Hedge Fund Capital Raising – The Fee Drag Impact on Hedge Fund Performance

Developing a successful hedge fund practice goes beyond producing low-volatility portfolios and high risk-adjusted net returns. Designing trading strategies and having strong risk management procedures are important parts of the equation. Hedge fund capital raising is at the epicenter of building a successful hedge fund business. However, far too often hedge fund managers underestimate the business risk and performance impact associated with fund expenses, which in-turn greatly impact the manager’s ability to raise capital. This is a significant component in developing a strong business, and we address the implications in the dialogue below.

The key to success for an emerging hedge fund manager is increasing assets under management (“AUM”). For smaller, emerging managers, a realistic first-level goal is to reach between $50mm-$100mm AUM. This range of assets becomes the stepping-stone to attract larger allocations from institutional investors. To achieve this goal, a manager needs to produce above average risk adjusted net returns. Without a close watch on initial expenses, a manager is less likely to generate strong net returns. Reducing fund expenses has a positive impact on net performance and can also change the risk/return profile of the portfolio.

Capital Raising

As an emerging hedge fund manager, your hedge fund’s net performance is one of the key drivers that will determine how quickly you as a manager will be successful in attracting and raising capital from Institutional Investors, and thereby increase your assets under management. Your fund’s increase in AUM is ultimately the primary factor that determines whether your hedge fund be- comes a viable and ongoing business concern, or if your fund is ultimately closed down due to lack of growth.

“How do I increase the AUM of my hedge fund?” “How do I increase my fund performance?” Questions often contemplated by global hedge fund managers.

There are two primary driving factors related to the process of increasing hedge fund assets under management: net performance and implementing a strong institutional marketing strategy.

So how do you as an emerging manager accomplish your goal to build a solid base of assets? The answers to these key questions lies in the following formula:

Strong Net Hedge Fund Performance X Institutional Marketing Strategy / Fee Drag = Increase AUM

For emerging managers, it is critical to act quickly in order to change the landscape of your hedge fund’s return profile.

Our Hedge Fund in a Box solution assists global hedge fund managers in accomplishing their goal of increasing hedge fund AUM… Thereby, the above equation can be expressed as follows:

HEDGE FUND IN A BOX =

Strong Net Hedge Fund Performance X Institutional Marketing Strategy / Fee Drag = Increase AUM

How to Increase Assets Under Management by Reducing Fee Drag

Have you as a hedge fund manager ever noticed the material impact of fees and the fee drag effect on your hedge fund’s performance? Many managers have experienced the excitement of nailing a trade or series of trades during a given Net Asset Value (“NAV”) period and creating great returns for the fund, only to be deflated as their hedge fund administrator calculates the hedge fund’s returns, net of fees, which results in a significant reduction in the fund’s gross performance.

Granted a portion of those fees go to your compensation as the investment manager/general partner of the fund. However, a significant percentage of this fee drag is the direct result of substantial fund expenses for various hedge fund services and service providers. High costs for prime brokerage, legal services, hedge fund administration, regulatory compliance, audit, tax, capital introductions and third party marketing result in erosion of the hedge fund’s performance and causes it to fall far too short of where it should be.

Fee Drag is an interesting phenomenon, and one of the most interesting consequences the Fee Drag effect on hedge fund performance is that is has a exponentially larger effect on emerging managers relative to more established funds. This phenomenon exists because many of the costs relative to a hedge fund are fixed and are not a variable function of increasing size. This concept is expressed visually by comparing the four graphic illustrations below:

This fee drag effect is exponentially worse for an emerging hedge fund versus a larger, more established hedge fund.

HF1HF2

HF3    HF4

Stonegate Global Fund Services’ “Hedge Fund in a Box” solution assists hedge fund managers implement optimal expense management programs. The comprehensive service offering provides emerging managers with all of the components needed to start a hedge fund and launch a successful business.

In order to mitigate the fee drag impact for smaller hedge fund startups, emerging traders can leverage our “Hedge Fund in a Box” solution that places emerging managers on the same relative expense plane as established managers enjoy.

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