There’s both good news and bad news for emerging hedge fund managers in a new report from Hedgeweek. First, the good news: Emerging managers have outperformed hedge funds for three consecutive years by an average of 4.8%.
Despite this, investors remain hesitant to invest in emerging managers who don’t have a strong industry reputation, solid capital base or structured team. These are the results of the latest Industry Report from Hedgeweek, The Next Generation: How emerging managers are adapting to the new hedge fund landscape.
Capturing Investors’ Attention
The Hedgeweek report makes it clear that emerging managers are struggling to capture the attention of hedge fund investors. More than eight out of 10 emerging managers (defined as those with less than $300 million in assets under management, or AUM, and fewer than five years of experience) say that attracting investor flows is their single biggest challenge during the initial launch process.
Despite this positive performance and their reputation at previous firms, nearly half (46%) of emerging managers said that it’s harder to raise capital now than it was a year ago. Two out of 10 consider a lack of an established track record and industry reputation to be major hurdles to raising capital.
One survey respondent put it this way: “You may have someone who has a ten-year track record in a particular strategy launching by themselves and even though you can follow the breadcrumbs of the track record, investors are still reluctant. It is frustrating,”
It’s not really surprising that after a rough start to this year, some hedge fund investors have decided to err on the side of caution. As another survey respondent put it, they’re looking to avoid the next “blow-up” and don’t want to take on what they perceive to be more risk with an emerging hedge fund manager. But while there may be more risk, emerging managers do offer value and the potential for strong returns, as the Hedgeweek report makes clear.
For example, emerging managers often bring innovation and a fresh perspective to hedge fund management, which can lead to novel approaches to their strategies. Complacency, on the other hand, can lead to sub-par returns. In the 2022 Alternative Investment Allocator Survey conducted by Seward & Kissel, more than 70% of investors said they have invested in managers founded under two years ago.
Investors tend to look for three key attributes in hedge fund managers:
- The manager’s return history and previous experience.
- Enough AUM to cover operating expenses and business risks to ensure that investors are getting the exposure and returns they expect.
- Proof of concept and faith in the manager’s investment process to give investors confidence that the firm will grow over time.
An Early Path to Institutionalization
According to one survey respondent, emerging hedge fund managers need a path to institutionalization early in their life cycle in order to meet investors’ expectations. “Investors aren’t waiting on the sidelines for new managers to produce a three-year track record,” he said. “They’re making allocations earlier in a fund’s lifecycle, and with earlier support comes accelerated expectations.”
One way emerging managers can stay focused on managing investments and attracting new investors is to outsource the fund’s finance and accounting functions to a third-party service provider. This will free up fund managers to spend more time focusing on alpha generation.
These services are sometimes referred to as Finance as a Service, or FaaS. FaaS goes beyond outsourced accounting to include a full suite of staff to support startup and launch efforts, payroll and HR support and financial records and planning services along with software that’s capable of managing the firm’s finance and accounting operations. In other words, FaaS is a one-stop financial and accounting services shop.
FaaS features flexible and transparent pricing, which makes it easy to forecast costs as the fund’s needs change in the future. This means that a FaaS provider charges based on the service offered, not by the hour or based on the level of staff assigned to the firm. As a result, hedge funds know exactly what they’re paying for and how their costs will rise or fall as they scale up or down.
Consero: The FaaS Specialists
Consero offers Finance as a Service to emerging hedge fund managers, PE/VC firms and their portfolio companies. If you would like to discuss the potential benefits of FaaS for your fund, please request a complimentary consultation.