While the credit crisis has wreaked havoc on the financial industry, it has also opened up new opportunities.
With hedge funds in a state of repair and growth, institutional investors—and their advisors—have a
particularly unique chance to be “seed investors” at a time when many promising hedge fund managers need
help raising capital.
Before the credit crisis, hedge funds had a strong run from the late 1990s through the early 2000s. During
these boom years, anyone with a desk and a Bloomberg could call themselves a hedge fund manager. Now,
the credit crisis has led to a massive exit of capital, cleared out many of these “hedge funds in name only,”
and also diminished the assets of good hedge funds with real growth potential.
Meanwhile, institutional investor demand for emerging hedge fund strategies is up and growing. At the same
time, institutional investors are demanding that hedge funds implement their strategies using institutionalbased
This means that emerging hedge fund managers who want institutional money are seeking strategic capital,
as well as help with compliance, distribution, and new product development. A number of investment
management firms (I was the pioneer in founding such a firm in 1996) have popped up to fill this role,
providing the hedge funds with capital and institutional investors with a means for accessing talented
managers. Essentially, this means institutional investors can become partial owners in a small- to mid-sized
hedge fund that is looking to grow, without having to do all of the research and monitoring themselves.
The best way to think about it is as getting a leveraged-like return without the risk of leverage. As seed
investors working with an investment management firm specializing in this type of activity, institutions can
own a revenue-sharing stake in multiple emerging hedge fund managers while also participating as investors
in the fund’s performance itself. As the hedge fund’s assets grow, a seed investor will benefit from the growth
in management fee revenue. This revenue is in addition to any returns from hedge fund performance. In fact,
the potential returns from a manager’s fees can sometimes be greater than the direct performance returns of
the managers themselves.
This type of investment would especially appeal to institutional investors, such as foundations and
endowments, looking to increase their allocations to alternative managers to bridge the gap between their
funding and their actuarial needs.
As with any investment, there are some important factors to research beforehand. You will want to
thoroughly understand the investment management firm’s process for choosing and monitoring fund
managers in its portfolio. Thorough due diligence is essential, including reviewing business models, team
members, underlying fund investments, risk, and operational timelines.
The next generation of hedge fund managers is much more process-driven and institutionally minded than
pre-crisis managers.This makes sense, because institutions are the bulk of the client base. Advisors who
work with institutional clients are more than familiar with the types of questions institutions have when it
comes to investing. How do you pick your investments? How deep is your management experience? What is
your process for risk management? Can you provide transparency and separate accounts? Do you have a
qualified COO and CFO?
Hedge funds are shifting from a model where a single trader had a desk and a Bloomberg terminal, to
becoming a real business. Now is the best time to get in on the ground floor of these emerging hedge funds
of today, which could very well become tomorrow’s big institutional alternative asset management firms.
Bruce H. Lipnick
Chairman and CEO, Asset Alliance