Tag Archives: institutional investors

Hedge Fund Predictions for the New Year

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Typically we do not comment non-law related hedge fund news stories.  However, we’d like to point attention to a very good article which opines on the likely trends for the hedge fund industry in 2009.  This article will be good reading for those managers who are starting a hedge fund in 2009.  The following are the takeaways from the article:

– Market neutral strategies to see increased demand
– Trend toward less leverage
– Investors are expected to ask for increased transparency and liquidity
– Short biased funds will be popular
– Commodity programs will become more popular
– Shrinking assets until end of Q2
– Institutional investors expected to dominate investor landscape Continue reading →

Hedge fund institutional investor due diligence

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The goal of many hedge funds is to reach a point where they can start attracting investments from institutional investors. Many hedge funds (especially those with pedigreed managers) are able to start with backing from institutional investors while others (including many start up hedge funds) will need to develop a track record before seriously courting these types of investors. This article describes institutional investors and details some of the hedge fund due diligence procedures which institutional investors will put a fund through prior to investing.

What is an institutional investor?

Institutional hedge fund investors include state and corporate retirement and pension plans, endowments (non-profit and educational), banks, insurance companies and other types of corporations and companies. Sometimes there are very large hedge funds which will themselves invest in small and start up hedge funds – in such instances the large hedge fund will be acting as an institutional investor and will require many of the same due diligence materials. Institutional investors are important for the hedge fund community because they provide a very large potential base for investments.

What is hedge fund due diligence?

Hedge fund due diligence is the process that an investor goes through in order to vet a potnetial investment in a hedge fund. Due diligence will include the following:

  • background checks on all of the managers and employees of the management company
  • thorough review of all of the hedge fund offering documents
  • review of the management company’s risk management procedures

Due diligence document request

The timeline for an investment by an institutional investor is likely to be much longer than the time an individual investor will take to invest in your fund. Typically an investment will need to be approved by the managing director in charge of investments or alternatives; then the institutional investor’s compliance department will typically make a request for certain documents and/or other information. A sample list of the documents requested might look like the following:

Please provide the following information:

  1. Brokerage Agreement with [name of hedge fund broker]
  2. Copies of the executed partnership agreement(s)
  3. Copy of executed opinion of legal counsel relating to the legality of the interests [HFLB note: this is not a legal requirement and many funds do not receive an opinion of counsel with regard to these matters]
  4. Copy of executed opinion of legal counsel with respect to U.S. Federal Income Tax Consequences [HFLB note: this is not a legal requirement and many funds do not receive an opinion of counsel with regard to these matters]
  5. Any other legal opinions rendered in connection with the Partnership
  6. Reference name, title and telephone number for each auditor, legal counsel, clearing broker, custodian, consultant, administrator engaged by the Partnership of General Partner for the past two years
  7. A description of valuation policies and procedures [HFLB note: this may not be applicable to a fund; will depend on the investment strategy and the potential investments]

Depending on the nature of the institutional investor, you will see different levels of analysis of the actual trading style and returns of the fund. A sample reqest for information might include the following:

A detailed information on the trading program including:

  • list of investments
  • execution
  • frequency
  • diversification
  • liquidity

A detailed examination of historical returns including:

  • weekly/monthly/annual returns (best/worst/average)
  • sharpe ratio
  • sortino ratio
  • standard deviation
  • VaR
  • drawdown analysis

While I have hit upon most of the high points, any one institutional investor may have requests which are completely different from the items requested above. If you have any questions on the due diligence process or an investment into your fund from institutional investors, please don’t hesitate to contact me directly.

Five Challenges to Raising Institutional Assets

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SEI White Paper: Maturing Hedge Fund Industry Must Shift Gears to Grow Institutional Business

Paper Identifies Five Challenges for Hedge Funds Trying to Attract Institutional Assets

OAKS, Pa., Feb. 11 /PRNewswire-FirstCall/ — As hedge funds increasingly look to the institutional market for asset growth, they must equip themselves to fit the high expectations and conservative attitudes characterizing institutional investors, concludes a white paper released today by SEI (Nasdaq: SEIC), titled “Five Critical Challenges for Hedge Funds Taking Aim at the Institutional Market.”

Hedge fund assets under management have been growing at a compound annual rate of 26% since 1990, reports the SEI analysis, with much of that growth coming from the institutional market. “To maintain that growth trajectory, the hedge fund industry will need to branch out from its traditional high-net- worth, foundation, and endowment clientele to serve the broader institutional market,” said Paul Schaeffer, Managing Director of Strategy and Innovation for SEI’s Investment Manager Services division. “But to compete for those assets, the industry must recognize that large institutions have a distinct set of demands concerning issues such as the quality of infrastructure, transparency, and risk.”

Based partly on a survey of more than 100 institutional investors by SEI and the research firm of Infovest21, the SEI analysis details growing institutional acceptance of hedge fund investing. Forty-seven percent of the institutions surveyed said they already invest in hedge funds. Within that group, 73% of pension plans and 55% of institutions overall said they had increased hedge fund allocations over the last several years. Portfolio allocations to hedge funds averaged 30% for endowments, 13% for pension funds, and 24% for institutions.

At the same time, institutions expressed continued concerns with hedge fund investing. “Headline risk” was named by 37% of survey respondents as their biggest worry, followed by lack of transparency (19%) and poor performance (15%). Institutions also remain cautious in selecting hedge funds, the survey found, devoting an average of seven months to due diligence and 12 additional weeks to approval.

In the paper, SEI identifies five challenges hedge funds should address in order to attract more institutional assets:

1) Demonstrate institutional-quality infrastructure and operations. Infrastructure was ranked the number-one criterion in hedge fund selection, with 46% of those surveyed naming it most important. Of those who responded this way, 54% said it was because “better managed firms produce better returns.” The quality of fund administration was a prime concern. Of those respondents most concerned with infrastructure, two- thirds said it is unacceptable for funds to handle their own administration internally, and half demand a “big-name” administrator; 81% said they take steps to verify that hedge fund investments are valued independently.

2) Meet investor demands for reporting and transparency. The lack of transparency was the second most commonly cited worry with hedge fund investing, with 19% of institutions ranking it number one. This concern was greatest at the strategy level, with 85% of respondents saying they would not invest in a strategy they do not fully understand. More than half said they seek portfolio transparency at the industry or sector level, and one-third were most concerned with transparency of the investment process. Only 11% said they seek transparency of specific investment positions.

3) Build stable management teams with a full range of skill sets. Interviewees ranked “people at the firm” as the third most important factor in hedge fund selection, surpassed only by “firm infrastructure” and “performance.” Other survey responses revealed that investor concerns with hedge funds’ organizational stability and staffing are not confined to those making investment decisions, but cut across all key management and support positions.

4) Shift focus from performance to investment disciplines. Institutions are as concerned with investment process and risk profile as they are with the level of absolute returns, the survey revealed. Interviewees ranked “consistent, stable returns,” “uncorrelated returns,” and “high risk- adjusted returns” as more important objectives than “high absolute returns.” Seventy-two percent of interviewees said the investment strategy, rather than performance, is their starting point for hedge fund selection.

5) Keep abreast of public policy and regulatory trends. Citing ongoing deliberations over hedge-fund-related regulation, tax policies, and accounting rules and investor concerns with “headline risk,” the paper urges the industry to “commit whatever resources are needed to ensure that hedge fund managers meet the highest possible standards for their overall compliance and general business practices.”

“The take-away message is that institutions clearly prefer to do business with institutional-style organizations,” concluded Schaeffer. “For hedge funds, the challenge will be to fit the profile of an institutional-quality fund while preserving the performance attributes that attracted major investors in the first place.”

The white paper is published by the SEI Knowledge Partnership, which provides ongoing business intelligence to SEI’s investment manager clients. To request a copy of the white paper, please visit www.seic.com/ims/General_5challenges.asp.