Marketing To Alternatives Investors
For portfolio managers, raising capital is one of those strange catch-22s – new fund managers often have a tremendously difficult time raising money, while fund managers with a long track record find themselves swamped with too much cash and often begin turning down new investment requests (see Exhibit A – Renaissance Technologies). For both securities lawyers advising fund managers and for managers in the litigation finance space, the issue of how to successfully market to investors is a crucial one.
There is no real guide to marketing to alternatives investors, nor is there a single “right” way to do such marketing. The following, then, is simply based on my own experience on both sides of the table – helping funds raise money, and helping investors identify attractive funds to invest in.
Starting a new hedge fund, private equity fund, or litigation fund often requires raising anywhere from $10M (on the very low end) to at least $100M. The reality is that most fund managers do not know enough individual investors that they can raise that sum on their own. Fund managers then are faced with two choices – turn to a placement agent, or begin calling on institutional investors.
Placement agents like FIRSTavenue often help funds with raising money in the four major private asset classes, but much like a job interview, the placement agent just helps a fund get their foot in the door. The fund still has to sell itself.
Given that reality, funds of all stripes need to understand what investors, especially institutions, are looking for.
While fund managers are often disdainful of financial theory and academic studies in the area, institutional investors are often much more interested. The institutions that I have worked with are typically using a combination of academic theory and informed market judgement. That’s most true for large endowments like those at Yale and Harvard, of course, but it also holds true for large pension managers, insurance companies, and family offices.
The cold truth is that smart institutional investors understand that fund managers are trying to sell them a product, and the institutions need to rely on third-party independent verification as to whether that product (the fund’s investing strategy) will work. The best source of unbiased but comprehensive analysis on the efficacy of investment strategies is usually the academic studies that have been done in the area.
Take Yale, for example – the endowment’s annual report specifically calls out the need to understand market efficiency in asset allocation. Yale’s goal is to earn a higher risk-adjusted return, and to do that, Yale’s $26 billion endowment looks for fund managers pursuing asset classes that are not efficiently priced and where the manager has a durable competitive advantage based on their investment process.
Yale’s view provides a roadmap for how alternatives managers should market themselves. Successful fund managers need to demonstrate that they have a quantifiable process that can consistently produce results based on some type of market friction – inefficiency in pricing, illiquidity, access to a specialized resource or information source, etc.
Funds need to have effective marketing documents in place that can communicate this message to potential investors. That certainly means backtests and Monte Carlo simulations, but neither of those alone is all that effective. Instead, fund managers need to demonstrate that their processes will create sustainable returns above a suitable benchmark.
Some alternatives classes have been more successful in understanding and applying this marketing message than others. Absolute returns by themselves don’t matter much – take hedge funds, for example. The average hedge fund has actually underperformed the S&P by 30 basis points over the last 15 years. Yet hedge funds remain a durable and attractive asset class.
Because hedge funds have been able to identify appropriate alternative benchmarks and beat those benchmarks, and then demonstrate lower levels of correlation to broader equity markets in order to justify those benchmarks. Private equity and venture capital have had similar success.
Many other forms of alternatives have not been as successful because they lack the right type of marketing approach. That group includes everything from products related to conventional investments such as muni bond derivatives and smart beta funds to true alternatives like tax lien investments and litigation finance.
As new alternative investment forms arise in the future, fund managers should bear in mind what has worked and not worked when dealing with institutional investors. Institutions are not going to adjust their mindset to deal with a new asset class – instead, new asset classes need to mold themselves to the expectations of institutional investors, or live with the reality that they will remain niche products.
Michael McDonald is an assistant professor of finance at Fairfield University in Connecticut. He holds a PhD in finance. Michael consults extensively with organizations ranging from Fortune 500 companies to start-up businesses on financial matters through Morning Investments Consulting. Michael has served as an expert witness in legal disputes, and is an arbitrator with the Financial Industry National Regulatory Authority (FINRA). Michael can be reached at M.McDonald@MorningInvestmentsCT.com.
Published at Tue, 14 Mar 2017 23:12:49 +0000
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