Prime Services’ David Kaufman explains how recent market volatility can lead to new capital raising opportunities for hedge funds.
How are hedge fund allocators reacting in their search efforts for prospective investments?
With greater recent market volatility, institutional investors are focused on managers with strategies that can provide both downside protection and generate alpha. But always keep in mind that allocators won't tolerate style drift. Consistency by managers in their stated approach in even turbulent times remains crucial. However, given the environment, many allocators are fine-tuning and reallocating across their hedge fund portfolios, which may create opportunities for certain managers.
In targeting these opportunities, managers should keep in mind the mixed expectations of significant new capital inflows to the hedge fund market, leaving us in an environment where a new allocation to a manager from an institutional investor often first requires a redemption from another hedge fund -- frequently from those with higher equity in bond market correlations to those with lower correlations. Managers ought to be mindful of these factors when engaging prospective investors.
How might a hedge fund manager take advantage of this market volatility in their capital raising efforts?
First, managers should always keep in mind that returns alone don't attract institutional capital. Managers really need to put themselves in the shoes of the investor they're meeting and lay out a compelling case for why their strategy is the optimal solution for that investor's portfolio.
Having said that, managers ought to address early on with investors how their strategy performed in late 2018, a significant current focus of allocators. Investors want to drill down and understand in detail how managers were positioned leading up to and during the fourth quarter of 2018. Did they deliver downside protection and generate alpha doing something unique? Or were they crowded in the same trades as so many others? How correlated to the broader markets were they?
Which brings us to the last point. While it's not unique to today, managers need to focus their presentation around differentiating aspects of their strategy, experience, and operation. What's unique to their approach, and how have they adapted to the market volatility? Have they successfully performed with the strategy over multiple market cycles? What's so special about their background compared to the other manager who pitched the same investor that morning? How is this strategy and opportunity set sustainable long term?
While it certainly is a challenging environment for capital raising, managers that can demonstrate to allocators the unique and uncorrelated nature of their strategy, and show how it might suitably fit within an allocators portfolio in a volatile environment, will be best positioned to raise capital this year.
David Kaufman is a Director for the Prime Services division of BNY Mellon | Pershing, based in Dallas, overseeing the business development and relationship management of hedge fund and alternative investment clients in the region. Dave also leads our capital introduction team in the southern and western United States, assisting clients in their capital raising efforts through targeted introductions to institutional allocators and private wealth investors.