In this in-depth look at hedge funds, families can learn how to set up and manage a fund, seek out third party providers and get insight into which trends to watch during the year. James Moore starts things off with advice on gaining access to exclusive funds
The dream of any investor is to find the next star performer at the start of its life, because this is where the really exciting returns can often be found. But locating such opportunities is difficult even at the best of times, and these difficulties increase ever further when dealing with hedge funds.
Identifying the best funds
The marketing of new hedge funds presents a formidable challenge to their managers, not least because the sort of methods used by traditional "long only" managers are unavailable to them. Even advertisements in specialist publications intended for a specialist audience with controlled circulations will often find themselves getting in trouble with regulatory authorities in many jurisdictions.
It means that the services of some type of intermediary are essential to unite family offices or high net worth individuals – who are seeking the type of capital protection and high returns hedge funds can provide – with hedge fund managers looking to raise sufficient capital to launch a new product.
Such intermediaries range from the capital introduction departments of investment banks, to private banks and third party marketeers, who seek to carefully evaluate hedge fund opportunities and then market the best of them to their clients. Campion Capital is one of the latter, specialising in the evaluation, selection and monitoring of individual hedge funds and funds of hedge funds for a diverse list of clients ranging from family offices to top university colleges.
Campion's hedge fund consultant, Will Maydon, says many startup hedge funds find it difficult to raise cash because of the restrictions placed on their marketing activities. "Marketing is a problem for hedge fund managers and how they market new funds is very much dependent on how big they are," he says. "Generally speaking, hedge funds tend to be seeded with capital from friends and family of the manager, as well as with their own capital.
"But you need at least €40 million just to break even and a lot end up drifting out of business because they cannot secure sufficient funds. It is not because they lose money – a lot don't. You need that amount simply to remain in business. Because of that, a lot of them tend not to last too long. But if they perform well, it tends to snowball."
Identifying the funds that have the potential to do very well from the outset is not easy for family offices, given the lack of marketing the funds are allowed to do and the scarcity of "brands" outside a handful of well-known operations, such as Man Group or RAB Capital.
And there are, as Maydon says, "plenty of bad ones out there". A number of traditional "long only" fund managers have, for example, attempted to enter the hedge fund space but good long-only fund managers do not necessarily make good hedge fund managers.
One way of accessing new funds is through investment banks, which have spent a great deal of time and money in building up prime brokerages dedicated to servicing the needs of the hedge fund industry.
Such brokerages offer to help their clients raise seed capital through capital introduction departments that help market new funds. UBS, the Swiss bank, is active in this field and regularly hosts roadshows around the world designed to bring new hedge funds together with new clients. Henry Knapman, head of European prime brokerage sales at UBS says: "Family office contacts are very important to our capital introductions team in prime brokerage. We work with hedge funds by introducing them to new sources of capital and organise a number of conferences and events around the globe each year to facilitate these introductions."
Another way of accessing new funds is through private banks, which have connections throughout the industry and research departments designed to sift the wheat from the chaff.
Charlie Hoffman, a senior director at HSBC's private bank, is keen to point out that going for young funds does not always mean "better alpha" and when considering new launches he prefers to look at funds where the manager has a strong track record.
"We have a substantial research department and we don't have a prime brokerage, so we think we can be seen as neutral," he says. "We often get to see a lot of new funds because we know the managers. That is really important.
"What we would look at with a new fund is whether it comes from an existing manager with a strong track record. We would be concerned if they were moving into a new space that they haven't been in before. What we can also do is pool a group of investors, five, 10, 15, to invest in a fund. Something we are careful not to do is invest in small funds that take up too much capital and risk."
Maydon's company is another option. "Almost all hedge funds will do some marketing on their own and some will employ their own marketing operations, but that is expensive," he says. "Some get money through prime brokers' capital introduction departments, whose job it is to put the fund in front of potential investors. Others will come to third party companies like ourselves."
There are, of course, the high-flyers who will rarely have any difficulty raising capital – a star proprietary trader at Goldman Sachs will be unlikely to have difficulty raising money when the bank's capital introduction department offers to market his new hedge fund. And a small number of superstars – such as the Zurich-based Philippe Jabre – can similarly attract money on name and reputation.
But for the rest, says Maydon, there is no one answer. "There are a number of different routes. What we do is spend our lives talking to hedge fund managers and researching them extensively.
"We service both single manager hedge funds and fund of hedge funds which we think are suitable, although we have a strong concentration towards London funds," he continues. "Having selected funds we like, we then attempt to raise money for those funds from our client base.
"Managers of hedge funds tend to be very focused on capital preservation, and most are designed to be relatively low risk. They are, therefore, tailormade for the needs of family offices. Hedge funds also like private capital because it tends to be a bit more sticky than fund of hedge fund money, which tends to be more flighty."
Do it yourself
There is, however, a final option available that is increasingly being used by family offices. Instead of sifting through the market to unearth a potential winner, simply hire a manager you like and set up your own hedge fund management company. This option is growing in popularity, and offices have recently started to join forces to capitalise on it.
There is also another added benefit. Management companies like RAB Capital in London and Fortress and Och-Ziff in the US have obtained attractive valuations through IPOs. Setting up one's own bespoke hedge fund operation offers the possibility that, if successful, it is not just the funds but the management company you have set up to run them that could generate highly attractive returns for you.
For advice on how to set up and manage a hedge fund, click here.
To find the best third party advice, click here.
To discover the hot trends for 2008, click here.