If you ask ten different hedge fund professionals to explain the difference between third party marketing and capital introduction, you are bound to get ten different answers. Though often confused, each practice serves a vital role in attracting capital to the industry. Recently in his Hedge Fund Capital Introduction Blog, Evan Rapoport, Co-founder of HedgeCo Networks, spent some time dissecting the two practices.
Capital introduction, according to Rapoport, is typically done by prime brokers. The largest prime brokers, such as Goldman Sachs & Co., Morgan Stanley, and Merrill Lynch all have teams assembled within their ‘prime services’ divisions that help clients of the firm to find investors suitable for their funds.
In order to properly utilize the services of a prime broker, you need to meet a few parameters:
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.
In contrast, Third party marketers are individuals, licensed by FINRA, that raise capital on behalf of multiple hedge fund products. Typically, they work for a fee that amounts to about 20% of the hedge fund’s fees. In essence, they receive a portion of all management and performance fees throughout the relationship with the investor client. Similar to capital introduction, third party marketers set up all investor meetings, conference calls, and road shows. However, unlike the cap intro business, where the representative is responsible for making the introduction, third party marketers assume a much more active role. Not only do they pique the investor’s initial interest, but they also follow up with potential investors after manager meetings and conference calls, update the prospective client with monthly performance, and do everything they can to facilitate the investment (provided, of course, that it makes sense for the client).
Just like with capital introduction, there are a few requirements for a fund to work with a third party marketer:
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. 🙂
Bear in mind, using a third party marketer does not make sense for all hedge funds. For some funds, they may be small and growing in size and cannot afford to pay hefty fees. Meanwhile, others may already employ their own marketing teams internally. This approach, while more expensive in the short term, actually tends to be more cost effective over the long run.
In summary, there are a number of effective means of raising capital for your fund. A few key points to consider when deciding between using capital introduction or third party marketing include:
-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 take action accordingly. Then, watch (and hope) the capital introduction or third party marketing teams work for 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 firstname.lastname@example.org.
Evan Rapoport is a registered principal and offers securities through HedgeCo Securities LLC. Member FINRA, NFA, SIPC.