The hedge fund industry is like an ecosystem and it’s important to understand how the various players in the industry interact. In order for you to better understand this system, I have recorded the following video on the hedge fund ecosystem.
Video Transcript/Summary: The strategies and tips provided within this video module include:
- The hedge fund ecosystem refers to the different business partners in the hedge fund industry, of which 95% of existing hedge fund managers utilise the services of at least four. These five are (i) legal compliance firms, (ii) audit firms, (iii) prime brokerage firms, (iv) fund administration firms and (v) third party marketing firms.
- Legal compliance firms are used when you are setting up your fund, which is a detailed process that can be quite expensive. In order to do this right, you have to retain the services of someone who charges usually $15-$40k but sometimes $60-$80k. Once the firm is launched, they manage compliance reporting, legal assistance, contract and other ongoing resources.
- Accounting firms will come in and do an independent assessment or help with financial controls or prepare for an audit. An auditing firm will carry out their audits quarterly and annually.
- Prime brokerage often refers to the service provider within a large investment bank and provides custody, trading and leverage to hedge fund managers. Most hedge funds work with a prime brokerage so for new hedge funds, particular focus and attention is emphasised here. We have set up www.primebrokerageguide.com as an insightful resource.
- Fund administration firm will do third party verification of wire transfers, help with operations outsourcing, do day-to-day account reconciliation, book keeping and all other operation processes. It is a growing trend in the industry to retain the services of a fund administration firm to reduce operational and fraud risks. More information can be got at www.fundadministration.org.
- Third party marketers are an independent capital raiser for the hedge fund. They often work for 2-5 years as a time, acting as a consultant outside of the firm. A third party capital marketer will typically work for a multiple of hedge funds at any one time, adopting various different strategies. Funds will pay him/her a retainer and a percentage of funds raised. This percentage is usually 20% for as long as the funds raised remains within the fund. To learn more, visit www.thirdpartymarketing.com.
- Due diligence on all of the five providers within the ecosystem should be carried out, meeting with at least three from each before making a final decision, rather than making an emotional decision after meeting just one.
- Hedge funds often fail or thrive based on the relationships developed in the hedge fund ecosystem.
Transcript for Hedge Fund Ecosystem
Hello, this is Richard Wilson and today we’re going to go over the hedge fund ecosystem. Basically, the different service providers and business partners that are basically included in the successful life of a business ran as a hedge fund, and that’s one thing that lost of hedge fund managers I think sometimes look over when they launch their fund, they’re really starting a small business and all those things that need to be in place for in a business, need to be in place for a hedge fund.
So if you’re looking to start a hedge fund, if you’re looking to enter the hedge fund industry or if you’re looking at different paths for how you could advance your career in hedge funds, this maybe one of the most important videos you want this year to just kind of cover the different business partners that hedge managers have and what I call a hedge fund ecosystem.
So first of, you should know there’s 5 main business partners that a hedge fund works with. And I would say over 95% of the 1,000 hedge fund managers I’ve worked with use all of these partners or at least 4 out of 5 and I’ll go over that here in just one minute. The 5 business partners are legal compliance firms, auditing firms, prime brokerage firms, fund administration firms, and third-party marketers. Now, I’m going to go over the definition of each and how and when they’re used.
Legal compliance firms are obviously used when you form your fund. It can be relatively expensive to form a hedge fund due to the number of provisions and partnership clauses and gaining clauses and a high water mark details. There’s just so many different things that go into creating a contract which is going to be flexible and robust for the operation of your funds the next 5, 7 or 20 years that you really want to do it right, and to do it right means you have to retain the services of someone who is usually is $15K to $40K or sometimes $60K to $80K depending on the structure of your fund. After you launch your fund, ongoing compliance reporting, ongoing legal assistance, just standard contracts for employees, nondisclosure, non-compete, that’s usually an ongoing resources using a lawyer or an attorney you can go to for the life of your fund.
Next is auditing and accounting firms. Sometimes you’ll have an accounting firm come in and do an independent assessment or help you improve financial controls as a consultant or it might just help you prepare for an audit. The auditing firm completes an audit either quarterly or annually. There’s some people, they may have some monthly activities but generally the big audits are done quarterly and annually. And if you’re an audit professional working in another industry you should know that a hedge fund auditing business is large and growing, more funds are being audited more frequently with more robust reporting each quarter which their investors get to see.
Prime brokerage is the space where a service provider usually inside of a large investment bank provides custody trading and leverage to a hedge managers and that they’re able to help managers leverage their assets and custody it within the third-party institution which helps improve the trust that investors have in their business. Often times a higher quality, the prime brokerage firm, the better it is for the hedge fund manager and almost every hedge fund I know works with a prime brokerage firm. It’s kind of expected, so this is one thing where if you’re starting a hedge fund you definitely want to seek out prime brokers and if you are looking to learn more about prime brokerage we actually have a website, primebrokerageguide.com which is a great website dedicated completely to prime brokerage.
Next, one business partner of hedge funds is a fund administration firm. This is a firm which will do third-party verification of wire transfers still help you with operations outsourcing day to day or month to month account reconciliation, accounting, bookkeeping. Basically all of the operational infrastructures or processes that your hedge fund is completing, almost all of those could be outsourced to a fund administration firm, they make sure they’re done by experts in those areas, they’re done consistently and professionally and as another source of operational improvement which investors are sometimes demanding.
I heard from a hedge fund just last quarter that they were on the board of another hedge fund and one of the advisers was — and he was requiring that his hedge fund retains a fund administration firm, an independent fund administrator or he would leave their board because he just didn’t want to have any of those operational risks or a possible fraud risk. It can go on when you don’t have an independent fund administrator. So it’s another point of assurance for investors to have one and it’s a growing trend in the industry to retain one.
The last business partner which we’re going to talk about is a third-party marketer which is an independent capital raiser. Third-party marketers often work for 2 to 5 years at a time. They’re outside of the fund and they act as a consultant who raises capital for the fund. So one third-party marketer, one professional might market for different hedge funds at once, usually they have different strategies and he might focus on something like wealth management firms or he could go all investor channels. But he is trying to raise capital on behalf of these funds and typically those funds are paying him a retainer plus a percentage of fees raise. So the typically rate in the industry is to charge some sort of fair retainer ongoing but then also charge a 20% of fees on assets raised.
So if you raise $10M, as long as that money is invested in the hedge fund, that third-party marketer should receive 20% of the fees earned off of that accounts. That’s different in every situation but that’s just kind of a template guideline for how those relationships work. And if you want to learn more about fund administration, please see fundadministration.org. If you want to learn more about third-party marketing, please see thirdpartymarketing.com. Both of those websites have hundreds of articles on those unique niche topics. If you’re looking to hire somebody in one of these areas, those websites will be helpful or this video might help if you’re looking to work in one of those areas, those websites might be helpful.
It’s good to do a thorough due diligence obviously on these professionals before you meet with them. Everybody is busy so it can be very tempting to meet with one. You know their reporting looks great, they seem very nice, they seem very nice, they were helpful on the phone, you know “Let’s go with them. Let’s just move on to the next task.” But I really think that whether you’re looking to work for someone or hire them as your service provider even more importantly, take the time to interview at least 3 different service providers who are not connected in any way, within each one of these niches. So interview 3 prime brokerage firms, interview 3 third-party marketers at least and have a short 1 to 2-page, 5-page due diligence questionnaire for them.
So have them complete information related to their references, their number of clients, their stability as a business, their niche expertise, their abilities, what they’ll be doing for you every week, every quarter, every month and exactly what that will cost. It’s good to have all that information upfront so you can compare kind of apples and apples with other organizations and make it less emotional and exciting or time-saving type decision because this is really critical. I’ve seen businesses in the hedge fund industry fail or thrive based on these 5 relationships. So it could be, you know choosing your business partners or it could be one of the top 3 most important things you ever do for your hedge fund. So it’s important not to rush it and to understand what you’re getting into.
So I hope this talk kind of helped clear it up. The main players in the hedge fund ecosystem, I hope it kind of makes it clear why it’s important to understand them and carefully choose them if you’re looking to work with them for any reason and I just want to thank you for your time here today. Thanks.
I hope that this video has given you a better understanding of the hedge fund ecosystem.
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