How a fund launched small, grew to over $250 million, lost more than 90 of its assets and found its way back.
By Andrew Saunders
The hedge fund business favors winners. Assets beget more assets. Investors flock to strong performers. Growth leads to more growth.
What the hedge fund industry has a low tolerance for, however, is loss … shrinkage … drawdowns … movement in the opposite direction. Too often when a manager’s assets shrink, regardless of whether the redemptions are due to drawdowns or market factors (e.g., 2008, using a fund as an ATM), the reflexive response is to shut the fund down. While not “investor friendly,” a manager’s reasoning is logical in that he thinks 1) I am not producing enough fees to support the business and don’t enjoy funding it out of my own pocket and 2) This was my one chance with this fund, so it’s best to close it down and start over as I doubt I can get investors to reengage and spend time with me.
My firm has been working with a client for four years that went through such an asset roller coaster. However, in our client’s case, he did not close. In fact, despite a few attractive opportunities to close the fund and join large multimanager firms, our client redoubled its commitment to the marketing process, right-sized the business, focused on performance and, with our help, managed to replace its lost capital, grow assets and develop a strong pipeline of institutional interest. This firm took the rare, difficult route and, instead of closing, dug in and rewarded its investors’ commitment with phenomenal risk adjusted performance.
We’ve reduced a 24-month effort into five lessons instructive for managers both looking to re-engage the marketplace as well as launch new strategies.
- Investors are people: Understand the strong biases at work
Investors are inundated with investment ideas and new “product.” As there is always a new hot launch or spin-out, it is incredibly difficult to reintroduce an “old story.” When they see something that they’ve already seen and made a conclusion about, it is VERY DIFFICULT to change their minds. They are subject to a variation of the often studied confirmation bias and belief perseverance bias whereby they interpret new information that confirms an existing view or where beliefs persist even when they are shown to be false. The mind processes the decision to re-evaluate the opportunity as harder than doing the work on a new fund (which it isn’t) and as a result the strong preference is to pass.
In the course of our outreach we uncovered a segment of the investor population that would routinely say “oh, that fund…they’re____.” Our approach was to quickly determine whether there was room on the margin to introduce some new information to continue the conversation. If not, we moved on.
Lesson #1: Understand that there will be some investors who can’t get there, and move on.
- Refresh the look and methods of investor engagement
An integral part of a re-engagement with the marketplace was providing some visual evidence that something had changed. After four years of version 1.0 of the presentation and tear-sheet, we advocated that the firm refresh and provide visual evidence that reinforced both explicitly and implicitly that change was in the air and the fund was doing something different.
Our client took an additional innovative step of creating a series of short videos covering the history of the firm, an introduction to the portfolio manager and a detailed discussion of the firm’s strategy and trading ideas. On a monthly basis the team shoots a five to seven minute video during which the PM covers the main performance drivers and any strategic updates.
It proved to be an incredibly effective tool to efficiently educate the investor community. Ahead of all introductory meetings, investors can now watch the PM explain the strategy. As a result, potential partners arrive at the meetings better prepared (and with more detailed questions) than was previously possible when given only a static pitch book.
There are numerous fintech tools where video and investment ideas can be placed to broaden the audience. Our client selectively posted on a few and received a positive response.
Lesson #2: Investors need a reason to revisit. Provide them one by refreshing the look and feel and by using innovative means to help them understand your strategy.
- Actively identify new targets, and be open to new structures
During the 18 months that our client went from $25 million to $200 million, we introduced the firm’s story to a range of institutional investors through 1:1 meetings and group events throughout the country. However, we were most successful through highly targeted introductions to investors that had articulated a specific interest to the firm’s strategy.
Motivated solely by trying to treat all investors fairly, our client had charged one fee structure and had not yet accepted managed accounts. We realized that, while equitable, this structure was limiting. We concluded that managed accounts, if structured so that the fund investors would not be adversely or unfairly impacted, we would consider it. We identified and introduced a pension fund which allocated $25 million via a managed account (with $100 million in capacity) at the same fee terms as the fund investors. The addition of a top pension fund provided welcomed stability and diversity to the shareholder base and long-term investors were supportive.
Once they brought in their first non-LP investment, the firm was open to other creative structures provided that they did not disadvantage the existing LPs. In the past year the firm has structured special purpose vehicles around single name positions and also contemplated long-only carve-outs of their core strategy.
Lesson #3: Aggressively introduce the strategy to new investors and be open to revisiting existing structures.
- Take the high road: Explain, don’t blame
I sympathized with my client when they were routinely told “too small” while investors piled into funds with far shorter (or non-existent) track records during a six-year bull market. We always took the high road and did not engage in the blame/responsibility asymmetry that is too often observed in our industry (i.e., if we’re up, we’re smart and if we’re down, it’s the market).
Rather, we embraced the firm’s track record – uneven asset trajectory and all – and calmly explained the root causes behind such a precipitous fall in AUM. In the case of our client, history was our friend as they had a track record and delivered positive performance in 2008. We were able to differentiate the story from new launches by providing evidence and reminding our audience that track records matter, especially during the 2007-2008 boom-bust of the financial crisis. The long, demonstrated history of positive performance and downside protection became the core marketing message and we were able to slowly move people beyond the headline AUM “volatility.”
Lesson #4: Don’t get negative or blame outside forces. Focus on your strengths and true areas of differentiation.
- Keep your team focused on the future
Make sure your team is forward-facing rather than nostalgic for old glories. You may have to have some difficult conversations about where people’s goals and foci lie. Our client hired an enthusiastic group unencumbered by the memory of past successes. It was easier to make introductory calls to investors and revisit old prospects as the team was focused entirely on the current portfolio and performance.
We applied the same philosophy to external intermediaries and service providers. They focused on relationships with partners who were motivated to help the fund in its current situation.
Lesson #5: Have fresh perspective and a motivated team – internal and external – to drive the effort.
Andrew Saunders, CAIA, is a co-founder and senior managing director at Castle Hill Capital Partners, Inc., a broker-dealer and strategic marketing advisor based in New York.