solutions
for their front-, back- and
middle-office operations.
efore 2008, start-up hedge funds had
much less to consider when launching.
Many start-up funds would spend most of
their waking hours focusing on alpha generation and running their intraday position-keeping on MS Excel, having chosen
a solid prime broker who met their needs. Those days
are gone and now a start-up fund has a long checklist of
regulatory and technology considerations before making that first trade. In today’s environment, creating the
right infrastructure is a critical first step before focusing on the primary goal of generating alpha.
Today, to be able to attract both high-net worth individuals and institutional investors, funds need to make
sure they can provide a greater level of operational
transparency. This means that the days of MS Excel are
gone: MS Excel is not scalable
and has no audit trail. The tools
given by the primes are still very
good tools, however, when you
add other counterparties, you
may soon find that these tools
do not play well in the sandbox.
Many funds are starting out of
the box with multiple PBs or
at least have a roadmap to adding additional PBs. This is why
start-ups are now motivated to
review how third-party technology can alleviate some of these
challenges.
When it comes to selecting
technology, most funds today
make an initial vendor selection
based on prior personal and/
or recommended experiences.
This is where prime brokers play a pivotal role, as they
provide a consulting service that assists in suggesting
who and what the start-up should be looking at based
on its business needs. Product-functionality and costs
are primary factors in the decision, but too often that
decision is made within the confines of today’s product requirements and without an eye towards growth
and a vision for the future of the firm. Creating a two
to three year vision is critical to building out technology requirements. One firm we worked with three
years ago started off with $250m in seed-capital. They
knew technology was key to their business growth and
invested heavily in building the appropriate infrastruc-
ture. Today they manage in excess of $2.3bn. That asset
growth has come as a combination of performance and
their ability to attract new assets from both institutional and high-net worth investors. Key to their success
was a scalable infrastructure that grew with them and
allowed them to attract the assets of investors demanding best practice, reducing operational risk and providing transparency.
As firms consider technology choices on start-up,
in addition to cost and functionality, they should be
thinking about the following considerations:
FUTURE GROWTH
The pressure to get up and running means a start-up
doesn’t always take the time to map out exactly where it
sees its business going to in the next two to three years,
as opposed to what is needed
right now. Limiting technology
decisions has in the past locked
firms out of pursuing some of
those long-term goals.
Start-ups need to consider
the possibility of taking on institutional money and resultant
requirements such as adding reports functions to strategies and
assets classes; the possibility of
making the fund international;
whether an administrator will
be brought on to manage your
books and records. From a technology perspective, the startup needs to be confident that
its selected platform will be capable of supporting all those
future needs.
Growth comes from two areas: organic asset growth
from fund performance and new investor money.
Systems infrastructure that supports the investment
styles necessary to achieve asset growth and drive
alpha, as well as providing the tools to support the
command and control requirements of institutional
investors is critical to funds with larger long-term
aspirations.
CREATING THE RIGHT
INFRASTRUCTURE IS
A CRITICAL FIRST STEP
BEFORE FOCUSING ON
THE PRIMARY GOAL OF
GENERATING ALPHA
”
SCALABILITY
Your future growth plans can define the potential
scale, number and complexity of strategies and funds
and therefore the number of prime brokers and ad-
S TA R T- U P S
ministrators that you may manage
in the future. It is also all too easy
to underestimate how the volume
of transactions going through a
system can accelerate over time.
After even a limited period, the
sheer volume of information can
be overwhelming. The resultant
high-data management and storage
demands can compromise system
performance if your selected solution is not sufficiently robust and
scalable.
For anyone trying to manage this
on a lightweight platform, or especially on spreadsheets, the volume
of information can render the platform inefficient. The degradation of
performance on basic systems, often
built in-house, is significant and can
introduce operational risk.
Small hedge funds often neglect
these key issues in the early days,
overlooking the implications of introducing alternative or separate
strategies. It is important to consider
coverage for managed accounts, and
the technology support to back this
up as transaction volumes grow.
REGULATORY SCRUTINY
Historically, within the hedge fund
market, scrutiny of systems and processes employed by funds has been
driven by the investor. Sophisticated
institutional investors were far ahead
of the regulators, in terms of demanding best practice
from the funds in which they invested.
That has changed significantly since 2008, as regulatory bodies have taken a much greater interest in what
funds are doing: regulations are looming for the hedge
fund industry. Hedge funds need to consider not just
today’s regulations, but how they will support future
regulations that will invariably be passed. The right
systems can perform an invaluable role in enabling
funds to both meet and demonstrate their compliance
with regulatory requirements, without imposing a considerable administrative burden. The key is to choose
a system which is able to meet regulatory scrutiny in
the future, and is flexible enough to be able to accommodate new legislative requirements through existing
workflows.
INVESTOR SCRUTINY
For start-ups, it is essential to focus on the transparency that any hedge fund solution offers, as the demands
of investors look set to increase. A start-up needs to be
satisfied that the solution has the full functionality required to run the business, as well as keeping investors
informed on a regular and ad hoc basis.
It is critical that the solution meets the needs of investors who are entrusting their money to the fund.
While initial reviews will be on process, compliance
and audit capabilities, the day-to-day demands will be
on providing some level of investment transparency
to those clients. Access to indicative NAV, P&L and
portfolio-risk profile is critical to effective client management.
OPERATIONAL RISK
One key technology consideration for a start-up hedge
fund is: does the platform provide the oversight needed to measure and manage operational risk?
Historically, many hedge funds would have had a
single prime broker, single administrator and quarterly
reporting to clients. Nowadays, the need to diversify
counterparty risk appropriately across multiple prime
brokers and custodians requires a platform which is
capable of carrying out the appropriate aggregation
of information and delivering it to the portfolio
managers and traders. These multi-prime demands
have driven the trend away from prime-broker
technology and towards third-party solutions.
Typically, having flexible reporting to present aggregations of cash, transaction and risk information from
multiple sources, be they custodians or multiple prime
brokers, is a key issue for start-ups. Fund administrators also present an aggregation point for such inforH F M W E E K . C O M 25
mation. However, the timely access that a hedge fund
manager requires of aggregated data is not always available through an administrator system.
Having a platform which performs the aggregation
in a manner which is visible on the manager’s desk top
is crucial. Now more than ever, institutional investors
are scrutinising the quality of a fund’s post-trade processes, and, when it comes to allocation of assets, they
will look for a system which is sufficiently robust to
deal with a multi-prime environment and to communicate with prime brokers.
MANAGING IN A MULTI-PRIME BROKER ENVIRONMENT
In the past, a single prime-broker platform would
have a level of reporting from an operational perspective, giving the fund manager an oversight of the entire fund. In a multi-prime broker environment, that
changes quite considerably and the complexity of this
environment should not be underestimated by any
start-up. In attempting to manage the multi-prime environment, spreadsheets are prone to manual error and
are extremely time-consuming. The five issues for success in a multi-prime broker environment can be summarised as:
1. A platform that can facilitate the allocation of
trades to multiple prime brokers
2. The aggregation of data from all the sources to
achieve a consolidated view of the fund’s positions
3. A reliable way of transmitting transaction positions to the counterparties
4. An efficient way of providing exception reporting
and reconciling the fund’s own records of trading
activity with those various counterparts. Being
able to rapidly identify those exceptions is a necessary and efficient way to manage much of the
operational risk incurred
5. Counterparty risk across those various parties is
something to be aware of. Having visibility of realised and unrealised P&L across multiple counterparties is vital in the present environment. Without a platform that can provide that data, and if
you are obliged to rely on third parties to provide
disparate information, you will introduce significant operational risk
VENDOR RISK
As we have discussed, choosing technology based
on functionality that will meet your future needs is
critical. Likewise, validating the technology vendor you choose can be equally important. Over
the past three years we have seen a rash of acquisitions in the market that have had an impact on the
support and focus of technology providers. How comfortable will you be if your technology provider is
acquired by a broker? A data provider? Another technology vendor? Even more troubling to consider is
whether they have the financial stability to remain a
viable solution provider in the years to come.
Start-ups should consider who they are buying from,
and whether the vendor has the core competency to
not only implement the system and support the needs
of the hedge fund, but to continue to invest in and release new functionality. Referrals are valuable but decisions should not be based on this alone.
Hedge fund start-ups need to ensure that their vendor
has sufficient support and backing such that the considerable investment in the system is secure. The people behind the solution are also important. When hedge funds
buy a solution they need to evaluate not only the system
but also its ability to operate efficiently according to
their business model. They need to evaluate the solution
provider’s people, their expertise in the hedge fund
market and their ability to deliver.
Where this is increasingly important is the level of support firms provide. Firms operating in a single geographic region often provide single-region support. While
that may be suitable for some, increasingly we are seeing
demand for 24/6 support by local staff.
One final consideration for a start-up selecting technology is the time available to manage the vendor relations and the sometimes complex integration of various systems. There are two schools of thought in the
market space on this issue. One says that you should
bring in and manage multiple vendors, each one the
best possible fit for that part of your business. This
option will deliver great solutions but a large vendormanagement commitment, repeated each time each
system is upgraded and interfaces must be renewed.
The second says it is best to mitigate this vendor-risk
by leveraging a vendor that can provide a full service.
This may offer solutions across all the business with
a hugely reduced vendor footprint and a relationship
that can be sustained and built upon.
In conclusion, the choices for a start-up hedge fund
are endless and often confusing. Knowing where your
start-up is heading and asking the right questions to ascertain how technology can support you on your journey will help a start-up to make the right choices. n
LINEDATA
Linedata is a global, independent solutions provider with 700
clients operating in 50 countries. With more than 840 employees
across the globe, it is dedicated to the investment management
and credit communities.
With more than a decade of experience in the industry and
the strong financials of a publicly listed firm, it makes long-term
investments in its solutions and services to help clients meet
their challenges now and in the future.
Linedata supports more than 300 hedge funds globally.
Linedata Services’ Hedge Fund Solution is a comprehensive
offering catering to multi-currency, multi-asset class, multi-prime
and multi-strategy investing. It encompasses order and portfolio
management, industry-leading pre- and post-trade compliance
monitoring and full reporting functionality. It comes with a
comprehensive-rules library and an intuitive rule-builder, full
trade-order management capabilities with portfolio modelling
and advanced rebalancing. At the heart of this unique package
is our award-winning portfolio management software, enabling
sophisticated tracking of product and counterparty financing plus
accurate NAV estimation to both reconcile with and monitor thirdparty administrators.
ONE COMPLETE MULTI-PRIME SERVICE PLATFORM
DESIGNED TO LET YOU FOCUS ON WHAT’S IMPORTANT.
Prime Brokerage Services
Fund Administration
RIA Services
Family Offices Services
Risk Management
Research & Capital Markets
Concept Capital is a leading institutional broker and total solutions provider for global hedge fund managers,
Registered Investment Advisors and family offices. Concept Capital provides a full suite of prime brokerage
services, proprietary research, fund administration, real-time risk management, and portfolio analytics. Concept
Capital also provides an experienced hands-on institutional trading desk for traditional buy-side customers,
hedge funds, and registered investment advisors. Concept Capital specializes in providing clients with
experienced, in-depth market knowledge combined with advanced proprietary systems, enabling clients to
quickly launch their businesses in the most cost effective manner possible.
Michael S. Rosen
Frank L. Napolitani
Senior Managing Director
516.746.5723
[email protected]
Managing Director
646.747.5228
[email protected]
www.conceptcapital.com
New York, NY
Garden City, NY
Greenwich, CT
Washington, DC
Chicago, IL
Concept Capital, a division of Sanders Morris Harris Inc., Member FINRA, SIPC
Bernardsville, NJ
apex_ad_a:Layout 1 21/01/10 12:01 PM Page 1
LEADING THE
WAY FORWARD IN
FUND SERVICES.
Entrepreneurial.
Innovative.
Proactive.
Insightful.
Viewing fund administration solutions from a
different angle provides a fresh perspective.
Our approach combines a commitment to
service excellence, robust operating solutions
and professional expertise in multiple financial
jurisdictions—all tailored to suit your needs.
Our insights will make a difference to your
business, guiding your organization to focus
on the possibilities, not the liabilities.
To learn more on partnering with one of the
world's leading independent fund administration
providers, please contact:
John Bohan
Managing Director, Ireland
Tel: +353 21 4633366
Cell: +353 87 656 0096
[email protected]
Jason Bibb
Global Head of Business Development
Tel: +44 1383 844629
Cell: +44 7791 400587
[email protected]
www.apexfundservices.com

HFM WEEK H O W T O S... F U N D I N ...

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