Washington calls it the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If you’re starting a hedge fund or if you’re in the business of hedge fund marketing, you can call it largely irrelevant.

The 2,319-pager shoots buckshot at the financial industry and, of its 16 titles, only one has a bead on hedge fund marketing or operations.

Registration in that Legislation?

Source: Reuters

Title IV is headlined, “Regulation of Advisers to Hedge Funds and Others” and it begins by providing a so-called “short title”.

“This title may be cited as the ‘Private Fund Investment Advisers Registration Act of 2010’,” the law states. In other words, you have Senator Dodd’s and Congressman Frank’s permission to shorten the title’s name from an eight-word string to an entirely different eight-word string.

And that may be the clearest thing it says for the next 27 pages. The short name begs the question from anyone even thinking of starting a hedge fund, “Do I have to register?” The answer is about as clear as Chris Dodd’s mortgage terms.
“In general, if you have between 25 million and 100 million dollars [in assets under management], then you’re going to have to register in your state, unless your state does not have an exam requirement,” parses Judy Gross, a securities lawyer and principal of New York-based JG Advisory Services.

“If you are required to register in more than 15 states, then you may register with the SEC instead of the states if you are in that dollar range for AUM. If you have over 100 million dollars AUM, then you’re going to register with the SEC unless you are below 150 million and you only advise private funds.”

She further cautions that the states play a complicated but critical part in the registration landscape. “There are some big exemptions in certain states,” she says. “Every single state has a different law. You should check your own.”
Some of the states, Gross notes, may require a licensing examination as part of the registration process, although the federal government does not.

Still, registration at the federal level is still a moving target. The law doesn’t go into effect until July 21, 2011, so the SEC recognizes the need to have the gray areas cleared up by then.

“We’re in the beginning of the process of writing rules,” an SEC spokesman said.

These rules-in-progress aren’t all about registration. The law also affects record keeping, reporting requirements, short-selling and the treatment of foreign-domiciled investment advisors. Until the commission’s staff has written the rules, invited public comment and promulgated final versions, hedge fund managers will have little to go on to determine their compliance requirements. But all these stipulations appear to be taking a back seat to the registration requirements, which are likely to be dealt with first. Not that these aren’t things to be concerned about, but it’s way too soon to panic just yet.

Another proviso of Title IV ties hedge funds to the law’s overarching mandate to limit systemic risk, something that the federal government has never attempted to do before. It brings hedge funds under the purview of the Financial Stability Oversight Council, which other provisions of the law created to regulate non-bank actors like the ones who brought you the 2008-2009 meltdown.

The council could, in the interest of preventing a repeat, call upon financial services firms on a case-by-case basis to increase the frequency and detail of their reporting or to firm up its capital reserves. But let’s remember why the council was dreamed up in the first place: AIG, Bernie Madoff, and other captains of infamy. We’re talking about people who could take tens of billions of dollars out of the U.S. economy through sheer carelessness. Whether you’re just now starting a hedge fund or whether you’ve been in the industry long enough to have owned a cell phone that was the size your computer is now, you’re probably too small to fry.

Aside from Title IV, there’s only one other section of Dodd-Frank that has anything to do with hedge funds. One section of Title VI, “Improvements to Regulation of Bank and Savings Association Holding Companies and Deposit Institutions,” prohibits banks from owning hedge funds. The real purpose of this section is to get the banks from doing the kind of proprietary trades that smack of conflict of interest. The ownership-of-hedge-funds prohibition is there mainly to ensure that the banks don’t have a back door into that business. But since very few people who ever dreamed of starting a hedge fund wanted to do it as an employee of a bank, this isn’t too hard to swallow either.

Dodd-Frank and Hedge Fund Marketing

The only potential impact the new law might have on hedge fund marketing is around what constitutes an accredited investor. Essentially, you used to be able to count the value of your house to claim to be a millionaire and thus an accredited investor.

“The accredited investor definition went from including the house in net worth to excluding the house in net worth,” says Evan Rapoport, CEO of HedgeCo Securities, a West Palm Beach-based broker-dealer that markets hedge funds. The law “didn’t have much of an effect on how third-party marketers work. Almost all the clients we deal with are well above that net worth threshold.”

According to Rapoport, the real estate crash did more to take these borderline cases off hedge fund marketing professionals’ radars than Dodd-Frank is likely to. In 2007, it was hard to find a homeowner in the northeastern United States or California who couldn’t qualify.

“Every plumber in the world could have been an accredited investor,” Rapoport reminisced.

As for the truly wealthy investors, their memories tend to be quite long-term. They don’t need an act of Congress to tell them how to avoid making the same mistake twice. If you’re starting a hedge fund, you would have been well-advised to get registered under some other aegis even if Dodd-Frank hadn’t passed.

“Many investors were already looking for [a registered investment adviser] before the legislation came up,” Gross says.

The hedge fund industry has been through a time of great change since the market crisis and the institutional sector has become increasingly important to the industry since this time. In August 2010, Preqin released the findings of its latest institutional investor survey.

Preqin probed 50 institutional investors on their hedge fund plans for the next 12 months, intentions for the asset class over the longer term and general satisfaction with hedge funds returns.

Despite a slight drop in investor satisfaction in hedge fund returns over the past 12 months, institutional investors are beginning to invest more capital in hedge funds in greater numbers than they were a year ago. With 29% of institutional investors planning to allocate more capital to hedge funds in the next 12 months and just 15% looking to make cuts, the balance of inflows into the asset class is positive.

Furthermore, 37% of institutional investors are planning to add new funds to their portfolio in the next 12 months and are actively seeking relationships with new fund managers. Long/short equity and global macro funds look set to be the biggest winners of institutional mandates over the next 12 months with these being the strategies most commonly cited by the institutional respondents as the most attractive over the course of the next year.

The long-term outlook for the asset class is even more positive, with 46% of investors planning to increase their exposure to hedge funds over the next three to five years.

It is clear that institutional investors still believe hedge fund investments are a valuable part of their portfolios. Recovery in terms of asset flows into the industry has already begun and the Preqin survey suggests it is likely to increase steadily over the medium to long term.

Preqin’s Investor Profiles products and services provide a comprehensive view of investors in alternative assets. They have profiles for over 4,500 investor institutions worldwide. Preqin analysts reach out to institutional investors from around the world to ensure our information is up to date. They also monitor news sources and regulatory filings to keep their resources current.

In a time of increased redemptions and closures, the hedge fund industry is facing difficult challenges. How to retain and raise assets has become a widespread concern on both sides of the Atlantic. Hedge fund standards are an important element in this conversation.

In the face of this commercial challenge lies the reality of imminent regulation and unavoidable compliance cost that will be levied against the bottom line of an already bruised and battered industry.

Three years on and still in the midst of the greatest global recession since the 1930s it seems an appropriate time to re-evaluate the importance of the standards of the Hedge Fund Standards Board (HFSB) in the EU and the President’s Working Group (PWG) in the US and how they can help rather than hinder in these difficult times for the hedge fund industry in the marketing effort.

Background to the HFSB and PWG and Summary of the Standards

The HFSB, as the custodian to the standards (Standards) formulated by the Hedge Fund Working Group, was established in 2007 with a membership of 14 leading hedge fund managers, most of which are UK-based. Currently this number stands at over 60 and includes several overseas hedge fund managers. As a custodian to the Standards, the HFSB has the mandate of updating the Standards as the industry evolves and faces new challenges.

The Standards entrusted to the HFSB number 28 in total and cover disclosure, valuation, risk management, fund governance, and shareholder conduct.

The PWG includes the heads of the U.S. Treasury Department, the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission. In 2008 a set of Best Practices were formulated that would act as a guide to the hedge fund industry in the US.

The Best Practices were separated into two groups. The Best Practices for asset managers call on hedge funds to adopt comprehensive standards in all aspects of their business, including the critical areas of disclosure, valuation of assets, risk management, business operations, compliance and conflicts of interest. The Best Practices for investors include a Fiduciary’s Guide and an Investor’s Guide.

In this article, we refer to both HFSB Standards and PWG Best Practices as “Standards”.

Learning from the Past

Many of the political concerns surrounding hedge funds emanate from debacles such as Long Term Capital Management, Amaranth and more recently Madoff. However, in adopting the Standards, investors should be comforted that those hedge fund managers that have adopted the Standards will not place themselves in such a situation or that such a debacle could or would occur within their walls.

Therefore, when asking the question if a set of standards will help hedge funds during these times of economic crisis, the answer must be yes, because they will benefit investors by providing a certain level of comfort against mismanagement or fraudulent valuation of their investment.

However, for those in the UK it must be remembered that the HFSB is an industry construct and not a supervisory body and just because a hedge fund manager has voluntarily adopted the Standards and attested to conformity, that does not mean that they actually do conform to the Standards or that they will not knowingly or negligently breach them in the future.

The PWG has its origins in the Treasury and is therefore set up under legislation and its status is fundamentally different to that of the HFSB.

Helping Through Windy Times

As hedge fund managers formulate strategies to retain and raise assets under management, the Standards must be seen as a positive tool through which this objective can be achieved. In windy weather a kite without string to hold it will paradoxically fall to the ground rather than fly higher.

Although important, it is not the wind that is the most important to making it fly. It is also not the kite itself that is the most important. The most important factor in a kite flying is the string that gives stability to the kite and prevents it from crashing to the ground. It does not restrict but rather facilitates the kite flying.

This is what the Standards can do for a hedge fund manager during windy times. By having appropriate disclosures, valuation procedures, risk management practices, fund governance and standards on shareholder conduct, they can act as the string that prevents them from blowing away or falling to the ground. As a “kitemark” the Standards will signify to prospective investors that a hedge fund manager has achieved, and is voluntarily abiding by, predefined and accepted standards of conduct.

Nobody ever describes the string of a kite as being restrictive because it is the manner by which the kite is able to majestically fly. However, this may be different if the string was substituted with a rope or chain. Similarly, the Standards should be seen as appropriate, analogous to the string and not the rope or chain.

The Upside of Standards

Surviving the storms of the current economic crisis is no doubt on the minds of every hedge fund manager. Retaining and raising assets is central to this survival.

By adopting the Standards, investors gain confidence that certain standards and best practices are being achieved and maintained by the hedge fund manager.  In essence the investor will be assured that there is a piece of string keeping the kite flying.

This is part of being a good capital markets citizen and should be at the forefront of every hedge fund manager’s mind in formulating strategy as the hedge fund industry forges its way through the current economic crisis. This should also be on the mind of every marketing manager who maintains a focus of retaining and raising assets.

About the Author

Thomas Bullman is the founder of The Hedge Fund Society and the Hedge Fund College and a noted resource regarding regulatory concepts, implications, and current developments within the hedge fund industry in both the European Union and United States.

You may have heard of a mythical creature called a finder or hedge fund placement agent – somebody, not otherwise connected to the financial industry, who can help you with starting a hedge fund by introducing you to wealthy friends. In return for this informal assistance with hedge fund marketing, you would pay this finder a prearranged fee.

It’s all perfectly legal. The Securities & Exchange Commission allows it, and has since at least the early 1990s and probably since the late 1970s.

But few people have ever heard of it actually happening.

“I’ve never encountered a finder in my entire professional career,” says hedge fund attorney Ron Geffner, a partner with New York-based Sadis & Goldberg. “It’s a mythical being. It’s like a unicorn.”

Once upon a time

Such was not always the case.  During the dot-com bubble, when starting a hedge fund first came into vogue, there were a lot of people with a lot of money and little idea of what to do with it. According to contemporary press reports, finders – also called placement agents – could provide names and phone numbers of acquaintances with money to invest, but had to steer clear of anything else resembling hedge fund marketing: making material, non-public disclosures; negotiating sales; preparing documents and so on.

There was probably never a plethora of finders involved in hedge fund marketing. Their role has always been eclipsed by broker-dealers governed by the Securities Exchange Act of 1934 who, assuming they see more than $25 million/year in volume, are registered with the SEC.

“Sometimes you can easily determine if someone is a broker. For instance, a person who executes transactions for others on a securities exchange clearly is a broker,” an SEC spokesman commented via email. “However, other situations are less clear.”

According to the SEC, “a number of factors,” which were not enumerated, govern whether or not a finder has to register with the SEC, and hedge fund marketing is one of those activities that the SEC looks at, as is serving as a placement agent for private equity. And they specifically call out anyone who puts “Consultant” on their business cards.

But what if a nice guy is simply trying to help out a friend who’s starting a hedge fund by providing the phone number of someone else who’s looking to invest in one? What if Mr. Nice Guy already made his money doing something else besides hedge fund marketing and has no interest in spending tens of thousands of dollars registering with the SEC, then spend weeks studying for the NASD Series 7 and Series 65 exams?

You’d think that the issue would have been settled by the leading financial minds who rule over Wall Street. But actually, it was settled by multi-platinum, Grammy-winning singer-songwriter Paul Anka.

source: SaturdayEveningPost.com

“Suddenly, it’s hard to find”

In May 1991, Anka was approached by associates who owned the Ottawa Senators hockey team. They were looking to sell limited partnerships in two classes and, in addition to hoping he himself would buy a stake (he did), they were willing to pay him ten percent of any proceeds coming from his wealthy individuals whose names came out of his Rolodex. (Anka, originally from Canada, is a die-hard hockey fan.)

That up-front percentage is what’s really attractive to a fund.

“A finder takes a one-time fee and only makes money when money is raised,” says Andrew Schneider, managing partner of West Palm Beach-based portal site HedgeCo, who is skeptical that there are any finders still hovering around the industry. “A third-party marketer gets paid an ongoing fee for the life of the investment.”

Anka was assured that this was completely on the up-and-up and he wouldn’t have to go through the hassle of registration, because the SEC had previously reviewed a similar arrangement approving a finder’s fee for non-brokers referring friends to potentially purchase condos in Hawaii. Unconvinced, Anka’s lawyers requested and received from the SEC a no-action letter.

It’s unclear how successful Anka was at helping the Senators raise capital, but it is now a settled regulatory exemption with nearly 20 years of effect.

It goes far enough back – how quaint it is that it doesn’t refer to email addresses or web sites – that the SEC spokesman was unable to find the no-action letter in a government database and a reporter had to locate it in a legal text. The letter cites at least three precedents going back to 1978. But because nobody ever heard of Victoria Bancroft, John DiMeno or Carl L. Feinstock, the exemption is called “the Anka rule”.

Specifically, the letter indicated that the finder will not:

• Prepare financial data, sales literature or any other materials,
• Distribute such materials,
• Perform independent analysis of the sale,
• Engage in due diligence,
• Arrange financing,
• Provide advice or
• Actually, physically handle any of the money or shares.

Rather, Anka agreed to just introduce potential accredited investors to the Senators, tell them what the securities’ unit prices were and disclose his own personal interest – his own stake in the enterprise as well as his right to receive a finder’s fee.

“Accredited investor” is a technical hedge fund term: the kind of wealthy individual or well-capitalized institutions covered under Regulation D of the Securities Act of 1933 – exactly the kind of investor that anyone engaged in hedge fund marketing is looking for.

At a recent hedge fund marketing conference sponsored by HedgeCo, panelists discussed how the Anka Rule would be as applicable to investment companies as to any tenant-in-common arrangement, such as limited partnerships or condos.

As far as the SEC is concerned, then, using a non-registered, non-licensed finder is completely legal.  So why would a finder, if one is around, relate most closely with, of all Anka’s four-decade catalog of hits, “Lonely Boy”?

It’s because the SEC doesn’t have the last word.  State regulators might not necessarily accept such arrangements as kindly. The state-by-state patchwork of licensure requirements is difficult to navigate, and even the most business-friendly of states, Utah for example, have pushed back.

Those interested in starting a hedge fund with the money of friends-of-friends may be well advised to see what the specific state regulations are governing their own situations and those of their prospective finders and investors.

Otherwise our mythological finder, Mr. Nice Guy, needs to be very careful how he accepts his friends’ gratitude.

Here is part two or our interview with Jerry Chrisphonte, CEO of HedgeFundDirectories.net, describing best practices in hedge fund marketing.

HFMA: Let’s say you are a service provider marketing to hedge funds and looking for a hedge fund database, what are some of the best practices for using a database in that marketing effort?

Chrisphonte: A really good question.  I was actually talking about this yesterday with a potential client that we were speaking to. Obviously, when you’re doing e-mail campaigns or when you’re reaching out to fund managers or senior-level executives within a hedge fund, you have to keep in mind a couple of things.  You know, you’re not the only person trying to reach out to them.  And more importantly than that, their time is very scarce and you really want to have a relevant message when you approach them.

So I think some of the best practices when using one of these type of databases or directories is really having a plan when you approach the campaign.  So for example, if you wanted to do kind of an outreach campaign to fixed income single managers in the U.S. and Europe, one I would do is I’d polish that list so you’re making sure you’re excluding all those funds that are non-fixed income.

Taking this a step further, where you’re not just doing an e-mail blast or an e-mail campaign, which is kind of cold and usually won’t get a very good response, but perhaps warming that up with taking a look at LinkedIn, seeing which one of those contacts or fund managers or principals would be in your network by a series of connections, warming up that lead through your network, and then after that maybe having an initial phone call and then following up that phone call with a bit of information in the form of an e-mail.

We’ve just noticed that the users of our service that kind of take a warmer approach or really kind of take the time to use their network and really build relationships, as opposed to kind of, hard and fast and, shotgun approaches to marketing really kind of have a better chance at being successful.

HFMA:  So, taking the data from the database, identifying who those targets are, so whatever your segment is that you’re going after, but don’t go broad, go very targeted in that effort. Then identifying, whether it be through LinkedIn or your personal network, “Who do we know here?” or “Who do we know that knows someone here?”

Chrisphonte: Exactly.  Because if you speak to service providers within the hedge fund industry, I’ll tell you, hands-down, far and wide they will tell you the majority of their business comes from their network.  It doesn’t really come from, cold calling or cold marketing or e-mail campaigns; it really does come from their network.

While you’re using a system like ours, it’s great as an aid to your network.  So to help you find out who the new fund manager is at a particular new launch or what the contact details are or an e-mail address if after you become familiar with them you actually can reach out to them, or really kind of help things along in the process or maybe kind of kick-start a campaign that might need some help.  But you’re always going to have to do some warming up, you’re always going to have to do some follow-up.  You should always do maybe some calls or some reach-out activity after that type of a campaign as well.

HFMA:  And what about also looking for other clues as to what might be going on at the firm?  So for instance, if they’re hiring for a particular position, where maybe they’ve got a new challenge that they haven’t had to hire for in the past and now they’re looking at it and saying, “You know, we really need to get somebody on board to handle,” whether it be the risk management side, be the technology side, it could be any one of the areas.  What about looking at things like that, where you say, “As a service provider we provide a service that fits with that.  We should be calling these guys”?

Chrisphonte: You said it.  So one of the main things that any salesman or any hedge fund marketing professional should be doing is really getting your hands around what’s going on in the industry as a whole.  So even myself, being in the industry, I get constant news feeds coming from Google, when we have kind of a hedge fund keyword search coming back to us, we get information from, Reuters news stories, publicly-available kind of daily newsletters within the hedge fund industry and we get all these to our inboxes.  So me and my team here, we’re constantly reading up on changes in the industry, people that are starting at new firms, new firms that are kind of going under, new firms that are launching.  And really we have to be involved in the industry; we have to really care about what’s going on, what changes are affecting us, and really kind of reaching out and trying to solve those peoples’ kinds of needs and wants and concerns.

HFMA: That’s good advice for both the service provider as well as the third-party marketer?

Chrisphonte: Yeah, of course.

HFMA: Because the third-party marketer is looking for firms with certain activity, right, to be sort of the triggers for them to say this would be a good time for us to be talking to them.

Chrisphonte: And I think in the third party marketing sense I have a couple of good colleagues that are in the marketing industry that are third-party marketers, it’s really one of those magical mixes if you’re going to become a third-party marketer for a hedge fund.  Because you really do have to have a solid network of investors and really kind of the right investors for that particular hedge fund, because they are very selective in terms of what investors they like to work with and they are very picky in terms of what type of criteria, what type of minimum investment, what type of, lock-up periods they like to kind of impose on a new investor.

So it’s really kind of a magical mix finding a third-party marketer that has the right network, as well as has kind of the negotiation, the kind of pull power to kind of get the capital in.

HFMA:  All right, now from the perspective of somebody looking at a hedge fund database, what are your thoughts – what are the things they should be considering when they’re evaluating hedge fund database providers?

Chrisphonte: Yeah, that’s a good question and probably a good point.  You know, I’ve been in this space for five years – well, five years on with Hedge Fund Intelligence, so more like seven years now working for myself, I’m just going to clarify one thing.  There are databases and there are directories.  So, differentiating what you need.

If you’re an investor that’s looking to track hedge fund performance, really get a sense for just kind of maybe the top three executives or who the fund manager is, who one of the principals are, maybe who the owner is, and you really need to track strategies, assets under management on a monthly basis, and really get a sense for how the fund is doing as a potential investor, you’d be looking more towards a database.  There are tons of hedge fund databases out there and tons of solutions to help you kind of mash these databases together so that you can really have a solid solution in terms of a database provider.

On the other hand, there are directories which are more geared towards sales and marketing professionals within the industry.  There are only a handful of providers out there.  And what you really want to do when you’re looking at a directory provider is a couple of key things.  You want to get a sense for how they collect their information, how often they update their information.  Another main thing you want to get a sense for is how they cleanse the data, so what’s the process by which they remove inaccurate and older contacts and what’s the process by which they add and pull in new contacts, whether it’s domestically or internationally.

So really just to kind of recap on that, so number one, getting a sense for whether or not you need an investor-focused database that tracks performance, and really kind of data points focus on investors in the industry, or whether you’re a service provider or sales professional that needs directory contact information to reach out to these professionals directly, they will give you typically more contacts per firm, and also will usually provide you with a phone number and an e-mail per contact.

And another point to bring in as well, when newcomers to the industry come in looking at database and directories it’s a bit overwhelming because there are tons of products out there; you really don’t know what is what and what you’re getting with what.  One of the main things you want to take a look at when evaluating the databases or directories is really how they list.  So what I mean by that is whether they list as a fund management company or as an individual fund.  And what I mean by that is take, for example, AQR Capital.  The management company, so the entity that runs their funds may have 200 employees that work across their six or seven different funds.

An investor-focused product will list each individual fund out, so if they have a U.S. version, a European version, a fixed income fund and an arbitrage fund, each fund will have their own contact details, their own fund manager, and their own kind of performance, which is a bit redundant for a marketer, yet for an investor it’s perfect because you are investing in that individual fund.  For a marketer you really want to look as a top-down approach, looking at the company and saying, “All right, for AQR, who are the principals, who are the C-level executives, and who are the kind of contacts of interest to me, and what are their contact details?”  So those are the kind of differences to really keep in mind when you’re evaluating one of these types of services.

Want more on hedge fund marketing best practices?  You can listen to the entire Hedge Fund Marketing Best Practices Interview

About HedgeFundDirectories.net

Gain access to the largest global hedge fund directory dedicated to the Hedge Fund industry; with over 3000 management companies encompassing upwards of 40,000 unique hedge fund and fund of funds contacts. HFD is perhaps the largest community of its kind dedicated to intelligently sourcing contacts within the hedge fund industry.  HFD is unique in that it was developed primarily for hedge fund marketing and sales.

Recently we had the pleasure of interviewing Jerry Chrisphonte, CEO of Hedge FundDirectories.net, to talk about the hedge fund marketing and hedge fund directories.  He provides some solid insight for investment marketers. Here is an excerpt from part one of that interview.

HFMA:  Before we start talking about the industry, maybe you could just give us a little bit of background on you and how you ended up with HedgeFundDirectories.net?

Chrisphonte:  Sure.  So I’ve been in the industry for a bit over five years now, and my initial start was with a company owned by Euromoney called Hedge Fund Intelligence….  This is where I really learned kind of what investors in the industry were looking for, what marketers were looking for in the industry, as well as what hedge funds themselves were looking to get out of listening to these databases and really kind of using the data that we provided.

HFMA:    And then the move over to Hedge Fund Directories?

Chrisphonte: So that transition really happened after about four years with Hedge Fund Intelligence.  We didn’t really sell a directory product, so I had my demonstrations with service providers to the industry.  While the majority of the products that were in the industry were geared towards investors in this space, so more tracking hedge fund performance details, tracking, prime brokers, orders, administrators, and really kind of investor-focused data points, there was really nothing for a service provider to the industry or a technology firm or a recruiter or a prime broker that really just wanted to maybe sell into the industry specifically, as opposed to really reaching out for all of those excess details that they didn’t need, so we created it.

And opposed to just kind of putting something out there that was good, we really took a community approach to developing a system where individual sales and marketing professionals could come together and buy and trade their hedge fund contacts in one place.  And what we’ve done is successfully put together a research team that scours the Internet, scours hedge fund blogs, hedge fund newsletters, sites like LinkedIn, Facebook, social networking sites, as well as registered filing authorities like the SEC and FSA.  So we’re really going to get a sense for on a global scale who is in the industry, as well as keep track of people moves, when someone moves from one hedge fund to another hedge fund.

HFMA:    Now, it sounds like the application is almost a vertical application of Jigsaw.com.

Chrisphonte: Yeah, you nailed it.  I love it when people understand what Jigsaw is, because that really makes my explaining of what we do here a lot easier.  So essentially what Jigsaw is exactly that, it’s just really a community where people can buy and trade their contacts on kind of more of a domestic scale.  But what we’ve done is we’ve just kind of taken that type of a model and really kind of honed it down just to the hedge fund industry and expanded it on a global scale, where people can buy and trade their hedge fund contacts in one place.  And we only do hedge fund contacts; we don’t look really outside of that.

HFMA: Let’s talk about the industry and what’s happening in hedge fund marketing right now.  What do you see happening?  What do you see changing?

Chrisphonte: Well, some of the key changes are, obviously with kind of the crash in the markets there have been some systematic changes in the way marketers are going to be able to approach hedge funds.  When the boom was going, there were tons of deals to be had within the hedge fund industry, and I think what you’re seeing now is, one, when the markets crashed hedge funds were a bit tighter with cash, adding on new services was less likely.  And I think now, when things are starting to rebound a bit, hedge funds are looking back at adding in different prime broker or maybe switching up the recruiter or maybe kind of looking to outside service providers for additional services now.

What I think is going to happen in the future, I know just with the size of hedge funds, their assets are steadily increasing, as opposed to fund-of-funds taking the lion’s share of investor capital.  It’s moving towards investors really kind of doing the due diligence themselves and really kind of starting to invest in single manager hedge funds themselves.

This is great for a couple of reasons, because single manager hedge funds will be able to kind of have that cash to reinvest and obviously try new technologies as well as try new systems, and obviously the service providers will benefit from that as well.  And companies like us will benefit from that, being that service providers will need those direct contact details.

HFMA: And when you think about hedge fund managers, what makes them stand out?  What makes them marketable in an environment like we have today?

Chrisphonte: Good question.  I think some of the main things that a hedge fund manager really has to be nowadays to really kind of stand out amongst the fray.  And obviously, breaking down hedge fund managers, there are three main tiers of hedge fund managers; so we have the new fund start-ups and the new fund launches that obviously are being written about, and then you have kind of the mid-tier guys, anywhere from $250 million to $750 million, and then you really get the $750 million and above managers, so really kind of the star players in the industry.

On a global scale I think there are maybe 400 to 420 billion-dollar funds.  So there really aren’t that many out there.  And if you look at kind of the kind of percentage of assets within those billion-dollar funds, they take up about 70 to 75 percent of the assets in the industry.

So I guess just taking a look at what makes a manager marketable, number one, trying to get your assets up to a space where an institutional investor or a larger investor wouldn’t feel like they’re kind of investing, into your portfolio and they became a majority stake or a majority percentage of your assets.  So one, getting your assets up to par.

Two, track record.  Obviously investors want to see historical returns, they want to see that, you’ve kind of weathered the climate of ups and downs successfully.  And then I think three goes really back into principal backgrounds and kind of, their own personal investment in the firm.

HFMA:  Now, one of the things that we’ve been hearing is that if you are starting out and you really need more than what you can raise just from the friends and family, you might want to take a different approach.  In other words people are saying, “Look, if you can’t get going with just your friends and family money, don’t bother.”  What’s your thought?

Chrisphonte: Okay… there’s two sides to that argument.  If you can’t get going with the capital that you have on hand it’s going to become extremely hard to get investors excited about your offering.  It’s really hard to get new investors onboard.  Even if you worked with a third-party marketing firm or you really had extensive contacts in the industry, when it comes to investors, a lot of the institutional investors and larger pension firms, their hands are really tied in terms of how much of their portfolio can be allocated to a smaller fund.

It’s really taking a risk with that new manager.  The appetite for risk right now wouldn’t be the highest, just because of what’s happened lately.  So I really think if you don’t have the capital to really get to a decent size, where a larger investor would be considered or be looking to invest in a hedge fund of your size it might not make sense.

On the other hand, if you have the potential to grow – so for example, there are kind of star traders or star fund managers that are rolling out of these billion-dollar funds where they’re launching a brand new firm and they’ve maybe taken some of their colleagues that have worked with them in the past and they do kind of have a track record on hand, even if they don’t have the assets to begin, those type of contacts would still make sense for them to be in the industry.

They’re not just kind of a new kid on the block, they really do have a track record, they’ve worked at a billion-dollar fund, they’re used to managing those types of assets, and if they transition into their own fund it’s really kind of the network that they already had, where they were really kind of using those network connections.

And chances are as long as the performance, stays in line or does well, they should have an easier time raising assets than maybe a newer guy.

Stay tuned for part two of our interview next week where we discuss hedge fund databases and directory best practices.

Want to hear more? You can listen to the entire Hedge Fund Marketing Best Practices Interview

About HedgeFundDirectories.net

Gain access to the largest global hedge fund directory dedicated to the Hedge Fund industry; with over 3000 management companies encompassing upwards of 40,000 unique hedge fund and fund of funds contacts. HFD is perhaps the largest community of its kind dedicated to intelligently sourcing contacts within the hedge fund industry.  HFD is unique in that it was developed primarily for hedge fund marketing and sales.

Institutional investors are swapping funds of funds for direct hedge fund investments.

Preqin surveyed 50 global investors from a wide range of institutions including public and private sector pension funds asset managers, insurance companies, banks, foundations, family offices and endowments, to gather information about their hedge fund portfolios and appetite for funds of hedge funds and single manager hedge funds.

The past two years have seen significant changes within the hedge fund industry. With institutional investors now constituting a considerable proportion of the investors in hedge funds they are shaping the industry as it emerges from the downturn with their demands for transparency, liquidity and better fee terms.

64 percent of all institutional investors make their first investments in the asset class through funds of funds.  Funds of funds remain the vehicle of choice for institutional investors when they take their first footsteps in the asset class.

When new to hedge funds, investors do not have the experience or the necessary understanding to invest in an often confusing and opaque asset class.

Not all investors move to a direct style of investment after years of investment in the asset class. Some institutions stick with funds of funds even as they gain more experience of investing in hedge funds.  Respondents stated the diversification benefits of a multi-manager vehicle, a lack of resource or the use funds of funds to access niche strategies or regions as reasons why they remain active investors in funds of funds.

However, as a general trend, the Preqin hedge fund investor survey reveals that funds of funds become increasingly out of favor with institutional investors as they gain more experience of investing in the asset class. Today just 36 percent of all the surveyed investors still invest in hedge funds solely through multi-manager vehicles. The tipping point seems to be 2008 with 80 percent of the respondents which had moved away from a fund of funds style of investment having done so in the past two years.

A reduction in fees and greater control over their hedge fund portfolios were the two most commonly cited reasons why investors which had previously invested in funds of funds had moved into direct hedge fund investment.

By all accounts, hedge fund investors – always a skeptical lot – have been more circumspect about their chosen fund managers since the Madoff scandal – and the Stanford, Kerviel, Cioffi and Tannin, Greenwood and Walsh, Cosmo, Petters, Nami, Traynor, Jones, and Randolph scandals — came to light over the past couple years.

It’s no longer enough for them to ensure that hedge fund marketing is above board in its representations of investment objectives and historical alpha. They want to know who’s running the money.

This has led to some anecdotal suggestions among hedge fund managers that they’re losing business because potential investors are turning their private lives into a Robert Ludlum novel, hiring retired members of the intelligence community to stake out their private lives and professional dealings for months at a time.

It’s not paranoia if everybody really is out to get you.

When it comes to investors who are wary of shifty operators pretending to be starting a hedge fund, it’s not paranoia. For those entering the world of hedge fund marketing with a spotted past, they should expect all eyes to be on them.

You can’t spell “Ponzi perpetrator” without …

At a recent New York conference organized by West Palm Beach-based portal site HedgeCo, a panel of hedge fund attorneys, administrators and third-party marketers discussed the “New Nervous”.

Based on the discussion, it was clear that the investment community, when performing their hedge fund due diligence, is focused on what’s widely called the Three Ps: performance, process and person.

Performance is well understood: How has this fund — and this fund manager — delivered on money that has already been entrusted? Process is also becoming more important. Investors want to know how these fiduciary miracles occur, or else no sale.

“My money is just as proprietary as your model,” one panelist quipped, taking the point of view of an institutional investor.

Process goes beyond that, though. More and more, investors want to see a separation of the administration and audit functions from the operational functions.

It is not hyperbole to say that incremental money spent on a third-party administrator can be considered money spent on hedge fund marketing — because vanishingly few investors will entrust their money to a manager who lacks independent oversight.

But what concerns many hedge fund managers is the increased focus on people.

Investors have long hired experienced investigators to ferret out misfeasance on the behalf of people who are marketing or starting hedge funds. Bankruptcies, liens and civil judgments are red flags as are, certainly, high crimes and misdemeanors. Also, investigators look into any violations of Securities & Exchange Commission regulations and, not stopping there, at any professional issues a hedge fund manager might have at the state level.

“In most states you need to be licensed.  Any customer complaints, trading infractions or violations [of state law] can show up,” said HedgeCo managing partner Andrew Schneider.  The results can be a devastating star-chamber court in which the accused need not be informed of what he is accused of. “I know someone with $65 million in assets under management and can’t get a hedge fund account [through a broker-dealer]. They don’t have to tell us what [the infraction] is.”

There are many investigator firms who specialize either entirely or in part on the hedge fund industry. One of the premier firms is New York-based Kroll, which relies on data gathered from intelligence sources around the world but doesn’t, as a general rule, send spies to your cul de sac. It generates reports in a nearly instantaneous manner, according to Schneider, who said he never heard of anyone actually being staked out, which is contrary to statements made by at least one of the panelists at the recent conference.

Spies like us

Altegrity, a New York-based firm that recently agreed to buy Krol, is headed up by William Bratton, famed as the New York police chief who took all the bows for cleaning up the city during Rudy Giuliani’s administration. The investigators at Altegrity tend to be, like their boss, former law enforcement officials, not former spies.

That’s according to Randy Schein, president of First Advantage Litigation Consulting, which has nothing to do with litigation consulting. It’s an investigator firm, known as BackTrack Reports back when it was a standalone company, which spends 80 percent of its time looking over hedge fund managers on behalf of institutional investors.

“We take them through a person’s history from college through the present day,” Schein said. “Has this person said anything about themselves in their bio that is untrue – in lawsuits, to the press, in regulatory filings? Have there been disciplinary actions?”

Schein said his reports are delivered in an even-handed, factual tone and are typically just one input into an investment decision.

“We’re not out looking for dirt,” he said. “We don’t tell clients what to do with the information, and we never find out if the client invests or not.”

Because his firm already has a file on just about everybody who has ever started a hedge fund, he only has to update files, so the response is usually in days, not months. The days of hedge fund investigation projects lasting months are long gone.

Recently, we had the opportunity to speak with Laurent Favre, CEO of Alternative Soft, a quantitative hedge fund software solution for portfolio construction, funds selection and tactical asset allocation using hedge fund strategies.

In the interview we cover changes in the hedge fund industry, the outlook for the next few years, and evaluating hedge fund technology providers.

Here is a summary of that interview (with some edits). You can also listen to the entire interview with Laurent Favre.

HFMA:    Before we jump into the interview, maybe you could tell us just a little bit about your background and how you ended up where you are today.

Favre: Okay. So what about my background, I have studied several years at university and several Masters, and then I decided to go and work in a large bank, which was a Swiss bank in Switzerland, where I worked four years.  I was responsible for doing tactical asset allocation long only, where I learned a lot.  And then after four years I decided to switch a bit due to reason incompatibility between the bank and myself. I looked for a job in the hedge fund space, which I found in London, which was in 2005.  But at that time I had launched a small software product that I was able to sell to the largest fund of fund in Switzerland.

So, I had been hired in London in a large bank, running a fund of fund, where I was working for them 50-percent and running as well my company 50-percent.  I did that during four years in London, which was excellent.  And then during the crisis, in 2008 and 2009, then the bank restructured a bit, so they fired some big bosses and other analysts and myself as well.  And then I worked 100-percent for my company since June 2010. And now I’m really happy to do that, because my company is growing at a fast speed.

HFMA: The dedication to the company is really what made it take off?

Favre: Yes. I have always helped people when they helped me. The bank in the U.K., they help me a lot by allowing me to work 50-percent for them, where I was responsible for the full investment process, and 50-percent for my company, which was at that time small.  We were around 8 people at the time and now we are 15.

HFMA: So tell us a little bit about AlternativeSoft.  What do you do?  What does the software do and who are your target clients?

Favre: Okay, the answer is easy.  We sell just the software for fund of hedge fund and banks investing in hedge funds, mutual funds, and ATF. Our software is different because it focuses on extreme downside risks.  Second, our software is easy to use.  Even though you are a big boss in a big bank, you open our software and you know what to do.

HFMA: Okay. Let’s switch gears here and let’s talk about some things that are happening in this industry, and specifically what are some of the changes that you’re seeing in the hedge fund industry?  And what’s your outlook here going forward?

Favre: First what I see is a change. I mean there is nothing clever here because you just need to open your eyes. What we have seen in our investor client needs is more transparency in the hedge funds.  Second is lower fees for the hedge funds.  Third is less leverage.  Fourth is more clients are investing directly in hedge funds.  Before they were investing in fund of funds; now they come to us and say, “Hey, we learned that you allow us to invest – or your software allows us to invest in hedge funds.  How does it work?”  So these guys are coming directly to us.  And the last point is higher liquidity required in hedge funds.

So these are the changes you can see that everybody who is reading a paper or you can see on Bloomberg and CNBC. Now some of these changes will not stay in the future. Because some are an overreaction.

For example, all this high liquidity with this less leverage, this is just overreaction.  It will come back, perhaps not as before.

HFMA: So let’s talk about that.  You’re right, you can pick up The Journal or any one of the financial magazines and read all about these things and of course the buzz about the additional regulation being levied on the hedge funds.  But maybe an overreaction.  So what do you see going forward?

Favre: Excellent question.  Why?  Because it’s important to know that it’s an overreaction. I will give you my outlook for the next three years.  I’m not sure that a lot of guys giving next three years, so just my view.

But what is important to know is that given all the debt we have everywhere in the world except in Asian countries and Germany, and with low interest rates, it’s an excellent time to invest in hedge funds.  This is the first point.  Because they are able to benefit from inefficiency.

So what we see next three years is two categories of hedge funds will emerge, which we see already.  The first category is a category which will look like mutual fund.  In this category we will put what we have today, these 130 and 30, these absolute funds.  And who will invest in them?  Pension funds and banks.  These categories of hedge funds will have lower fees and it will be possible to do large investment.

There is a second category.  This category will be for fund of hedge funds.  There will be less liquidity.  The hedge fund will be smaller. They will be opaque.  They will have higher return and they will have lower correlation to equity than the first category.

I gave you two categories and this differentiation will take time.  Why?  Because it will take 12 months to clean all that, to understand what is the next business model.

HFMA: It’s going to take some time just to sort through the new hedge fund market that we have and the changes that you mentioned earlier. Right?  There’s the ability to report at a higher level of transparency, managing the fact that you’ve got different liquidity requirements.  All of those things from an operational standpoint have to happen first, and I think as firms figure that out, then they’ll be looking at longer-term – what’s the strategy? How are we going to grow the fund? How are we going to attract new investors? You know, what’s our differentiation?

Favre: Exactly the point, differentiation. If you are running a shop now, whatever, it’s a small shop or bank.  What do you offer to invest in?  If you offer fund of fund with UCITS, tell me, what do you offer me?  A bit liquidity, why do you offer me that? Differentiation, it is a business strategy.

HFMA: When somebody is looking at, for instance, your software or any piece of technology for their business, what should they be looking at?  What are the things that they should be considering when they’re evaluating technology providers for their fund?

Favre: First I would say this is not difficult. The first question is does the software answer all my needs?  Okay, yes, so I save the first one.  Now the price, what is the price? Is it $100,000 USD or is it $10,000 USD software?

The third one is when I select the technology provider, what is this technology provider’s annual profit?  Why? Because we have to be sure that the guy is in the business in three years. But if the guy does not know whether UCITS will survive or whether liquid hedge funds will survive, the technology provider does not know where to direct his company, where to develop his software.  So we have to be sure that this technology provider has enough annual profit.

The fourth one is client references. It’s always good to be sure that this technology provider has some big clients. The fifth is what is the speed in delivering new models?  For example, if suddenly UCITS are coming on the market, is the case in three months, there are some database which are providing special data with UCITS funds. Now, the question is how long will it take for this technology provider to update?  If it’s two years, clearly it does not work; you should not go with him.  If it’s two months you should go with him.

And the last one is user-friendliness.  Because when you buy – I’ve seen a lot of times that a fund of funds buys software or technology, which can be simple or really complex. It should not be a burden, it should help you.

I’ve seen some fund of funds buying software, where one guy was working 100-percent of his time on the software, just to input data, nothing automated, and then nothing really was working, it was losing data.  The question is user-friendliness.

HFMA: So, the idea there being if you’re going to make the investment, the only way you’re going to recoup the investment, you’re going to get an ROI, is to make sure that it’s being used as it was designed and on a regular basis.

Favre: Yes. Not only on a regular basis, but it should be easy to use.

HFMA: Well, Laurent, thank you.  We appreciate you investing the time here with us.  Any parting thoughts?  Anything you’d like to say before we sign off here?

Favre: Yes, that the hedge fund industry will increase in the next three years according to my categories, category one and category two.  They will not disappear.

HFMA: So, all the discussion of the additional pressures, those pressures are here, the market will adjust, and you’ll find funds that will thrive in the new market?

Favre: Sure.

To Learn More

Interested in knowing how AlternativeSoft can help your business? Follow this link to learn more about Alternative Soft and their technology solutions.

Effectively US hedge funds will find it next to impossible to market into the European Union.

When two Bear Stearns hedge funds collapsed in June and July of 2007, the resulting questioning of the safety of investing in hedge funds created an initial political motivation for regulating the industry, especially the issue of hedge fund marketing.

By the time that Lehman Brothers collapsed and the 2008 financial meltdown was in full momentum, political temperature for regulation had hit fever pitch and it was all but decided that hedge funds, this unregulated and uncontrolled beast, were to blame.

OTC derivative trades, illiquid markets and dark pools, leveraging and short selling were all touted as instrumental in attacking the financial stability of the global economy.

A Mis-Directive?

The initial political response to regulating hedge funds was nothing short of irrational and illogical and no research has ever been provided to support the position that hedge funds caused or magnified any financial instability (it must be remembered that stock markets fell further and faster after the global bans were introduced on short selling in 2008).

However, when the first draft Alternative Investment Managers Directive (AIFM Directive) was published by the European Commission in 2009 it was viewed as nothing short of an attack on the UK hedge fund industry and an EU protectionist measure designed to prevent US hedge fund managers from selling funds into the EU.

What had initially began as an issue of hedge fund trading techniques, such as leveraging and shorting, had turned into the most controversial financial services directive in EU financial services history with a marketing war of epic proportions at the core.

The Hedge Fund Marketing Issue

The initial European Commission draft text for the AIFM Directive was followed up by successive new proposals as the 6 monthly presidency of the EU changed hands. Each presidency was expressing different views and each European body (European Commission, European Parliament, European Council) was also forming separate and distinct proposals.

This process of altering versions of the draft directive continued until May 2010 when a series of votes took place resulting in the European Parliament formally adopting one version of the directive and the European Council formally adopting another version.

Both versions would be debated as part of the June/July trialogue discussion between the European Commission, European Parliament and European Council in order to vote and accept one text that would be implemented across the European Union.

However, on the third country provisions concerning the marketing of non-European Union funds by EU fund managers and the marketing of EU funds by non-EU fund managers the European Parliament proposed more stringent restrictions than the European Council in relation to passporting and national private placement regimes.

The European Parliament’s rapporteur, Jean-Paul Gauzès, came under immense industry and political pressure from other MEPs to soften his hard-line approach to the third country marketing rules proposed for non-EU hedge funds selling into the EU. A more palatable text would favour the European Council stance of allowing national discretion. However Gauzès appears to have even dismissed a possible highbred regulation that merges a passporting regime with a national private placement regime.

The Bottom Line to Hedge Fund Marketers

This means that all EU marketing teams selling non-EU funds, and all non-EU marketing teams selling funds will have to become familiar with new regulation affecting their ability to access the European Union.

The breaching of these rules will have serious implications and therefore it will become even more important going forward that marketing departments make themselves aware of EU licensing rules and private placement regime rules.

The Current Dilemma

On the June 24, talks between the European bodies collapsed as the parliamentarian leading the negotiation efforts to agree a common proposal announced it was disbanding for the duration of the summer and that renegotiation would not commence until September at the earliest.

At the core of the problem remain the third country marketing rules which neither side is willing to concede on. Only if non-EU funds meet EU standards can they be marketed within the EU but this has especially angered the US who will feel that the EU are attempting to place an embargo on US funds in the EU.

The US Equivalency Test

The UK appears to have been fighting a loosing battle with the AIFM Directive as more powerful French and German voices within Europe ring out. However, the US has joined forces with the UK to argue that protectionist measures will only hurt the European Union hedge fund industry, admittedly more so in the UK where all the hedge fund managers are based.

Effectively US investment funds will find it next to impossible to market into the EU. Equivalency requirement placed on US funds under current European Parliament proposals would be difficult for US funds to comply with.

Conclusion

This directive continues to threaten Brussels’ plans to overhaul European financial regulation, whilst coincidentally Obama continues with effective overhaul in the US. With third country marketing rules threatening to divide Europe internally, and spark an adverse reaction from the US externally, there has never been a more needy time in the history of EU financial services regulation for a mutually agreeable position to be found.

About the Author

Thomas Bullman is the founder of The Hedge Fund Society and the Hedge Fund College and a noted resource regarding regulatory concepts, implications, and current developments within the hedge fund industry in both the European Union and United States.