What are capital introductions?
Capital introduction is a term used to describe the introductions that prime brokerage firms will make on behalf of their money managers to help raise assets under management. It is a service whereby the prime broker attempts to introduce its hedge fund clients to qualified hedge fund investors who have an interest in exploring new opportunities to make hedge fund investments.
Some prime brokerage firms will have a whole team of qualified people dedicated to the work. These prime brokers get paid through trades made by the managers so the more assets they have under management, the more they will get paid.
Rules to receiving capital introductions
There are, however, rules that need to be followed to receive a capital introduction.
- Firstly, a firm needs to be doing enough business with the prime brokerage firm to be able to afford their employees time and risk. When owning a hedge fund, one must be aware of series 7. Series 7 allows clients to sue for poor recommendation. This is what is meant by ‘affording risk’ as this is the type of risk that these licensed professionals will take on when making introductions to your funds. If your fund fails, you are open to the risk of client complaints and lawsuits.
- A second rule is that your fund needs to be performing. It is a clear obstacle to making a capital introduction for a fund that is not performing. Good performance always makes it easier for a capital introduction.
- A third rule is that your firm should have a good reputation and solid fund infrastructure. This eliminates any question of the integrity or the accuracy of information being given by your firm. These infrastructures include having an independent fund administrator, a well-recognized auditor, large firm prime brokers and an intelligent legal team. With a highly knowledgeable staff in order, capital introduction teams will feel more confident that their investment referrals will have access to sound information regarding your fund.
Prime brokerage is the term given to the services that are offered by investment banks and security firms to hedge funds and any other professional investors who need to borrow securities and cash. They offer a group of services that are given to specific clients.
These services include securities lending, leveraged trade executions and cash management. Securities and cash are normally borrowed so that they can be invested to create a return. The requirements of hedge funds are handled by prime brokers.
Each client will have different needs which can range from something as small as daily statements to something as complicated as real-time portfolio reporting. It is highly advised for clients to works as close as possible with their prime brokers to ensure that their needs are fully met. There are prime brokers who offer exclusive services to certain clients.
Prime brokers facilitate hedge funds mainly through loans secured by their clients. It is, therefore, evident that prime brokers are exposed to risk. This is especially true if the value of the item held as a security has its value drop below the actual value of the loan. This will most likely result in the client being unable to pay off the deficit. There are two other forms of risk namely
- Operational risk
- Reputation risk
Brokerage firms monitor the risk involved with their client’s portfolio through considering the worst case loss of a portfolio. This is based on liquidity and a number of other risks of the portfolio. Another major risk involved with a prime brokerage is that the majority of brokerage firms are self-funding businesses.
Hedge funds and 3rd party marketing
Regarding hedge funds, 3rd party marketing refers to a set of sales and marketing services offered by specialised marketing firms. The target audience of these specialised firms is hedge fund managers. Third party marketing is an important aspect in hedge funds as there are very specific rules and regulations that forbid managers from advertising hedge funds directly to the investors.
These third party marketing firms are essential in drawing more investors’ attention to the hedge fund. They are needed to raise capital for funds and start-up funds. These firms help hedge fund managers reach out to investors much more efficiently than would be possible for a fund attempting to publicise itself individually. The main reason for this is that third party marketing firms have the necessary marketing expertise and contracts needed to gain the attention of potential investors.
By helping to determine the worth of hedge funds, and which the best to invest in are, third party marketing firms gain the trust of investors which ultimately creates greater participation in hedge funds. This is a way hedge funds attract more investors who contribute to the capital of the firm.
Requirements for 3rd part marketing
- Asset management is important as the smaller the fund, the harder it is for the 3rd party to make any money.
- Hedge fund strategies are important. If your firm does not have a good and secure strategy, it is unlikely that any 3rd party firms will be attracted to your funds.
- Fund manager pedigrees. The more reputable your managers are, the more likely marketers will be interested in your fund.
- Fund infrastructure is equally important to third party marketers.
- Positive fund performance. It is harder to sell a hedge fund with poor performance in comparison to a fund that has performed. Third party marketing firms usually have access to multiple products and seeing as their pay is tied to their performance; it is almost unlikely that they will choose a low performing fund.
Some hedge funds choose to shy away from 3rd party marketing firms as they have limited capacity and cannot afford to give away a portion of their fees. These funds believe that they can raise the assets needed themselves. Other funds, on the other hand, have their own marketing teams and choose to raise the assets through their team.
There are various ways in which to grow your fund. When choosing a method you should, in short, consider the funds’:
- Hedge fund track record
- Hedge fund trading volume
- Assets currently under management
- Hedge fund age
- Hedge fund capacity
- Current marketing budget
It is important to assess your fund individually and decide what method will ultimately lead to quicker success.