Hedge funds, marketers and the JOBS Act
More than 1100 new hedge funds launched in 2011, according to Hedge Fund Research. In April, the Jumpstart Our Business Startups (NASDAQ:JOBS) Act became law allowing hedge funds to market directly to the public. Although the JOBS Act did not change the eligibility requirements for hedge fund investors, the law eases restrictions on marketing hedge funds to the general public by hedge fund managers.
Because large, established hedge funds tend to be better known to investors because they can devote more resources internally to marketing, the JOBS Act has the potential to benefit emerging managers in their
capital raising efforts. Because emerging managers tend to devote relatively more resources to running their trading strategies and relatively less to marketing, the JOBS Act opens the door for such managers to hire outside placement agents-also known as third-party marketers (TPMs).
For these reasons, both investors and managers should understand the benefits of TPMs.
How do TPMs fit into hedge fund marketing?
To properly understand TPMs, it is useful to understand the alternatives that a hedge fund manager is likely to face regarding marketing. The most obvious option is to hire marketing personnel internally. For emerging
hedge funds, the marketing duties are likely to be shared with other job responsibilities including those of the portfolio managers themselves. Alternatively, another staff member, such as the COO, might handle these duties. As a fund grows, a manager will often hire a marketing team in order to separate these duties
from the investment or operational staff. Institutional investors often view such separation of duties as a good practice when evaluating a hedge fund.
Another option is to use the services of a prime broker's capital introduction team. Prime brokers typically employ such teams to varying degrees as a service to their hedge fund clients.
A third-party marketer occupies a place in between an internal marketing team and the capital introduction services of a prime broker. A TPM can complement an internal marketing team or it can be a substitute for such a team. In addition, a TPM can provide additional capabilities to a prime broker's capital introduction team.
Institutional investors are typically more accustomed to seeing placement agents when looking at private equity investments. In both cases, more and more
institutional investors are disclosing the relationships between the funds they invest in and the placement agents that work for them.
What do TPMs do?
A third-party marketer's primary goal is to leverage their investor relationships and knowledge of investor sentiment to help hedge fund managers raise assets. The best TPMs are adept at establishing relationships with investors and at leveraging those relationships to make introductions for managers that lead to allocations.
Many TPMs have significantly more experience marketing hedge fund products to investors than the hedge fund managers themselves. As a consequence, TPMs can help managers target their marketing efforts to the investors who are most suitable for their strategy.
In addition to maintaining relationships with a variety of investor types, TPMs keep their finger on the pulse of the hedge fund sector by attending conferences of various kinds, by monitoring the trade press related to hedge funds and by interviewing managers who are candidates for representation. Some TPMs are also investors in some of the funds they represent. All these activities give TPMs insight that can help managers
judge when market conditions are conducive to the particular strategy the manager employs.
TPMs can also provide additional services that can be particularly useful to emerging managers. An experienced TPM can assist a manager in preparing investor materials such as marketing presentations, due diligence questionnaires and monthly performance reports. By helping managers' focus and refine their marketing presentation-both in print and in person-a TPM can make meetings with investors more informative and more productive.
A good TPM is an ambassador, advisor, and extender of a manager's reach. TPMs can also design, book and execute manager road shows in a way that maximizes the value of a manager's time away from their trading duties. TPMs also often offer additional services to emerging managers such as advising on compliance policies and procedures, as well as on the acquisition of the services of administrators and law firms.
What are the incentives for TPMs?
TPMs generally get paid based on the assets they raise and therefore have the incentive to represent high quality managers. Their compensation is a share of the fees that the manager earns from the investors' assets that the TPM brings to the manager's fund. The TPM receives a percentage-typically 20-30 percent-of both the management and performance fees that the manager earns, but only on the assets that the TPM raises. Further, the TPM only receives those fees for as long as the capital that they raise is under management by the hedge fund.
The management fee portion of the TPMs
compensation will depend only on the amount of assets that they bring to the manager. The performance fee portion, however, will depend on the level of assets as well as the return that the manager produces. The better the manager's returns are, the larger the portion of fees that will come from the performance component. If the manager's returns are high enough, the performance component can easily exceed the management component of the TPM's compensation.
This is why TPMs have the incentive to represent the best managers they can find. If the manager doesn't perform well, either the performance component of the TPM's compensation is lower, or even worse, the investor redeems the investment altogether and the TPM stops receiving compensation for those assets.
Possibly the most important aspect of this compensation structure for investors is that there is no additional layer of fees incurred by them for working with TPMs. Rather, TPMs are compensated directly by the managers they represent. And typically, a TPM does not cost the manager anything unless assets are raised, so there is no overhead expense component charged to the fund in connection with the TPM's efforts.
How do TPMs benefit investors?
By taking over the bulk of the marketing activities, a TPM can free the manager to focus on their expertise- generating returns in the investment strategy they employ-which is what the investor is seeking. By offloading some of the marketing responsibility to a TPM the manager can better maintain focus which may result in better returns.
Some established TPMs take a very consultative approach to their dealings with investors. They take the time to understand the investor's objectives and processes with respect to hedge fund allocations. In doing so, they can help investors evaluate their hedge fund investments and construct their hedge fund portfolios. TPMs often maintain and are willing to share with investors a variety of educational materials related to investing in hedge funds. The due diligence reviews
that TPMs perform can be useful to investors as a guide and supplement to their own due diligence. TPMs that represent multiple managers can suggest combinations of hedge fund investments that can be customized to fit the investors existing portfolios. TPMs, particularly
those that work with emerging managers, can be a source of high-quality managers which the investor might otherwise never learn about.
In sum, investors can benefit from the same expertise and experience that a TPM offers to hedge fund managers.
An important additional point is that TPMs are regulated or registered by industry regulatory bodies. TPMs either hold broker dealers licenses, which means they are audited by both FINRA and the SEC, or they are registered with the NFA. They are also subject to the same state regulatory regimes that asset managers and brokers are. In all these ways, the activities of TPMs are heavily scrutinized.
With or without the JOBS Act, the TPM business is expanding as the number of hedge funds expands. The regulatory regime in the financial services industry, including the Volcker Rule provisions of the Dodd-Frank legislation are contributing to the expansion of the hedge fund business. That means that investors are likely to see more hedge funds using TPMs to assist in raising assets.
In this article, we have described how TPMs provide significant benefits to both hedge fund managers and to hedge fund investors. We look forward to the opportunity to meet with investors to discuss how Asset Alliance can assist in their hedge fund allocation process.