I often hear the terms Capital Introduction and Third Party Marketing used interchangeably. They actually however, represent two different services within the hedge fund asset gathering space.
Capital Introduction is a service usually provided by hedge fund prime brokers. The biggest teams coming from the largest prime brokers, firms like Goldman Sachs & Co., Morgan Stanley, Merrill Lynch, etc. These prime brokers have teams within their ‘prime services’ divisions that will help clients of the firm to find investors suitable for their funds.
How do they introduce investors you may ask? Well, investor introductions are made through occasional capital introduction conferences, road shows, one on one investor meetings, and individual investor conference calls. When done properly, this service can help to raise a fund millions of dollars at no cost to the general partner and no harm to the limited partner.
The real trick here, is finding a firm that actually follows through with what they claim. Many smaller trading firms and ‘mini-primes’ claim they offer capital introduction when in reality all they offer is a list of fund of funds or introductions to third party marketers.
There are rules that have to be followed however in order to receive capital introduction. First, your fund must be doing enough business with the prime brokerage firm to be able for the firm to afford their employees time, and risk. That’s right risk. Most hedge fund managers do not understand what it means to have a series 7 and therefore have never had to worry about a client suing them for a poor recommendation. This is exactly the risk these licensed individuals and firms take on when making introductions to your fund. If your fund fails, they are at risk of client complaints and lawsuits, and if you commit fraud…..whoa boy! They can say goodbye to their career, or at least thousands of dollars defending themselves as to how they had no knowledge that this low life manager decided to run off with their clients money. Anyway, point is, if you are not trading or borrowing, don’t expect too many investor introductions from your prime broker.
Second, your fund needs to perform. It is hard to make investor introductions for a fund that is down thirty percent. Stellar performance obviously makes it easier to make investor introductions.
Next, your fund infrastructure must be solid whereas no one can question the integrity of the information coming out of your firm. This includes having an independent fund administrator, industry recognized auditor, larger firm prime broker and custodian, and knowledgeable legal team. With these providers in place the capital introduction team can feel more confident their investor referrals will have access to the proper information when needed regarding your fund.
Third Party Marketers for hedge funds are FINRA licensed individuals and firms that raise capital for multiple hedge fund products. These third party marketers work for a fee that usually amounts to twenty percent of the hedge fund’s fees. This includes both management and incentive fees usually for the life of client. Third party marketers , similar to capital introduction teams, will set up investor meetings, conference calls and road shows. Unlike capital introduction however, where the representative simply makes an introduction, third party marketers usually help to close the client down. What I mean by that is, third party marketers will not only get the client interested initially, they will also follow up with feedback after conference calls and manager meetings, update the client with monthly returns, and help to do everything possible to facilitate the investment provided it is suitable for the client.
Being a third party marketer for many years myself, i am a little biased (full disclosure, I also run a capital introduction firm) however, I believe this service provides hedge fund managers an incredible way to grow their firm assets at a limited cost to them. I have watched and been part of helping to grow hedge funds from as early as seeding to $400 million, and to raising assets for funds as small as $5 million and helping them to get to critical mass of $50 million, then up and away. These funds would have not been able to receive capital introduction because they were too small or if they are a strategy that does not trade, like private equity. Therefore, using third party marketers was critical in order for them to grow. How many companies with huge profit margins like hedge fund firms would hire sales people with no money up front, no benefits required, etc., and only have to pay them if they sell a product? Me, Me, Me! I know I have to pay my sales people much more than twenty percent and would kill for a deal like this. Again, point is, third party marketing is a great service if you can get a solid third party marketing firm to represent you.
Now, again like capital introduction, third party marketing has some requirements as well. One is length of track record. As a result of taking on the risk of marketing your fund to investors, third party marketers typically like to work with funds that have several years worth of track record. I would say the typical minimum to be considered for most third party marketing platforms is around eighteen months worth of track record that is actual to the fund (no pro-forma!) with the standard being thirty-six months.
Assets under management are also important. The smaller the fund the harder it is for the third party marketer to raise assets. Again typical minimums to be considered for most third party marketing platforms are about fifty million USD and average about one-hundred million USD plus.
Hedge fund strategy is the next item of importance. There are specific times that certain strategies are simply out of favor. If your strategy is out of flavor currently, don’t expect many third party marketers to come to your rescue. However, if your strategy is this year’s Miss Universe, then you may not need to go looking for third party marketers, they will come finding you.
Fund manager pedigrees are another factor third party marketers look at before representing a new fund. If the manager was a plumber and now has decided to start a hedge fund because he doubled his money at Ameritrade, chances are, third party marketers will pass. However if the fund manager was formerly at one of the larger hedge funds, and has a portable track record and strategy, this certainly will help to move him to the top of the marketers list.
Fund infrastructure is equally important to third party marketers. The reasons are the same as mentioned for capital introduction, but maybe even more so being that third party marketers are paid a fee by the fund and therefore are perceived to have more responsibility for their recommendations as opposed to capital introducers that simply make a referral. Having top tier providers makes due diligence much easier for these firms and their clients.
Lastly, and probably most important again, is positive fund performance. It simply is harder to sell a hedge fund with poor performance as opposed to one that has performed. As a third party marketer, we usually have access to multiple products and being that my pay is often tied to their performance….well, nuff said. I do always keep in mind however what is right for individual clients portfolios. and also do realize sometimes the best time to invest in hedge funds is when they have had a short term losing period, especially if this type of strategy has paid off in the past. If I don’t include that last disclaimer I will get tons of hate mail from poorly performing managers. 🙂
Some funds do not like to use third party marketers because they have limited capacity and therefore cannot afford to give away a portion of their fees because they feel they can raise the assets on their own. There are others that have their own internal marketing teams and choose to raise assets only via those employees. This marketing strategy typically costs the fund more money up front, but less in the long run.
So to sum up, there are various differences between hedge fund capital introduction and third party marketing, however I believe when making a decision which method you will use to grow your fund you should consider your:
- Hedge Fund Track Record
- Hedge Fund Monthly Trading Volume
- Current Firm/Fund Assets Under Management
- Hedge Fund Age
- Hedge Fund Capacity
- Current Marketing Budget
Decide what is most important to your fund, and what will ultimately be the fastest path to your firm’s success. Then hope the capital introduction teams and third party marketers will help you!
If you are looking for help with capital introduction, prime brokerage, or third party marketing for your fund feel free to email me for consideration at email@example.com.
Evan Rapoport is a registered principal and offers securities through HedgeCo Securities LLC. Member FINRA, NFA, SIPC.