New research from GPP, the alternative prime broker and industry trade body, the Alternative Investment Management Association (AIMA), reveals emerging hedge fund managers aren't yielding to fee pressure, but could raise capital faster by adopting innovative fee structures and investing more in marketing.
'Making it Big', the second edition of the emerging manager research report from GPP and AIMA, found the emerging hedge fund industry is robust and healthy, with the amount at which firms can breakeven static at $85m of AuM ($86m in 2017).
But despite 94% of sub-$100m managers currently raising capital, more than a quarter (27%) spend none of their management fee on marketing.
The research reveals that emerging managers, those with less than $500m of AuM, are less flexible on management fees than their larger peers, although at the sub $100m AuM level, there is greater flexibility on fees. The report finds 20% of emerging managers charge 2%+, versus just 8% of larger managers charging the same fee, perhaps reflecting a greater reliance on this income to support the basic running of their business.
The percentage of hedge funds charging a management fee of 2% or more has risen from 14% in 2017 to 22% in 2018. The proportion charging a performance fee of 20% or more has risen from 35% to 45% over the same timeframe, dispelling the myth that competitive pressures and investor demands are pushing hedge fund fees into a downward spiral.
GPP and AIMA surveyed 155 managers representing a total $402bn AuM, with a median size of $235m. They also surveyed 59 asset allocators representing a total of $942 AuM, with total hedge fund allocations of $79bn. Further findings reveal:
- Performance fees are relatively similar across different sizes of manager, with the largest proportion of managers charging 20%+ (42% of emerging managers and 49% of larger managers)
- The smallest managers are most likely to offer management fee reductions in exchange for a significant investment. More than two thirds (67%) of sub $100m managers would consider reductions, versus 45% of managers with $100m-500m AuM
- Smaller managers (sub $100m) would only consider management fee reductions for investments greater than 10% of AuM
- The majority of allocators (65%) need a prospective hedge fund to have a track record of greater than a year when evaluating it for an investment
- Managers must have 'skin in the game'. All (100%) of the asset allocators surveyed demand that the fund principal has their own money invested in the flagship fund
- More than two thirds (69%) of sub-$100m managers hold more than 5% of flagship fund capital, while more than 40% of $1bn+ managers hold the same stake
Sean Capstick, Head of Prime Brokerage, GPP, says:
"The hedge fund industry has enjoyed rude health over the past year with strong performance driving allocator confidence despite a pervasive narrative of investor–driven fee pressure. Our research reveals it is still possible to launch a hedge fund and be successful in this climate, but there is a lot more that emerging managers can do to grow AuM.
"Key to 'Making it Big' is a flexible fee structure and strong marketing strategy. While the smallest managers are happy to offer fee reductions in exchange for significant investments, emerging managers are generally and understandably reluctant to forego fess. Increasingly we are seeing more innovative structures that place greater focus on performance fees rather than management fees, ensuring greater alignment of interests with allocators and increasing confidence in new managers. Negotiating on a greater and more bespoke range of fee options may help to land important investors at a critical stage of a fund's growth.
"Contributing to a substantial marketing resource is often a chicken and egg scenario for smaller managers, who may find they cannot justify the in-house expertise that larger competitors wouldn't go without. There are a number of outsourcing options for smaller managers that recognise the importance of marketing to business growth, but many should consider hiring this experience internally at an earlier stage to ensure they can reach and exceed critical mass."
Jack Inglis, AIMA CEO, commented:
"This road map for the aspiring billion dollar fund manager is an invaluable resource. It reveals the importance of effective marketing, aligning your business with your investors and maintaining efficient working capital levels.
"This work, produced in partnership with GPP and Edgefolio, offers a series of digestible, takeaway lessons that funds can use now or keep in mind for the future."