Why Great Hedge Funds Still Struggle to Raise Capital

Over the past decade, the vast majority of hedge fund net asset flows have gone to a small minority of managers with the strongest brands. With Intelligence estimates that nearly 88% of industry assets are controlled by firms with more than $1 billion in assets.

Each year, hedge fund investors are inundated with thousands of emails and phone calls from managers seeking meetings. Faced with this overwhelming volume of information, investors increasingly rely on a firm’s brand to determine which funds they will meet and ultimately consider for investment. A brand represents an investor’s perception of a hedge fund’s overall quality based on multiple evaluation factors that evolve over time. While a high-quality brand can take years to develop, once established it can significantly enhance a firm’s ability to raise capital and retain assets during periods of performance weakness.

Where Strong Hedge Fund Brands Actually Come From

Although most industry assets are concentrated among the largest firms, a strong brand is not necessarily defined by size. Many large hedge fund organizations based in Asia, Europe, or other regions outside North America have substantial regional client bases but limited name recognition in North America. There are also many large, well-established firms that have become complacent and gradually allowed their brands to erode.

The vast majority of the approximately 15,000 hedge funds have less than $250 million in assets and collectively represent approximately 4% of industry assets. However, a small percentage of these firms have successfully built strong brands and raised significant amounts of capital. Over time, we believe small and mid-sized managers will capture a greater share of industry assets due to the increasing sophistication of institutional investors, the recent underperformance of many large, well-known hedge funds, and pressure on institutional investors to enhance returns. There is a growing belief that some smaller, more nimble managers have an advantage in an environment increasingly dependent on security selection. This may be particularly true for managers operating in less efficient markets or capacity-constrained strategies. Despite these opportunities, building a strong brand remains critical for smaller firms seeking to differentiate themselves and ultimately succeed.

One illustration of the power of branding is the small number of “high-profile” startup firms that are able to raise substantial assets despite having little or no transferable track record. Their brand was typically established at a previous firm. This may result from having held a senior position at another highly regarded hedge fund, spinning out of a major investment bank’s proprietary trading operation, or being seeded by a well-known investor. Many of these high-profile startups ultimately generate performance below expectations. For hedge funds that do not have the benefit of launching with this level of visibility, the key question is: What are firms with the strongest brands doing differently?

Three Factors Separate the Strongest Hedge Fund Brands

Regardless of a firm’s size, there are three critical factors in building a strong brand and raising assets in today’s competitive environment: the quality of the fund offering, investors’ perception of that offering, and the firm’s marketing and sales strategy.

1. A High-Quality Offering

The first step is having a high-quality product offering. In our hedge fund research process, we evaluate thousands of hedge funds each year across multiple criteria and have found that approximately 90% of hedge funds are not particularly compelling. With more than 15,000 hedge funds from which to choose, it is extremely difficult for lower-quality managers to raise meaningful assets beyond friends and family.

The biggest mistake many of these managers make is failing to understand the factors investors use to evaluate hedge funds and, as a result, developing a subpar product. These factors typically include a firm’s operational infrastructure, investment team and pedigree, investment process and the inefficiency it seeks to exploit, the differential advantages used to capture that inefficiency, risk controls, performance, service providers, and fund terms. A weakness in any one of these areas can eliminate a firm from consideration.

The marketplace is highly competitive, and hedge fund investors generally use a process of elimination when selecting managers. This often begins with screening thousands of funds, meeting with a few hundred, conducting follow-up meetings with approximately 50, and ultimately hiring only a select few each year. In some cases, relatively minor adjustments can materially improve a fund’s marketability. Performance is typically the initial screen that eliminates a majority of managers. However, once a fund clears a certain performance hurdle, performance often becomes less important in the overall evaluation process than most managers realize.

2. Perception That Matches Reality

The second step in building a strong brand is ensuring that the market’s perception of the firm accurately reflects reality. This requires a consistent, concise, and clearly articulated marketing message that identifies the firm’s differential advantages across the various factors investors use to evaluate hedge funds. Many high-quality managers struggle to raise assets because they do a poor job communicating their value proposition to the marketplace, leaving their strengths underappreciated or unnoticed. Unfortunately, it can take only one poorly worded answer to eliminate a firm from consideration.

The marketing message should be clearly understood and consistently articulated by every employee at the hedge fund. Ideally, someone other than the portfolio manager should also be capable of communicating the firm’s message effectively in an initial meeting. That message should be integrated consistently throughout all firm communications, including the website, oral presentations, written materials, due diligence questionnaires, and quarterly letters. A well-prepared and accurate marketing presentation creates consistency and builds confidence among prospective investors.

3. A Focused Sales and Marketing Strategy

The final step in building a strong brand is implementing a highly focused marketing and sales strategy that penetrates the marketplace broadly while remaining compliant with regulatory requirements. Accomplishing this with limited resources can be extremely difficult. The hedge fund investor marketplace is highly interconnected, and investors exchange information about managers through both formal and, more often, informal channels. As a result, the more effectively a manager penetrates the marketplace, the stronger its brand can become.

Building a strong brand and raising assets takes time and cannot be rushed. The hedge fund industry is not transaction-oriented, and being overly aggressive can cause a firm to be eliminated from consideration. A majority of institutional investors require at least three or four meetings with a manager before making an investment.

One way to accelerate this process is to utilize a seasoned, highly respected internal sales team, a top-tier third-party marketing firm, or a combination of both. A major mistake many hedge fund firms make is underestimating the impact that the people representing the firm can have on its perceived quality. Experienced and well-regarded sales professionals often have a reputation and brand of their own within the marketplace, which can materially influence a hedge fund’s credibility and success in growing its asset base.

It can be advantageous to partner with a top-tier outsourced marketing firm that works closely with the hedge fund’s sales team or senior management. In this model, hedge fund employees can serve as “product specialists,” allowing the firm to significantly expand its market coverage and create greater awareness throughout the industry. This strategy also maximizes portfolio managers’ time, enabling them to focus more on managing the portfolio and less on educating prospective investors during the early stages of the sales process. As mentioned before, the hedge fund industry is not transaction oriented. It usually takes multiple meetings for an investor to conclude their assessment of a hedge fund. It is very important to have a process in place for following up with prospects and helping them through each stage of their due diligence.

Another way to strengthen a firm’s brand is through active participation in both in-person and virtual industry capital introduction events and conferences. The more frequently investors are exposed to a firm’s name and investment strategy, the more familiar and credible the firm becomes. All else being equal, greater visibility increases the likelihood that investors will agree to meet with the manager.

In summary, strong performance alone will not attract assets. The firms most likely to successfully grow their businesses are those that remain highly focused on providing a high-quality offering, clearly articulate their differential advantages, and implement a highly professional sales and marketing strategy that deeply penetrates the marketplace.