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Hedge funds need at least $250m in AUM to garner institutional investor attention

INVESTMENT INDUSTRY INSIGHTS  | 

At RSM’s Fifth Annual Investment Industry Summit, which took place on Wednesday, September 18, 2013, at Convene Midtown West in New York City, the panel discussion, titled “Institutional Acceptance,” discussed how higher institutional standards have made it harder for investment advisors to receive institutional allocations, and what managers need to consider when trying to attract this capital. The session was moderated by RSM Partner Alan Alzfan, and the trio of panelists included: Chris Kundro, senior vice president, co-head global fund services, Wells Fargo Corporate Trust Services; Geoffrey Bradshaw-Mack, senior managing director, North American Practice, Far Hills Group; and C. Krishna Prasad, senior managing director-head of alternatives product management, asset management, TIAA-CREF.

Among some of the areas discussed were: the importance of an investment adviser’s assets under management (AUM) to an institution, and if it could be flexible, based on strategy; the significance of an advisor abiding by its core strategy; why managers need to invest money in a strong internal infrastructure; and finally, concluded, by letting the audience know the allocation process can be lengthy, taking up to a year, on average.

How important is the AUM of an adviser to attract institutions?

Panelists concurred that an investment advisor’s AUM is generally a key factor when looking to gain institutional allocators, although there could be exceptions. Certain advisors can be successful with a lower level of AUM, but they must be prepared to explain this to the investor. As a general rule, advisors will need to have at least $250 million in AUM to attract institutional investors, arguing this threshold will cover their expenses, and provide the robust internal infrastructure that allocators have demanded since the latest global financial crisis. Also, since institutions tend to make larger allocations, it can keep them from being a too-large percentage of the fund.

Bradshaw-Mack was one panelist who attributed the importance of a manager's AUM to the shift in the balance of power institutions have gained since the 2008 crisis, requiring hedge funds to have a certain dollar amount before even considering them for an investment.

“Institutions are playing a larger and larger role in the amount of capital being placed to the hedge funds, and it is becoming very very difficult for the small boutique firms to break in,” he said. “The big are getting bigger, which is no surprise there, and the multi-billion dollar funds are sucking up a lot of capital out there, and so, if you are a boutique firm trying to make that jump to the institutional level, it is a lot harder than it was four years ago.”

Do hedge funds need to adhere to their core strategy?

Just as important as the AUM requirements, panelists emphasized the need for managers to stick to their core strategy, and further, being mindful that the AUM is suitable for the respective strategy.

Prasad specifically told attendees that an advisor must do this to prove to investors they have a legitimate business.

“The more focused you are, the more you can convey that to investors, the more comfort you get,” he said.

Furthermore, panelists suggested that advisors, in addition to the investor presentations, should have a business plan that clearly documents their investment thesis in a way that is easy for allocators to understand.

Managers need to invest in an internal robust infrastructure

Following the global financial crisis, institutions have required hedge funds to have a strong robust internal infrastructure, which has increased managers' operational costs, hence making the $250 million AUM figure inherently essential. Specifically, regulatory requirements, including filing Form PF and having to boost their employee head count for dedicated operational and compliance roles, to name a couple, have added to their expenses.

"I think investors six, seven years ago barely knew what operational costs were, and now they want specific reporting coming from the fund, in terms of liquidity reports, in terms of exposure reports, so there are quite a lot of expenses that are coming in, and these expenses will continue to go up," Kundro said.

Kundro further suggested that just like advisors put together an investment pitch book, they should prepare an operational pitch book for institutions, which would include an Alternative Investment Management Association (AIMA) questionnaire, for example.

Furthermore, while some hedge funds have responded to institutional requirements by adding staff to enhance their infrastructure, others have opted to outsource many components of their operations, and panelists urge delegates to closely monitor their outside service providers.

The panel concluded that it is more difficult for a small to mid-sized advisor to gain a capital allocation from an institutional investor. Managers need to be aware that having an appropriate level of AUM, having a focused investment strategy, having a proper operational infrastructure are key to the process. Alzfan concluded the panel by reminding the audience that “remember this is going to be a long process, starting with an institution watching your performance, initial meetings and a due diligence process and then another waiting period. The process will be long and can take up to a year or even longer, so you have to be patient”.

For more information please contact a RSM professional or Alan Alzfan, Partner, 212.372.1380