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

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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