According to recent headlines, hedge funds had their best first quarter in 13 years to start 2019 with sharp capital gains. While this might indicate that investors are seeking out alternative strategies in greater numbers and are more comfortable with the risk/reward profile, there is still an opportunity for alternative asset managers to communicate the benefits of adopting an alternative investment strategy to advisors who are still tentative about jumping in.
At a recent conference hosted by our firm, a quick show of hands from advisors indicated that more than three quarters of the attendees were already including alternatives in their allocation strategies. So how does the industry get the message out to those advisors who have not yet ventured into the alternatives realm? Getting into the mind of the advisor to account for the perceived roadblocks is one way hedge fund managers and other alternative asset managers can tap into this potential investor pool.
Process before performance
As a best practice suggested to advisors, investment industry experts agree that developing a tight process around alternative investment selection rises to the top of the priority list. For some, that means partnering with an outside firm to help with operational due diligence so they can focus on overall asset allocation. For others, it means rolling up their sleeves to do their own research – sometimes that’s as basic as studying the landing page of a hedge fund’s website. Whatever the specific process, an advisory firm that can set aside resources to prioritize their own education will be able to commit to adopting an alternative strategy more efficiently.
Where can a hedge fund help with education? Some suggested areas include providing transparency, helping the advisor understand the complexities of a strategy, and explaining how risks are measured and controlled. An advisor who truly understands a strategy will face fewer obstacles in convincing their colleagues, their risk decision-makers and eventually their clients about the benefits of investing in alternatives. For some hedge funds, that could mean more technical training for their marketing professionals so the actual portfolio managers can stay off the road and focus on what they do best. Additionally, marketing professionals should be able to speak to risk management processes to communicate the details of their risk mitigation tools to advisors and their investors.
Once an advisory firm has a solid process in place, the conversation about fees and performance can continue with confidence. And potentially with less focus on chasing short-term performance because the long-term vision is more digestible.
Fees: the other F-word
One point of differentiation that a hedge fund can leverage in the advisor space is flexibility around fees. If a fund is lacking in pedigree, performance history or having an anchor investor, being creative around fee structure could help in keeping the attention of advisors and their clients. Whether the appetite is for double-digit returns or a defensive strategy, alternative investment managers should consider that an advisor’s expectation on fees could be the result of expectations set from prior experiences or no experience at all.
If an advisor can show that the fee-versus-reward ratio aligns with the profile of the hedge fund – whether that is a start-up, an established fund or an outperformer – properly correlated fees can make alternatives a more palatable investment to their investors.
Even the most alternative investment-savvy advisors can fail to see what differentiates one hedge fund from another. Outside of the household names of the largest funds or those with activist reputations, how a hedge fund tells their individual story can help an advisor connect and commit. If there isn’t a track record of solid performance, shift the focus to leadership, transparency, potential, integrity of the team or flexibility to move with the markets. The traits that resonate within a hedge fund could also ring true in the culture of an advisory firm.
From the advisor’s point of view, whether it’s articulating their own unique value proposition or addressing how to stand out among different generations of investors, chances are an advisory firm is putting resources towards differentiating themselves in their own space. BNY Mellon’s Pershing understands this challenge and we work with our advisor clients to help them refine their differentiation strategies.
Advisors should consistently be reminded that alternatives are an evolving asset class, each cycle bringing about new ideas and more efficiency. At our recent conference, one fund-of-fund manager shared feedback he heard from an advisor who claimed his clients didn’t want to bother getting to know more about alternatives. How can that reaction be avoided? By reminding the advisor community that they are in the driver’s seat in helping their clients make the move towards alternatives. Keeping an open mind and being receptive to information and education could map the path to a true commitment for an advisor to adopt an alternative investment strategy. Hedge fund managers who recognize this can benefit regardless of market conditions and fluctuations in risk/reward appetite.
Published in HFM’s Prime Broker 2019 Special Report, July 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.