15 questions you must answer before joining any hedge fund
As we reported earlier, Comac Capital, a London-based hedge fund which expanded giddily on the back of exceptional performance after the financial crisis, has had second thoughts and cut one third of its staff. 18 ex-Comac employees are now looking for alternative employment after assets under management at the fund fell 9% in 2012 and by another 5% this year through to September.
If you go off to work for a hedge fund, how can you ensure you choose an entity with little likelihood of dumping chunks of its workforce? Hedge fund recruiters, analysts and consultants say you need to find the answers to the following 15 questions.
1. How much are the assets under management?
This is the first fundamental no-brainer that you need to answer before you join a hedge fund. Figures for assets under management (AUM) should be publicly available. More assets under management are usually better than less: they indicate greater stability. Too many assets under management may be a bad thing, however: massive funds are unwieldy.
2. What's the performance history?
This is the second fundamental no-brainer and again, you should be able to find the answers in the public domain.
3. What's the client base?
If the fund you're thinking of joining is completely dependent on an individual investor, don't go there, said Barry Seath, managing director of hedge fund-focused Mirage Recruitment. A diversified client base is more stable.
4. Are there any institutional investors?
Institutional investors are a good thing, said John Godden, chief executive of hedge fund advisory group IGS. "A fund that has institutional investors will have more stable money. If a fund's investors are all family and friends and a bit of high net worth money, there will usually be less rigour and the money will be more volatile," Godden added.
5. How long are the investors locked in for?
This is particularly important if the hedge fund you're joining is a start-up. You don't want to join a fund full of hot money, said Seath.
6. Who owns the business?
You should always establish who owns the fund you're joining, said one hedge fund start-up consultant. Is it owned by the people who work there? Is it a closed shop?
7. What's the fee structure?
Traditionally, hedge funds charged fees of 2% of assets under management and 20% of performance. This is all changing, however. The Wall Street Journal reported this week, that hedge fund fees are now more like 1.6% of assets and 18% of performance gains. Funds are being 'creative' about fees. You don't want to join a fund that's too creative, however - fees pay salaries.
8. Is the fund above its high water mark?
A hedge fund that's below its high water mark will not be able to charge performance fees. Avoid it on this basis.
9. What's the bonus structure?
Are you joining a fund that pays discretionary bonuses or that pays bonuses which are a fixed percentage of an individual's profits. The latter still exist.
10. How long has the fund been going for?
Again, this is fundamental. Do you really want to join a vulnerable start-up with no track record?
11. Is any of the past performance notional?
This applies particularly to start-up hedge funds. Nicola Ralston, director and co-founder of PiRho Investment Consulting, said start-ups will sometimes produce documents showing their notional track record after back-testing their performance strategy. Notional performance counts for less than actual performance; make sure you differentiate between the two.
12. Who is the fund regulated by?
This is a telling question, said Godden. Most funds in the UK are regulated by the Financial Conduct Authority, but some are also regulated by the U.S. Commodities Futures Trading Organization (CFTC). Funds regulated by the CFTC are usually more serious and institutional in nature, Godden said.
13. What's happening to fund flows?
This is another crucial question, according to Ralston. "You need a picture of how the fund has grown over time - it's no good knowing that it grew from $50m to $500m, you need to know whether it increased to $5bn before falling back down again," she said. Before joining any fund, Ralston advises you establish historical flows in and out of the fund on at least a quarterly basis.
14. Why have assets under management risen/fallen quickly?
A dramatic drop in assets under management is a warning sign, but so is a rapid increase in assets under management. "You want a fund that's not too volatile in either direction," said Ralston. "A rapid increase in funds under management can be a sign of hot-money inflows."
15. What proportion of your assets are gated?
Watch out for funds which have annoyed investors by 'gating' a large proportion of funds, thereby preventing money from being withdrawn. Ralston said the practice became quite common after the financial crisis. The Financial Times reported in July that 32% of hedge funds now have some form of gating in place.
If you join a fund at which a lot of investors' money is gated, you could be setting yourself up for problems, Ralston said. Gated investors are annoyed investors and will retrieve their money as soon as they're able to. This may put the future of the fund at risk.
"You need to find out how much - if any - of a fund's assets are gated, and how much of its assets are gated now compared to 2008-2009," Ralston said.