How Investors Choose Hedge Funds

How Investors ChooseHedge FundsAdvent Industry IntelligenceResults of the Advent HedgeFund Investor SurveyAugust 2013Key Findings1. Investors say they often see managerswho cannot clearly differentiate theirstrategy2. Many investors decide within the firsthalf hour of a pitch whether or not tocontinue3. Operational quality is one of themost important considerations wheninvestors and consultants evaluate ahedge fund4. Large institutional investors are notlikely to choose hedge funds that donot have a system of record in place fortheir investment process5. Three out of four investors want to seeresearch management systems in placeat funds they are consideringWith 10,000 hedge funds competingfor the attention of investors, raisingcapital has never been more competitive.Demonstrating an edge is increasinglydifficult in an environment whereovercapacity means opportunities toproduce alpha are being crowded out.Despite institutional commitmentto hedge funds, recent widespreadunderperformance has many investorsin a more skeptical frame of mind. Theintroduction of advertising to whathas historically been a word-of-mouthbusiness may further muddle messages.And success does not necessarily begetsuccess. Because hedge funds are oftenthought to be most successful beforebecoming too large to effectively executetheir strategy, investors tend to hunt foremerging managers. The playing field iswide open.Investors and consultants all have theirown ways of meeting, evaluating, andchoosing the hedge funds with whom theywant to invest. There is no prescriptionfor success, but hedge fund managerswho take the time to better understandindustry best practices and the needs oftheir prospective investors will be severalsteps ahead of their less well informedcompetitors.

2 How Investors Choose Hedge FundsHow hedge fund investors andconsultants evaluate and choosefunds.% of respondentsAdvent surveyed hedge fund investors and consultantsin early 2013 on how they evaluate and choose hedgefunds. A total of 152 responses came from investmentadvisors, funds of hedge funds, family offices,foundations, endowments, and pension plans. Assetsunder management ranged from less than 100million to more than 50 billion. Individuals respondingto the survey were typically employed in investment oroperations functions.Hedge fund managers who take thetime to better understand industrybest practices and the needs of theirprospective investors will be severalsteps ahead.29.6%31.6% Consultant Investment Manager Fund of Funds Family Office Foundation of Endowment6.6%15.8%6.6% Other Institution9.9%Advent surveyed hedge fund investorsand consultants in early 2013 on how theyevaluate and choose hedge fund managers.In this brutally competitive environment,the 150 responses to the survey shedlight not only on what investors look forwhen making new hedge fund investments,but also what stumbling blocks fundmanagers should take pains to avoid asthey make their pitch.Connecting with CapitalIt used to be that hedge funds couldpick and choose investors like high endnightclubs selecting the most desirableclientele. The velvet rope is now gone, andinvestors are in the enviable position ofbeing able to invest with managers of theirchoosing. The new paradigm is not withoutits disadvantages, the most obvious beingthe question of how to find the rightmanager in the first place.Personal networks remain the mostuseful channels for sourcing hedge fundmanagers according to most investorsand consultants (Figure 1). It may seemcounterintuitive to rely on the relativelylimited perspectives available amongfriends and acquaintances, but the trustembedded in such relationships is valuable.Market reputation is also widely seen as auseful channel. If managers wish to be topof mind on the cocktail circuit, they shouldconsider a range of promotional activitiesthat could raise their profile. PR strategies,sponsorships, and thought leadershipcampaigns can all create buzz.Manager databases present a morestraightforward way of getting investorsto take notice. Databases from firms likeHFR, HFI, and Morningstar are all seen asuseful channels, with consultants indicatingthat they are particularly avid users.Hedge fund managers using third-partymarketing firms may not want to makethem a centerpiece of their distributionstrategy. Only one in four surveyrespondents view these firms as animportant way for them to source hedgefund managers.Conferences can play an important rolein connecting funds to capital, but fundmanagers will not want to limit theirfundraising strategies to the conferencecircuit. Many investors participating inthe survey made a point of saying they donot often attend or source managers atconferences. Foundations and endowmentsare the least likely to attend conferences,while family offices, investment advisors,and consultants are the most likely tofind conferences useful in identifyinghedge fund managers. Events sponsoredby GAIM and Goldman Sachs are themost likely to be attended by investorssearching for new hedge funds. Otherconferences of note include those hostedby AlphaMetrix, Bloomberg, InstitutionalInvestor, HedgeWorld, Morgan Stanley, andMorningstar.

Advent Industry Intelligence 3Personal Network71.2%ReputationFigure 153.8%Fund manager databasesWhat are the three mostuseful channels for sourcinghedge funds?Consultant “gatekeepers”% of respondentsConferences45.5%36.4%PB cap intro session31.1%28.8%Third-party marketers25.8%PB index list7.6%0%Long-winded presentations are acommon problem.Two thirds of all investors andconsultants decide within the firsthalf hour of a pitch whether or notthey intend to continue.20%Making the PitchIntroductions are only the beginning,leading to pitch presentations that canoften make or break budding relationshipsbetween investors and fund managers.Consultants and most types of investorshear fewer than ten presentations aweek, underscoring the fact that pitchopportunities should not be taken lightly(Figure 2). Family offices tend to attendmore pitch presentations than otherinvestors, a fact that fund managers shouldbe aware of if raising capital from thissegment of the market.There is broad consensus that pitchpresentations are best when 11 to 30slides in length (Figure 3). Fewer than20 slides are preferable. Consultants inparticular like concise decks. Pensionfunds, on the other hand, are more patient,with almost half saying 21 or more slidesare appropriate.About two thirds of all investors andconsultants decide within the first halfhour of a pitch whether or not they intendto continue evaluating a fund (Figure 4).Of these, one in four makes a decisionwithin the first ten minutes. Family offices,which see the most pitches, tend to reacha decision the most rapidly. FoHFs andinvestment advisors are also quick topull the trigger. Endowments and pensionplans tend to take the longest time makingdecisions, with more than a third waitinguntil after the initial meeting. Whether or40%60%80%100%not they change the actual length of theirdecks, fund managers may want to pacetheir presentations according to theiraudience.Presentation MistakesOverly complex or long-windedpresentations are a problem, but blithelyabridging a presentation can lead toother problems. Half of all investors andconsultants say it is all too common fordata to be presented without sufficientexplanation.Despite strides in the right directionover the past few years, transparency ingeneral remains a problem. More thanhalf of those in the survey say there is notenough of it in the pitches they attend.Transparent investment processes arelikely to score points for managers makinga pitch. Research management systemsmay be used by astute managers wishingto illuminate some of the more complexaspects of their investment processes.Fund managers will be even moresuccessful if they take the time to doa little homework on their audience.Highlighting an approach that is probablyan artifact of an earlier time when fundmanagers held all the cards, more thanfour out of ten investors say too manymanagers do not know enough about theirneeds.

4 How Investors Choose Hedge FundsFigure 210 or less per weekHow many pitches do you attend inperson or via phone/online?11 to 20 per week% of respondents21 to 30 per week31 or more per week80.1%15.9%2.6%1.3%0%Figure 331-40 slidesHow many slides do the mostsuccessful pitch books contain?21-30 slides% of respondents11-20 slides% of 0%After how many minutes into aninitial pitch presentation do youdecide whether or not to continueevaluating a hedge fund?40%3.8% 10 slidesFigure 420%20%After the meeting40%60%22.1%31 to 60 minutes11.5%11 to 30 minutes48.1%Less than 10 minutes18.3%0%20%40%60%

Advent Industry Intelligence 5Unclear strategyFigure 575.8%Long-windedWhat are the top three mistakesthat funds make when pitching toprospective investors?Lacking transparency% of respondentsDidn’t know enough about61.4%52.3%Too much unexplained49.2%40.9%Not energetic20.5%0%Three out of four investors say theyall too often see presentations bymanagers who are unable to clearlydifferentiate their strategy.20%The most common mistake? Three outof four investors say they often seepresentations by managers who are unableto clearly differentiate their strategy oreffectively communicate the advantagesof their fund (Figure 5). This is a call toaction for hedge fund managers. Investorswant to know how you plan to invest theircapital, but they also need to know howyour approach is distinct and superiorto the thousands of other investmentstrategies available to them.Evaluation CriteriaHow do investors evaluate funds in whichthey are interested? Risk-adjusted returnsare commonly used as an early screen.Many also look at volatility statistics.Liquidity terms became another commoncriterion in the wake of the financial crisis.Beyond these commonly used measures,investors are most likely to look at thecaliber and integrity of the professionalsrunning a fund (Figure 6).40%60%80%100%the apparently insatiable appetite amonginvestors for more transparency may beheartened by the tradeoff; fewer investorsare looking for investment teams to bereadily accessible.Investment consultants are more likelyto appreciate demonstrably efficientand repeatable processes, once againunderscoring the benefits of systematicapproaches and tools like researchmanagement systems. Consultants alsoplace slightly more emphasis on duediligence, saying that a manager witha proven ability to perform exhaustiveresearch would boost their confidence(Figure 7).Investors, on the other hand, are morelikely to highlight transparency in theresearch process. Half say it boosts theirconfidence. Some types of investors aremore likely to need hand holding. Familyoffices, for example, are the most likely tosay that better reporting capabilities wouldinspire confidence in a manager.Transparent and Robust OpsMission Critical SystemsHighlighting the growinginstitutionalization of the business,investors say the quality of fundoperations is the next most importantevaluation criteria. Over half of thoseresponding to the survey say transparentreporting is one of their top threeevaluation criteria. Managers lamentingSupply and demand dynamics have shiftedand investors are in the driver’s seat. Acharming personality and a black boxapproach is no guarantee when raisingcapital. With an increasingly attentiveand demanding audience, hedge fundmanagers need to be able to demonstratea differentiated strategy, solid operation