Download - 3916 Hedge Fund Business Models 20091027
Business Models
forHedge Funds
and Funds of Hedge Funds
Agenda
IntroductionBusiness Models for Funds of Hedge FundsBusiness Models for Hedge FundsCritical analysis of business models
Literature• BARRA1: Success in investment management:
Building the Complete Firm, Meryll Lynch and Barra Consulting Group, 2000
• CQA1: Success In Investment Management: Three Years Later, Casey, Quirk & Acito, 2003
• CQA2: Fund of hedge funds-Rethinking resource requirements. Casey, Quirk & Acito, 2001
• CQA3: The Hedge Fund of Tomorrow: Building an Enduring Firm; Casey Quirk, 2009
Investment Business – similar value chain and business model
• Hedge Funds
• Funds of Hedge Funds
• Classical Investment companies
5
•Sourcing and screening
• Due diligence
• Place-ment
• Portfolio construc-tion
• Ongoing monitoring
Value chain of a FOFH*
*Source: CQA2
6
• Investment
• Sales and customer care
• Ongoing monitoring
Value chain of a Hedge Fund
Agenda
IntroductionBusiness Models for Funds of Hedge FundsBusiness Models for Hedge FundsCritical analysis of business models
Maturing Market in investment management and of FOHF*
• Before 2000 • After 2000• Low customer
requirements• Little formal marketing
needed• Only sales, no
lifecycle management• No demand for
rigorous investment process
• Robust portfolio construction
• Sound risk management• Transparency and
separate accounts• Specialized resources• Professional marketing• Lifecycle management
*Source: CQA2
Historical view on Investment companies
• FOHF are typical investment companies, looking at their value chain
• We look at the historical environment and the historical business models
• We look at the challenges and the possible business models for the future
Investment Management in the 70’s and early 80’s– the first generation*
• Environment
• Underfunded retirement System in the US
• Poor market performance
• Retirement Security Act-> cash flows from private pension funds
• Low level of customer expectation
• Inv. Companies
• Low barriers to entry
• Boutique shops of investment professionals
• FOHF
• First** FOHF in 1969 – Leveraged Capital Holdings by Rothschild Capital Management
• High professionalism
• Exotic kind of investment
*We follow here BARRA1 and CQA1**Source: Lhabitat, Handbook of Hedge Fund Management
Investment Management until 2000 –expansion and the second generation*
• Environment
• Bull market hided inefficiencies
• Customers did not have tools to differentiate quality
• Huge amounts of assets accumulated
• More sophisticated buyers
• Inv. Companies
• Continued professionalization
• Expansion of franchising• Many new products• Complex organizations• Overdeveloped
investment manufacturing vs. distribution
• Low business management skills
• High fixed costs• Mediocre products
• FOHF
• Low customer requirements
• Little formal marketing needed
• Only sales, no lifecycle management
• No demand for rigorous investment process
*Source: BARRA1 and CQA2
Investment Management after 2000 –maturity and the third generation*
• Environment
• New technology• Lower return
environment• Global opportunities
• Inv. Companies
• Balance quality investment with distribution capability
• Modern technology and operation
• Efficiency• Superior business
skills needed
• FOHF**
• Robust portfolio construction
• Sound risk management
• Transparency and separate accounts
• Specialized resources
• Professional marketing
• Lifecycle management
*Source: BARRA1**Source: CQA2
Driving forces and implications
• Technology
• Capital Markets
• Global scope
• Review of Client-Partner-Competitor Relationship
• Attain Investment Quality
• Implement Professional CRM
• Attain overall High efficiency to keep talent
*Source: CQA2
Implication: Quality Assessment Framework for FOHF*• Investment
Quality
• Performance Quality
• Investment process quality
• Organizational quality
• Communication quality
Inve
stm
ent
Phi
loso
phy
Dat
a C
olle
ctio
n an
d sc
reen
ing
Res
earc
h an
d an
alys
is
Sec
urity
Sel
ectio
n
Por
tfolio
C
onst
ruct
ion
Perfo
rman
ce
Attr
ibut
ion
and
Qua
lity
Con
trol
Process Feedback*Source: BARRA1 and CQA2
What is the Organization that guarantees Quality? Answer 2000: The Complete Firm
• The defining features of a Complete Firm are: – balanced excellence in investments and distribution– strength in its underlying business management
Investment management
Distribution
Business Management
*Source: BARRA1 and CQA2
Complete Firm Score Card – Why is it incomplete?
*Source: CQA2
17
Business Models*four viable
business models
• Distribution Specialist
• Single Platform Manager
• Multi platform manager, the franchise conglomerate
• Financial holding Company
*Source: BARRA1 and CQA2
The distribution specialist• Breaking the value chain• minimal or no proprietary investment
management capabilities• competitive advantage in the relationship
management• thorough understanding of and appreciation for
Investment Quality• multi-line financial services companies –
including banks and insurance companies – will increasingly consider employing the Distribution Specialist model
Single Platform Manager • Senior
Management team
• Investment • Distribution
• focus on more specialized asset classes• Investment Quality will be the defining
feature• dependent on intermediary channels
The Franchise Conglomerate• multiple investment platforms can remain autonomous• unique brand identity• single distribution group (synergy)• business risk is diversified• larger distribution force• the costs of complexity
• Senior Leadership Team
• Invest-mentPlatform1
• Invest-mentPlatform2
• Invest-mentPlatform3
• Segment Team1
• Segment Team2
• Segment Team2
Coordinated distribution
Financial Holding Company• financial commitment to one or more investment management firms• core competency is to identify outstanding investment management
companies• will not work to centralize core activities• sharing best practices
• Financial Holding
• Complete Firm 1
• Complete Firm 2
• Complete Firm 3
• Complete Firm 4
• Complete Firm 5
• Complete Firm N
…
22
Summary: who will survive the transformation?
• Growing assets • Matching liabilities
• Chasing performance • Chasing quality
• Brokers • Advisors
• Sales • Product and customer Lifecycle management
• Distribution wide spectrum of products
• Distribution focus on quality of products
Agenda
IntroductionBusiness Models for Funds of Hedge FundsBusiness Models for Hedge FundsCritical analysis of business models
Hedge Funds Evolution since 2000• Main stream investors enter• Growing Beta, Leverage and Illiquidity• Stagnation in fee practices• Low transparency
-50
-40
-30
-20
-10
0
10
20
30
40
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Ret
urns MSCI World
HFRI Weighted
• Bear Market Period• Growth• Market Crisis• Market recovery
*Source: CQA3
Hedge Fund Assets Q2/2009
*Source: CQA3 and own calculations
Hedge Fund loss and redemption
*Source: CQA3
What are the current challenges for Hedge Funds?
*Source: CQA3
28
• Single prime Broker
• Hedge Fund
Operating Model: Business relationship with Brokers
Custody; Cash management; Leverage; Short borrowing; cost subsidizing by broker; Back office Administration (even HR and Real Estate)
The Enduring Firm
• What is the difference to FOHF Complete Firm?
Business Management
Inve
stm
ents The
Enduring Firm
Dis
tribu
tion
Operations
• Need for redesign of:– Liquidity terms (gating,
redemptions, maturity)– Return coupled to
maturity– Fees– Compensations– Performance
measurement
*Source: CQA3
Agenda
IntroductionBusiness Models for Funds of Hedge FundsBusiness Models for Hedge FundsCritical analysis of business models
Complete Firm vs. Enduring Firm
•Operational resources•Independence and empowerment•Counterparty diversification and monitoring•3rd party administration•Delegation•Tracking and reporting•Controls and compliance
•Empowered distribution team•Client centric culture•Systematic relationship management•Client tiering•Managing capacity•Strategic marketing
•Source of alpha and investment edge•Disciplined investment process•Investment leadership and team•Aligned investment team compensation
•Business leadership•Strategic vision•Business strategy•Client centric culture•Product development process•Aligned compensation framework
•Operational infrastructure•Strategic distribution•Holistic Sales and Client Service approach
•Core value proposition•Investment Excellence•Investment Process integrity
•Product and service offering•Business leadership•Aligned compensation framework•Dynamic Organization
•Channel orientation•Strategic marketing•True client service•Thought leadership
•Clearly defined value added•Disciplined investment process•Accountability of decision making•Use of quantitative techniques
•Vision and leadership•Corporate development•Business Performance Monitoring•Aligned compensation and ownership•Integrated product management
OperationsDistributionInvestmentsBusiness Management
Com
plet
e Fi
rm F
OH
FEn
durin
g Fi
rm F
OH
FEn
durin
g Fi
rm H
F
Complete Firm vs. Enduring Firm Business Models
Investment
Distribution, alignment
DistributionOperations, alignment, transparency
Operations DistributionInvestment,Transparency, Alignment
Investment,Performance, alignment
Distribution, alignment
Strengths
Alternatives Holding company
Converged Traditional Alternatives Manager
Merchant Bank Manager
Multi Capability Platform
Single Strategy Boutique
Hedge Funds
Business Management, Operations, Distribution, alignment, transparency
Financial holding Company
Investment, Operations
Investment, Talent leaves
Business management, complexity cost
Multi platform manager
Distribution, Operations, Transparency
Single Platform Manager
OperationsDistribution Specialist
Weaknesses / Challenges
FOHF
Conclusion
• Two firm models were discussed: Complete firm and Enduring Firm
• Big difference: professionalization of operations (happening right now)
• Two sustainable business models for the future: Distribution Specialist and Multi Platform manager