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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.
Like = usually better economics for the manager IF it works out. Something like 0/50 I believe is standard fee. Also, it gets firm AUM up which may be important to certain other "box checking" pools of capital
Dislike = pretty much everything else. The manager has to put up firstloss piece and the "investor" will redeem if they get close to losing a dime if the firstloss is close to breeched. It has a negative context of "desperation" as there are many other routes a manager might take to raise AUM before this. Your LP investors may feel slighted as this managed acct will like have better liquidity.
I think there are rare circumstances where this makes sense for a hedge fund firm (certain low net mkt neutral strategies in mature, low growth firm) but generally would be very skeptical.
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+%
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.
John Paulson runs several with his own money. Wouldn't call him a "small start up manager"
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.
All of the major first loss providers allow you to hold as much cash as you want.
Yes you can raise the first loss money from investors in exchange for whatever those investors will agree on.
That's actually more flexible than I thought. Who are the main first loss providers? How much of a track record would they require?
I have dome some research and spoken to a few of them, including institutional firms that were using them too.
In the typical scenario your are runnining a strategy that they like (does not need to be USD 200m with 3 sharpe like HH for pods claim to search for). In my case I was high single digit return with 1.5 sharpe and 4% maxDD. You do an interview with them and their risk to explain how you run your money and your risk management.
If all go well you decide to put let's say USD 1m (to make it simple). They give you up to 9m so in total you can manage 10m.
You will be paid monthyl c. 50% of your gain but as soon as you loose 7-9%..so c. 800k you need to put other money or the close down your account. The 800k loss if yours! so out of you initial 1m you are left with 200k. If you continue to put money (similar to margins if you trade futures) than you can cotinue.
Plrease note that you can also use less than the 9m they give, for example you use only 4m (5m including your 1m) and you trade with a stop loss of again 800k which in this case is 16% and not 8% just because you are less levered.
If you trade only or mosty futures you do not need them as you can get the implied levered by yourself dealing with broker margins. If you trade equity it's a qay to get equity, but the leverege (mponey they give you) does not come for free as it's backed by your investments.
Pros:
- they help you with set up of the vehicle
- they help you with some initial costs
- you start building a trackrecord which is verifiable / certified
- sometimes they also have seeding business for the next stage of your investing career
Cons:
- they don't let you run whatever you want (i wanted to use some external strategies run by other people on top of mine but they were not that flexible)
- if you trade futures, the leverage and stop loss they give you it's ever more restrictive than the implied leverage you can get trading your own money through interactive brokers
- I am not sure how easy you can get third party money flowing into the account, unless family and friends
- the step between starting from a trainding for a first loss capital to (1) beeing properly seeded or (2) have an exit to a bigger HF, I find it just big and not easy to achieve
I am not sure if the discussion here around managed account is relevant as they give you capital and they certify your track record, so it's better than an account on interactive brokers with your own pesonal money.
Just my two cents here, hope it helps
Great summary.
I will add that the providers also charge fees on the leverage provided e.g., $9m out of $10m AUM, so effectively adding a hurdle rate to the PM.
Not sure if you noticed that you made a typo it seems.
Only for the desperate. Why else give them a free call option?
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