The environment for raising capital among hedge funds continues to be a mixed bag at best, a challenging one at worst. Yet, for those managers who can present a differentiated strategy and proven experience, there are still substantial opportunities. This requires having the right investment team and highlighting their experience managing through volatility, differentiating the fund’s strategy from other garden variety long/short funds, and acknowledging the fund’s performance in the fourth quarter of 2018.
Recent reports underscore this mixed picture. The number of funds managing over $1 billion hit a new record in 2018 while in the same year, net outflows for the industry reached their highest since 2016.
Still, 2019 looks to be another healthy year for hedge fund launches.
What could tilt the scales to a favorable environment for hedge funds is the desire by investors to refine and reallocate to strategies in light of a slowing global economy, their concerns around Federal Reserve policy, and a potential repeat of the market volatility witnessed at the end of 2018. Against this complex backdrop, hedge fund allocators are increasingly seeking managers that offer unique strategies and better downside protection.
To take advantage of this market-driven churn, managers looking to grow their asset base need to put themselves in investor’s shoes and present accordingly.
Highlighting the Investment Team’s Past Experience in Volatile Markets
One of the major focal points for hedge fund managers in 2019 should be highlighting the pedigree and experience of their investment team. Investors are looking for managers with a history of generating alpha across multiple market cycles, who can also articulate a well-designed risk management approach. This is all the more crucial in an environment that has shifted away substantially from the low volatility, high return paradigm that characterized much of the current bull market run. In addition, attracting top talent remains a key priority for many hedge funds and should continue to serve as a distinct competitive advantage over the coming years.
Differentiating the Strategy
While always an important competitive factor, fund managers now more than ever must differentiate their strategies from the pack. Allocators’ portfolios are often full when it comes to typical hedge fund strategies and they are now seeking managers that bring a unique value proposition and edge to their approach. In performing their due diligence, allocators will target various points of differentiation, from how the manager researches securities to what types of niche strategies a firm offers to the sustainability of those strategies over the longer-term. We continually hear from investors on the hunt for niche, off-the-run strategies with a fresh approach and opportunity—and as the search for alpha in recent years has progressed, appetite has grown for emerging managers that can produce in this environment.
Acknowledging Where the Fund Was in Q4 2018
Addressing the elephant in the room today during capital raising discussions with investors is crucial: How did the strategy perform in late 2018 and what was its correlation to the broader markets? In addition to outperformance, one of a hedge fund’s most attractive qualities is the ability to provide investors downside protection. Our team has heard from many investors about how allocators are increasingly scrutinizing how a manager’s portfolio was positioned, both leading up to and during the fourth quarter of last year. In the case of long/short equity strategies, were they crowded in the same technology stocks as everyone else? Was the short portfolio targeting individual names and truly producing alpha in the broader sell-off, or was it merely a basket hedge against a heavily long-biased portfolio? If a hedge fund is not able to deliver on the core tenets of its strategy, maintaining its existing capital—much less raising new funding—will be a challenge in 2019.
As we move away from the era of accommodative monetary policy, volatility will likely continue. Those managers that can demonstrate to investors not only the unique, uncorrelated nature of their strategy and how it fared late last year, but also their expertise in producing sustainable alpha across market cycles, will be best positioned to raise additional capital in 2019.
Published in FundFire Alternatives, March 20, 2019
Mark Aldoroty is a Managing Director for BNY Mellon | Pershing. He leads Pershing’s Prime Services and Collateral Funding and Trading teams. Prior to this role, Mark led the Prime Services Sales and Relationship Management teams.