re: Getting Past the Gate: Capital Introduction at Prime Brokerage Firms

II. STAGES OF HEDGE FUND DEVELOPMENT

A. (cont.)

The range of investors:
(from least "institutional" to most "institutional")
1. Partners, Friends, Families, & Angels
2. HNWIs
3. Seeders & Acceleration Capital
4. Managed Account Platforms, SMAs, First-Loss Capital
5. Funds of Funds
6. Family Offices
7. Consultants & Third Party Marketers
8. Foundations & Endowments
9. Pensions (Public & Corporate)
10. Sovereign Wealth


B. Investor Due Diligence & Preparing to Market

It seems the big idea here in recent years is to realize that investors have become more demanding of hedge funds that are trying to solicit capital, especially in terms of the sophistication of their quantitative analysis of projected performance.

Traditionally, a hedge fund pitch for investment was focused around giving a basic spiel about the 4 P's: people, process, philosophy, & performance. The first 3 are definitely still important, but the gist of recent developments in the industry seem to be that traditional performance analyses no longer cut it, and more advanced forms of performance analytics are now mandatory for attracting savvy sources of capital.

So before, knowing (i) your performance relative to an appropriate equity index, (ii) your gross and net, & (iii) calculating your beta and alpha, pretty much covered your bases. Now, there are more sophisticated benchmarks to measure against, delta-adjusted exposure to measure, advanced regression analysis, relative attribution calculations, etc.

To prepare to market, you have to learn how to put together a pitch book in the standard way, and be ready to answer all the questions that you know potential investors will throw at you.

Above all, you have to be able to make a convincing argument as to why you have alpha, and why anyone should believe that your process for generating alpha (more on that in the next part of this series) is repeatable. You have to assure potential investors that you are measuring risk accurately, that you are adopting best business practices, that you have successfully harmonized a team of truly outstanding partners, and that your hedge fund is not overly reliant on any single person.

Then, you have to also go over all the biggest weaknesses that your particular strategy has. You have to know your competition, and you have to be able to explain what types of investors should NOT be seeking your investment services.



Note that all of the above assumes a year or two of investing performance already in the books, so the game is different trying to get off the ground with seed capital versus trying to make the jump to more institutional forms of capital with the "capital introduction" process. Nonetheless, even before jumping to the next level, these things would probably be helpful to do work on even before investments start on Day 1.