A few years ago, I went to Vienna to give a pre-conference workshop at a hedge fund conference. Because I had more than one connection, I checked my luggage, which I almost never do. When I arrived at the Vienna airport and retrieved my luggage, I discovered that it was soaked with a mysterious pink liquid. Everything in my bag was moist, a little fragrant and a lovely shade of rose.
I rushed out into the Vienna evening to purchase something to wear to the event the next day and was at least able to score some skivvies and something to sleep in before the shops closed. I sent those and a suit out to the hotel cleaning service immediately upon my return to the Vienna Hilton.
After two hours, there was a knock on the door.
“Fraulein Jones! We have your laundry!”
I opened the door and was greeted by a white-gloved hotel staffer holding a few coat hangers in one hand, and a silver tray above his head in the other. As I stood slack-jawed and jet-lagged in the doorway, the tray was lowered to my eye level.
On it were my neatly folded and laundered undies. Which had been paraded in all of their unmentionable glory through the entire conference hotel.
The next morning, the “room service undies” story was the talk of the event. I, or at least my underclothes, was the highlight of the conference.
Now, don’t get me wrong, I appreciated the professional Austrian laundry service. The prompt delivery to my door before I collapsed into bed was lovely, too. But much like Goldilocks, there was a desired level of service that was too much, one that was too little, and one that was just right. I’m not sure I quite needed the white gloves. And the silver panty platter? Well, let’s just say that was straight-up overkill.
It’s not much different in hedge fund land either. At another conference last week, I had the pleasure of sitting next to two gentlemen who were running a small hedge fund. They gave me their elevator pitch (interesting) and then peppered me with some questions about how to take their fund to the next level. It wasn’t long before the question of service providers came up.
“Just how important are our service providers anyway?” they wanted to know. “We’re a small fund and we really need to be cost conscious, so can we get by with what we have?” they asked.
Unfortunately for them, the answer was a fairly unequivocal “no.” They were using individuals, not firms, for the most part. And while inexpensive, these individuals were almost certain to cause problems in one of three areas eventually.
- Scalability – When a fund is small, the number of LPs may also be quite low. This means fewer K-1s, usually no tax-exempt or offshore investors, few requirements to register with a regulatory body or file ongoing forms, no separate accounts, etc. If you are dealing primarily with your own money and that of your friends and family, then your uncle’s friend’s cousin’s accountant son-in-law may be sufficient for your needs. But as a fund grows, the demands on fund infrastructure and service providers evolve. An administrator who can handle money-laundering regulations becomes mandatory as you accept offshore dollars. Audited financials, not just a performance review, are essential. Late or incorrect K-1s become a kiss of death. It is essential to pick service providers that can grow with your fund.
- Due diligence – And speaking of growth, it is also vital that your service providers aid the expansion of assets under management, rather than impede capital raising. The last thing a fund manager should want in an already extensive and extended due diligence process is to force an investor to have to investigate a service provider, too. If you don’t select service providers with at least a basic level of “street cred,” then investors must evaluate not just your skills and organization, but the skill and organization of the groups that support you. And this flies in the face of one of the best pieces of advice a fund manager can hear: “Make it EASY for investors to allocate. The more impediments you put on the road to an investment, the less likely someone will actually send you a wire.“
- Level of service – Finally, while I’m sure Aunt Sally’s friend’s neighbor’s daughter is great at creating account statements each month, she probably isn’t going to invite you to industry events, hold webinars on topics that are pertinent to your business or have value-add service like cap intro or strategic consulting. Just like it’s important to make it easy on investors to invest, it is equally important to make it easy on yourself to grow. The straight money-for-service trade is only part of the equation – you have to evaluate whether there is additional “bang for your buck” that you may miss by being penny wise and pound foolish.
Having said all this, I do believe there is a Goldilocks principle at work with fund service providers too. To use my Vienna analogy, you do want to make sure you can get dressed in the morning, but many managers probably don’t need their drawers delivered on a silver tray.
For those looking to play exclusively in institutional investor markets, the biggest names may be essential, but for many hedge funds, there are a range of players (and price points) available. Several publications, like Hedge Fund Alert for example, provide rankings of service providers based on their total number of SEC filings. This can be great starting point for managers looking for firms with experience (and name recognition) in the industry. Ask around and see who other fund managers use as well. At the end of the day, pick a competent, reputable, scalable provider with value-added services at a price point that seems like a good trade for those services.
Now clearly, I don’t have a dog in this hunt, so all y’all fund managers should ultimately do what you want. But since so many of you might have already seen my undies, I felt we were close enough for me to offer this unsolicited advice.