Investor Questions You Should Expect When Marketing a Hedge Fund

September 13, 2012

When it comes to starting a hedge fund or stepping an existing fund up to the next level, garnering assets through assorted fund solicitation efforts targeted to investor groups ranging from individuals to institutions is an ongoing fact of life—no money and there’s no hedge fund to manage. This holds true whether you’re the new manager in the nascent stages of operations or the seasoned manager seeking to really step it up and “go big.”

Hedge fund marketing is no easy task and a fund manager can count on investor questions…lots of them. Ranging from simply getting to know you and developing requisite initial rapport that gets you in the front door to the intensive due diligence process that determines “go/no-go” on an investment, you can expect to provide lots of information spanning the gamut.

According to Doug Carpenter, CEO and owner of Strategic Asset Management, a New York-based full-service fund administration company, as a fund manager you better expect and stand ready to answer questions across a number of key categories, including performance, differentiation, disclosure, tax treatment and consequences, information reporting, transparency, safeguards, IT and business continuity.

Not surprisingly, performance tops the list in terms of questions you can expect in your hedge fund marketing efforts. “Obviously investors are going to focus on performance…it’s the first thing they are going to question,” says Carpenter, whose firm helps prep fund managers for hedge fund marketing presentations.

“We call it the alpha question,” he says. “How are you going to generate alpha? In an efficient market, where everybody has the same information, how is it possible that you are able to generate a return in excess of the standard return? It’s a given that investors are going to want to have a good understanding of how the investment will work.”

Differentiation is extremely important and dovetails with performance in the investor eye, according to Carpenter. You can expect to be asked what makes you and your approach unique and worth investment. “A good example is a client I have that manages a tax lien fund. He’s done tax liens for the last 20 years. He has expertise that you and I don’t have and he employs that expertise to get excess returns,” says Carpenter. “It’s obviously a little bit tougher though when you have a black box system.”

Taxes are a big concern for investors and can play a major role in the feasibility and overall extent of any potential investment. “The tax question is the one that most often trips up managers. I’ve seen the ‘deer in the headlights’ stare when the tax questions come up” Carpenter cautions. “Investors want to know how your investments might affect them from a tax perspective; what the tax consequences might be. You’re going to look unsophisticated and are unlikely to capture their assets if you aren’t ready and prepared with good answers.”

Another critical topic in hedge fund marketing is that of information reporting. Transparency is important to investors, as is speed and the amount of reporting. This can range from questions on auditing and related audit reports to the tax information investors will receive. According to Carpenter, this is a very big issue for investors that have burned before. Additionally, there is the practical issue of when they will receive their K1 report from the fund. “If I’m waiting till September to get my K1 so I can do my taxes, there’s a good chance I’m not going to want to invest,” he says.

Safeguards have taken on much emphasis in the industry and constitute a major area of focus for investors today, given the myriad hedge fund scandals in years recent. “Investors don’t want to invest and have the money manager running off to Brazil… Money managers can put safeguards in place to prevent that from happening—even in the context of the mere thought that it could happen,” warns Carpenter. “Conducting an annual audit, appointing an administrator for the fund and having a gatekeeper to perform cash movement operations, which is a custodial function, are the kind of answers a fund manager will want to provide potential investors.”

You can also expect questions relating to business continuity and the IT system you use. Investors are going to want to know what happens in the event you get “hit by a bus.” Regarding the IT system, it’s mainly a factor of assurance and handholding, as most won’t know much about the systems generally utilized in the industry.

Bottom line, whether you’re starting a hedge fund or simply trying to grow your assets under management by approaching bigger investors, such as institutions, you have to be prepared to disclose information on many different fronts. Carpenter’s advice is to never lie, period—it’s sure to scuttle any opportunity for investment and can land you in jail. Moreover, be sure to engage in full and fair disclosure. “You don’t want to omit any information. Even if you have a negative, put it out there yourself,” he suggests. “There’s nothing wrong with putting it in a positive light, but you have to put it out there. Don’t ever let the investor find it out on their own.”

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