Hedge Funds Compete with Liquid Alt Managers in the RIA Market

Reduced marketing restrictions make it easier for hedge fund firms to approach registered investment advisers and their clients.

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U.S. one dollar and one-hundred dollar banknotes are arranged for a photograph in Soka City, Saitama Prefecture, Japan, on Wednesday, Aug. 29, 2012. The dollar headed for a monthly advance versus the yen before U.S. data forecast to show consumer spending rose the most since February. Photographer: Kiyoshi Ota/Bloomberg

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Hedge fund managers have begun to consider marketing to a broader audience — particularly independent wealth managers. Although exact figures for the U.S. are not available, some surveys suggest that less than 20 percent of alternative assets under management is allocated by wealth managers. Unlike family offices, which have been a target market since the hedge fund industry’s inception, registered investment advisers (RIAs) in the prior regulatory environment were more difficult to approach.

Since most RIA practices have a client base encompassing a blend of both accredited and nonaccredited investors, it was challenging to market to the audience without potentially running afoul of private placement rules. The new regulations allow performance data and fund specifics to be broadly advertised, although investments are still restricted to qualified individuals. These rules put private fund offerings in a similar place as registered products when reaching out to RIAs.

In a cycle that is tough for raising assets under management, the prospect of a fresh pool of investors would seem to be a dream come true. But many industry professionals believe that the rise of so-called liquid alternative products — mutual funds and exchange-traded products that provide nontraditional strategies in a registered format — will stymie the efforts of these latecomers. “It’s an asset grab, and some of the biggest alternative managers such as AQR [Capital Management] have been successfully operating alternative mutual funds aimed at the adviser market for years,” says Julie Cooling, founder and CEO of RIA Database, a Charlotte, North Carolina–based firm that provides data and analysis of the independent wealth management industry for asset managers. “Hedge funds will find it difficult to sell higher-fee, lower-liquidity products in the space.”

“There has been a definite change in adviser appetite in recent years,” says Thomas Kirchner, portfolio manager of the Quaker Event Arbitrage Fund. “When we started, there was skepticism on the part of the investors. The perception was that if you were really that smart, you would be running a hedge fund rather than a mutual fund.”

Kirchner is a pioneer of the liquid alternative space. In November he celebrated the tenth anniversary of his fund, which was known as the Pennsylvania Avenue Event-Driven Fund until June 2010, when it merged with Malvern, Pennsylvania–based Quaker Funds. Kirchner’s firm now runs $285 million in alternative strategies and more than $350 million overall. On a ten-year average annualized basis, the Event Arbitrage Fund has come within 60 basis points of the HFRI event-driven index and has a volatility profile lower than that of the index.

Kirchner echoes Cooling’s expectations that fee compression will be the biggest hurdle for hedge funds. “Let’s put it this way: Even if you have really exceptional performance, it will be hard to justify 2 and 20,” says Kirchner, who worked at Fannie Mae and Banque Nationale de Paris before launching his fund.


Whereas many hedge fund managers concede this point, others remain optimistic. “The simple answer is, like with anything, if you’ve got the goods, you can charge higher fees,” says Neal Berger, president of New York–based hedge fund firm Eagle’s View Capital Management. “If you’re a fund manager really doing something interesting — exploiting a unique niche opportunity — then you will find an audience.”

Berger’s firm operates a multimanager fund and advises wealth managers, family offices and ultra-high-net-worth individuals on hedge fund allocations. Eagle’s View specializes in managers outside crowded spaces like long-short equities. Berger and his portfolio managers believe that by identifying truly noncorrelated alpha niche strategies, they will be able to continue to charge a premium for their services.

Some managers straddle both sides of the debate. Stamford, Connecticut–based SummerHaven Investment Management offers private investment vehicles available exclusively to institutional investors, as well as a series of alternative ETF products focused on active strategies in the commodities markets. According to SummerHaven partner Kurt Nelson, this dual-track approach has paid off. “We are looking to deliver diversified commodity products to all classes of investors,” says Nelson. “We launched our ETF products specifically to provide access to advisers who were looking for exchange-traded liquidity and low fees.”

Nelson founded SummerHaven in 2010 with his fellow former senior UBS commodities executive Ashraf Rizvi and K. Geert Rouwenhorst, presently deputy dean of the Yale School of Management and a recognized expert on commodity investments. According to Nelson, hedge funds that are considering an entry into the liquid alt space need to be realistic and understand that there is increasing competition in the registered fund universe.

“We’ve managed to grow because we are doing something different,” he says. “I think that’s the key to success in the liquid alternative space. You need to be price competitive; you have to have a real strategy, rather than a gimmick; and your strategy has to work. No one can win without performance in the end.”

For large, established hedge funds, the change in regulations may ultimately be a nonevent. “The legendary names in the business don’t need to be concerned,” says Jay Ramey, managing director of business development and consulting at Triton Capital Advisors in La Jolla, California. “It’s doubtful they would want to take a more public approach to marketing anyway. They will most likely maintain the mystique of limited access.”

Triton, an independent alternative investment consulting firm, advises wealth managers, financial advisers and institutions on alternative allocations and manager selection. According to Ramey, emerging managers will not be so fortunate, however. “With increased regulation, there are a lot of new barriers for start-up managers,” he says. Ramey and his colleagues predict that this higher bar will prevent smaller managers from reaching the critical mass needed to steal market share from the established firms in either the private or public fund space.

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