First-Loss Managed Accounts

All I know is that managed accounts aren't the best way to raise money... Majority of HFs who do accept these personalized portfolios for clients only do so for very large/longstanding relationships with HFoFs, etc.

SonnyZH:

All I know is that managed accounts aren't the best way to raise money... Majority of HFs who do accept these personalized portfolios for clients only do so for very large/longstanding relationships with HFoFs, etc.

The administrative burden of managed accounts can be pretty significant (have to handle allocation of trades, booking, accounting, and tax issues, etc).

As for first-loss accounts, they are an intriguing idea but they're a bit of a catch-22 because they really only make sense for small/start-up managers, but these managers generally won't have enough personal capital to put up a meaningful first-loss tranche.

quixoticelixer:

From my understanding the manager would benefit immensely if their strategy turns out to be successful. What I don't get is- If managers are looking to raise capital, and assuming they are confident in their strategy, why are they so hesitant to put up their own risk capital if they believe in their strategy? (excluding managers that just don't have the risk capital to put up and managers who have strategies focused on level 3 investments)

Correct me if I'm wrong but if you're truly confident in the strategy then why is it a problem to put up risk capital? especially if the performance payout is going to be 50+%

a) Why do you think the payout is going to be 50+%? Do you have some executed LP agreements for this type of account? b) You have to think about scalability and duration. If I do a first-loss account, it's generally going to be a one-off managed account for one investor-presumably I can't take monthly subscriptions for new investments from a range of interested parties. And what happens if the account is really successful? Is the investor locked into the account/fee structure on a long-term basis? If they have standard HF redemption language, the "benefit" of higher fees is likely only going to be sustained until for a few years and then the LP (if they're smart) will look to go back to a standard fee model-you're very unlikely to continue to reap 50% incentive fees from a sophisticated LP. c) It's always better to not have to put up capital than to have to put up capital. Part of the beauty of the hedge fund management model is that it is in theory extremely asset-lite. d) The first-loss structure puts your (the manager's) capital at risk in some different and asymmetric ways when compared to a more-typical "our founders put all their invest-able net worth in the fund." Besides the obvious (first dollars of loss come from your money instead of pro-rata), you also have the risk of your (sole) investor pulling the plug at an inopportune time and forcing you to liquidate at fire-sale prices.

The typical set-up on these things seems to be 9 or 10:1 and the manager puts up $4-5 million and gets something like $40mm of capital. They eat all the downside and take 40-50% of the upside. Its basically a really crappy form of leverage where you give a free-call option on your returns. Maybe if you were really good at running a market neutral book this would make sense but otherwise its seems like suicide. If you are down 10% your capital is basically gone and they will pull the external capital.

It makes sense for talented PM’s with good risk management who run market neutral strategies.

55% monthly is the normal payout of profits above high water mark.

The first loss firm covers all for he expenses for the prime brokerage account, back office, accounting, audit etc.

It’s a way for low net high gross investors to make a shit ton of money if it goes well.

5-10% in the levered account with a 55% payout is a huge payday for the PM.

Putting up those same returns in a personal account without that interest free leverage wouldn’t add up to making much.

Also worth mentioning that these first-loss platforms insist on the PM putting in the majority of his net worth into the fund. So if things go wrong, you esentially piss away your life's savings. Imagine the amount of stress that would put on anyone, can't imagine the quality of your decision-making won't be impacted by that.

Would you be allowed to mingle these funds with other LPs? Also, depends if you need to be fully invested. If they provide 9:1 but you only deploy a third or half of that you can essentially control risk.