Wells Fargo Prime Services has written a number of articles and papers about the changing nature of the hedge fund industry. Speciﬁcally, we have written about the various requirements that funds need to meet in order to attract and reach the right investors. What we have not addressed is who those target investors are and how managers can determine the appropriate investors for their speciﬁc fund. In fact, we feel that surprisingly little has been written about this topic in the post-crisis environment. Now more than ever, it is critical that hedge funds know their investors, know what those investors require, and understand how to tailor their marketing strategy accordingly.
The hedge fund industry is experiencing a period of unprecedented uncertainty. Many existing and established funds are struggling simply to keep moving forward against redemptions and perilous market conditions. Additionally, for many managers who have launched in the past several years, while their initial goals may have been clear – get the fund up and running, build a track record and grow to the target AUM goal – the ﬁnancial crisis has knocked them off course.
Many investment managers made early infrastructure investments they felt were necessary to reach their goals: they bought advanced trading, reporting and risk technology products; took up expensive space; and hired top-tier talent. They built the foundation for a signiﬁcant fund platform.
Then came the ﬁnancial crisis and the ensuing turbulent market. The “ready” capital these managers expected to ﬁnd early in their development was invested instead with larger, more established funds with better pedigrees and longer operating histories. Additionally, the revenue they’ve anticipated from their “2 and 20” compensation structure never materialized: the management fees suffered from smaller AUM, and performance fees suffered because the market has been difﬁcult to navigate. Many of these funds are experiencing low single-digit returns and are still under or near their high-water marks.
For these managers – as well as other existing managers whose revenues are simply not sufﬁcient to support their operating expenses – today’s climate necessitates difﬁcult decisions both for the top- and bottom-lines. Critical questions that must be asked include: What expenses should be reduced? How can managers grow AUM in this environment? How can a fund meet its day-to-day obligations and pay top-tier talent when the revenues are not where they need to be?
These questions are – at their core – the most basic questions any business manager must ask. And while little good has come from the ﬁnancial crisis, one positive development has been the realization among many hedge fund managers that they are not simply managing a fund – they are operating a business.
This concept, while seemingly straightforward, is the key to moving up through the various levels of potential investors.
The spectrum of hedge fund investors
The spectrum of hedge fund investors is arranged, generally, in terms of how “institutional” each type of investor group tends to be. Regardless of whether these investors are in fact “institutions,” by “institutional” we are referring to the level of general requirements each investor group places on their hedge fund managers: assets, operational practices, risk management framework, track record, reporting and so forth.
Just as the spectrum goes from risk-tolerant to risk- averse, as a general rule of thumb, hedge funds can assume that if they are ill-equipped to meet the needs of one level of investor, they are unlikely to realistically be able to target any higher, more risk-averse levels further along the spectrum.