Monday, December 19, 2011

Before starting a hedge fund, read this

For anyone starting a hedge fund, this document called "A Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures" from the Alternative Investment Management Association is a must-read. This is what institutional investors are now demanding from hedge funds. The better a fund is set up to meet institutional investor needs, the higher are its chances for success. In the current environment institutions such as pensions and endowments have enormous clout over hedge funds, particularly over those who have not been around for very long. And they will make their needs known.

Therefore this list of requirements from institutions should be viewed as "best practices" by a fund manager. The customer is always right, and the largest customers, are even more right. Here is an example of the typical requirements institutions now ask for - in this case when addressing transparency:
  • Management fees should be designed to cover operating costs. 
  • Performance fees should be structured in a manner consistent with the underlying strategy, investment horizon and liquidity including, where appropriate, the crystallisation of some portion of the fee over several periods.
  • Business model should be designed to retain majority of investment and management talent when the fund is below the high-water mark for more than a year.
  • Control of assets so that the investor has the ability to receive most, if not all, of its capital within a year or less with minimal, if any, constraints.
  • Transparency that is sufficient for the client to understand the hedge fund exposures and the risks taken in the portfolio, as well as performance drivers.
  • Transparency so that the investor receives security level information that can be used in a risk analytics tool.
These types of transparency requirements were unheard of a few years ago.  But times have changed dramatically for the industry and "a couple of guys in a garage" starting a hedge fund will no longer fly. 


A Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures
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