There are several effective ways to grow your hedge fund. Many of those methods will be discussed and evaluated here. Obviously superior performance among investors with comparable risk is a great way to grow your fund. This section will delve into how investment teams can derive the superior performance that all funds strive for.
Character of the Management Team
There are certain key characteristics of successful investors that generally indicate whether the management team will be successful. A concentration on the business processes of the fund and consistent learning rather than daily results will generally lead to a knowledgeable management team. Most successful money managers understand that markets tend to be fickle and daily results are not always a good barometer of achievement. Hubris has the potential to plague intelligent investors; however, humility tends to lead to personal improvement and less risky investment strategies.
Investment managers should focus on their love for their work. Investors like to invest with people they can trust and those that exude a love for their work. A common trait amongst successful investors is a deep understanding of how investing induces the progress of our society. If investors have a sense that they are actually doing good for society, they tend to be more enthusiastic about their work which encourages investment. Investors should focus on the value that they provide to society. Many sophisticated investors want to believe in positive effects of their investments in addition to creation of wealth.
In addition, managers should focus on their skills rather than attempting to predict general macroeconomic trends. Successful managers know that there are always excellent opportunities in the markets to exploit. There are many trading strategies that successful investors can employ but the management team should focus on their abilities. Good management teams are patient. They fully understand their methodology. They rarely look for shortcuts or the easy way out.
Investment professionals aspiring to become masters will strive for understanding and be consistent in their philosophy. Novices tend to look for an easy way to succeed. New investors will extrapolate previously successful investment models in books and project future gains. Inexperience leads investors to search for immediate profits rather than the consistent model of return that successful long term managers achieve. Thus, patience and consistency is a virtue.
Understanding and Application of Economics
A superior understanding of market forces can lead to growth of a fund. Investors that align their investment strategies with the overall economic and liquidity environment tend to be more successful and are able to maximize profit in nearly all environments. An intrinsic understanding of the drivers of market prices and examples of investment success guides successful funds. In addition, staying dynamic and perceptive of changing market trends is vital to maintaining the edge that superior economic knowledge grants.
Being able to time the liquidity cycle of the market should be a determinant in how a fund allocates capital. It has been found that 97% of equities fall in a period of tightening while 90% of equities rise in a steep yield curve environment. In addition, liquidity cycles can be utilized to determine the attractiveness of foreign markets that actively trade stocks and bonds. In an increasingly flat economic environment understanding global liquidity and economic indicators is essential to most funds.
Large cash positions provide low returns but good investors should be patient within their preferred asset class. Thus, investors looking to grow their funds should seek out other asset classes in which to allocate capital. While investors should find asset classes that best match their portfolio, it has been found that allocating 10 to 25 percent of assets to actively managed futures can increase long term returns and decrease long term risk. Many studies have found that adding actively managed futures to a portfolio of stocks/bonds can decrease volatility and increase gains.
In addition, investors should understand the almost universally recognized truth that joining several risky investments into one portfolio decreases risk and raises return. Mixing together uncorrelated assets should smooth out long term performance and increase fund size as the investments will react to different market forces.
In today’s increasingly competitive market for the capital of sophisticated investors, hedge fund managers need to market their fund properly in order to encourage large infusions of capital. A hedge fund manager may not solicit investment into the fund through any “general solicitation” or “general advertisement” per SEC regulations and thus funds rely upon advisory services to raise capital. Hedge funds used to rely on networks of advisors and their high net worth clientele; however, with the increasingly flat investment world, hedge fund consultants can be easily contact via the internet. Hedge fund advisors utilizing the internet are subject to the same SEC regulations as traditional advisors. Operational websites must adhere to the following regulations: the site is password protected, there are no references to a specific fund on the home page, the internal contents of the website are only available to qualified clients, and prospective investors are required to wait thirty days before investing.
In addition, a hedge fund administrator may be helpful in marketing and managing the fund. A hedge fund administrator provides valuable third party resources that: reduce expenses of the fund, validate performance results to investors, increase the managers’ time available to focus on investing, and provide access to accounting and finance professionals.
Hedge funds can benefit from using banks as a prime broker as it provides many resources and most importantly a centralized clearing house for transactions. Prime brokerages also provide value-added services of: capital introduction, risk management advisory services, and consulting services. Outsourcing non-investment activities to another firm decreases distractions, allowing the managers to focus on investing.
Transparency and Simplicity
Hedge funds trying to grow should encourage capital infusion by being somewhat transparent and simple. Typically hedge funds want to be relatively opaque; however, increasing investors are requesting more information and a minimum level of transparency for effective due diligence in now usually required. A level of transparency can be accomplished with an operational website that complies with all regulations. Many investors may not seriously consider investment in a fund without a website. In addition, managers should list performance on hedge fund databases. Acknowledgment of outperforming associated risk benchmarks on a hedge fund database will typically induce some investors to choose your fund over another.