Business Models

for
Hedge Funds
and Funds of Hedge Funds
 Agenda
ƒ Introduction
ƒ Business Models for Funds of Hedge Funds
ƒ Business Models for Hedge Funds
ƒ Critical 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

• Classical • Funds of
• Hedge
Investment Hedge
Funds
companies Funds
 Value chain of a FOFH*

• Due • Place-
diligence ment

•Sourcing and
screening • Portfolio • Ongoing
construc- monitoring
tion

5
*Source: CQA2
Value chain of a Hedge Fund

• Investment

• Sales and
customer • Ongoing
care monitoring

6
 Agenda
ƒ Introduction
ƒ Business Models for Funds of Hedge Funds
ƒ Business Models for Hedge Funds
ƒ Critical analysis of business models
 Maturing Market in investment
management and of FOHF*
• Before 2000 • After 2000
• Low customer • Robust portfolio
requirements construction
• Little formal marketing • Sound risk management
needed • Transparency and
• Only sales, no separate accounts
lifecycle management • Specialized resources
• No demand for • Professional marketing
rigorous investment
• Lifecycle management
process

*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 • Inv. Companies • FOHF

• Underfunded • Low barriers to • First** FOHF in

retirement System entry 1969 – Leveraged
in the US • Boutique shops of Capital Holdings by
• Poor market investment Rothschild Capital
performance professionals Management
• Retirement Security • High
Act-> cash flows professionalism
from private • Exotic kind of
pension funds investment
• Low level of
customer
expectation
*We follow here BARRA1 and CQA1
**Source: Lhabitat, Handbook of Hedge Fund Management
 Investment Management until 2000 –
expansion and the second generation*
• Environment • Inv. Companies • FOHF

• Bull market hided • Continued • Low customer

professionalization
inefficiencies requirements
• Expansion of franchising
• Customers did not • Many new products
• Little formal
have tools to • Complex organizations
marketing needed
differentiate quality • Overdeveloped • Only sales, no
• Huge amounts of investment lifecycle
assets accumulated manufacturing vs. management
distribution
• More sophisticated • Low business • No demand for
buyers management skills rigorous investment
• High fixed costs process
• Mediocre products

*Source: BARRA1 and CQA2

 Investment Management after 2000 –
maturity and the third generation*
• Environment • Inv. Companies • FOHF**

• New technology • Balance quality • Robust portfolio

• Lower return investment with construction
environment distribution • Sound risk
• Global opportunities capability management
• Modern technology • Transparency and
and operation separate accounts
• Efficiency • Specialized
• Superior business resources
skills needed • Professional
marketing
• Lifecycle
management
*Source: BARRA1
**Source: CQA2
 Driving forces and implications
• Review of Client-Partner-
Competitor Relationship

• Technology • Attain Investment Quality

• Capital Markets
• Implement Professional CRM
• Global scope

• Attain overall High efficiency

to keep talent
*Source: CQA2
 Implication: Quality Assessment Framework
for FOHF*
• Investment
Quality

• Performance • Investment • Organizational • Communication

Quality process quality quality quality

Security Selection
Data Collection

Quality Control
Attribution and
Research and
and screening

Performance
Construction
Philosophy
Investment

Portfolio
analysis

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 Distribution
management

Business
Management

*Source: BARRA1 and CQA2

 Complete Firm Score Card – Why
is it incomplete?

*Source: CQA2
 Business Models*
four viable
business models

• Distribution • Single • Multi • Financial

Specialist Platform platform holding
Manager manager, Company
the
franchise
conglomerat
e

17
*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- • Invest- • Invest-

• Segment • Segment • Segment
ment ment ment
Team1 Team2 Team2
Platform1 Platform2 Platform3

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 • Complete • Complete • Complete • Complete … • Complete

Firm 1 Firm 2 Firm 3 Firm 4 Firm 5 Firm N
Summary: who will survive the transformation?

• Growing assets • Matching liabilities

• Chasing performance • Chasing quality

• Brokers • Advisors

• Product and customer

• Sales
Lifecycle management

• Distribution wide spectrum • Distribution focus on

of products quality of products

22
 Agenda
ƒ Introduction
ƒ Business Models for Funds of Hedge Funds
ƒ Business Models for Hedge Funds
ƒ Critical analysis of business models
 Hedge Funds Evolution since 2000
• Main stream investors enter • Bear Market Period
• Growing Beta, Leverage and Illiquidity • Growth
• Stagnation in fee practices • Market Crisis
• Low transparency • Market recovery

40
30
20
10
Returns

0 MSCI World
-10 HFRI Weighted
00

01

02

03

04

05

06

07

08

09
20

20

20

20

20

20

20

20

20

20
-20
-30
-40
-50

*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
Operating Model: Business relationship with
Brokers

• Single • Hedge Fund

prime Broker

Custody; Cash management; Leverage; Short

borrowing; cost subsidizing by broker; Back office
Administration (even HR and Real Estate)

28
 The Enduring Firm
Business
Management
• Need for redesign of:
– Liquidity terms (gating,
redemptions, maturity)
– Return coupled to

Investments

Distribution
maturity
The
– Fees
Enduring
– Compensations
Firm
– Performance
measurement

Operations
• What is the difference to FOHF Complete Firm?
*Source: CQA3
 Agenda
ƒ Introduction
ƒ Business Models for Funds of Hedge Funds
ƒ Business Models for Hedge Funds
ƒ Critical analysis of business models
 Complete Firm vs. Enduring Firm
Business Investments Distribution Operations
Management
•Vision and leadership •Clearly defined value •Channel orientation
•Corporate development added •Strategic marketing
•Disciplined
Firm FOHF

•Business Performance •True client service

Complete

Monitoring investment process •Thought leadership

•Aligned compensation •Accountability of
and ownership decision making
•Integrated product •Use of quantitative
management techniques

•Product and service •Core value •Strategic distribution •Operational infrastructure

Firm FOHF

offering proposition •Holistic Sales and

Enduring

•Business leadership •Investment Client Service

•Aligned compensation Excellence approach
framework •Investment Process
•Dynamic Organization integrity

•Business leadership •Source of alpha and •Empowered •Operational resources

•Strategic vision investment edge distribution team •Independence and
•Disciplined •Client centric culture empowerment
Enduring

•Business strategy
Firm HF

•Client centric culture investment process •Systematic •Counterparty diversification and

•Product development •Investment relationship monitoring
process leadership and team management •3rd party administration
•Aligned compensation •Aligned investment •Client tiering •Delegation
framework team compensation •Managing capacity •Tracking and reporting
•Strategic marketing •Controls and compliance
 Complete Firm vs. Enduring Firm
Business Models
FOHF Hedge Strengths Weaknesses /
Funds Challenges
Distribution Specialist Distribution, alignment Operations

Single Platform Single Strategy Investment, Distribution, Operations,

Manager Boutique Performance, alignment Transparency

Multi platform Multi Capability Operations Distribution Business management,

manager Platform Investment, complexity cost
Transparency, Alignment
Merchant Bank Distribution Investment, Talent leaves
Manager Operations, alignment,
transparency
Converged Traditional Distribution, alignment Investment, Operations
Alternatives Manager

Financial holding Alternatives Holding Investment Business Management,

Company company Operations, Distribution,
alignment, transparency
 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