Ten Commandments for Pitch Book Salvation

Last month I launched a blog series on capital raising with a diatribe about why money managers actually need a pitch book. I got several emails afterwards asking if I had any advice about what should go in an effective pitch book. Do I have any advice? Silly question!

As a result of those inquiries, I came up with my Ten Commandments for Pitch Book Salvation. Follow them or be eternally damned to limited AUM.

FIRST COMMANDMENT – Thou shalt not create a pitch book longer than 25 pages or shorter than 17 pages. If a pitch book is too long, you’ve probably gone too far into details that may not be pertinent during a first meeting. The goal of a good pitch book is to get you to a second date, not to show everything you’ve got on your first meeting. If, on the other hand, your pitch book is too short, you risk leaving out critical information that investors expect to get in a first meeting.

SECOND COMMANDMENT – Thou shalt include your contact information. There are a lot of sinners out there on this one and you know who you are. I’d call you to let you know for sure, but I can’t find your contact information.

THIRD COMMANDMENT – If thou can say the same thing about other funds, it doesn’t belong in your first five slides. Your first five slides are about you. What makes you unique? What makes this the right opportunity and the right team? When you include phrases like “Our goal is to generate superior risk-adjusted returns” or “The principal’s have their own money invested in the fund” my reaction is, “Yeah, and…?” Ubiquitous and obvious phrases don’t help you communicate your unique value proposition

FOURTH COMMANDMENT – Thou shalt remember Miller’s Law. Investors (and really anyone for that matter) can only absorb about five facts at a time. When you get more than seven bullet points on a slide, you run the risk of overwhelming investors with information. Plus no one really has the time (or the desire) to read all that.

FIFTH COMMANDMENT – Thou shalt learn to use the slide master in PowerPoint so thy slides are uniform. Nitpicky, yes. But there are investors out there who are crazier about uniformity and attention to detail than I am. Have someone who is good with spelling and grammar check it over, too. 

SIXTH COMMANDMENT – Thou shalt include sample positions if thy legal counsel permits it. Most of the information in the pitch book is theoretical. Sample trades let me see what you do in practice.

SEVENTH COMMANDMENT – Thou shalt have slides on position/portfolio risk management AND operational risk management/infrastructure. Because portfolio risk is only one part of the risk equation.

EIGHTH COMMANDMENT – Thou shalt have thy pages numbered. If an investor skips ahead and asks a question that is answered later in your deck, you should be able to tell them what page to turn to while you discuss the answer.

NINTH COMMANDMENT – Thou shalt ensure you articulate the following: who you are, what you do, why it’s a good opportunity, why you’re good at what you do, who you work with (staff, outsourced services and basic service providers), what your terms are, how you manage risk, and how you perform. You are trying to establish your value and uniqueness. Leaving out any of this information makes it hard to learn to love your fund.

TENTH COMMANDMENT – Thou shalt use graphics periodically to make thy presentation visually interesting. Including VAMI charts on performance, org charts, or graphics to depict the security selection process and/or the portfolio construction process can help make your presentation pop. Also, many people react more strongly to visuals than words, so a VAMI chart in the place of a simple monthly return chart can be quite compelling.

And of course, it goes without saying that you need explanatory notes and bios (preferably with pictures to humanize the presentation) within your presentation. But if you follow these simple rules, you are one step closer to pitch book salvation. 

The Truth About Hedge Fund Performance

There has been a lot of negative rhetoric about hedge fund performance lately, including a rabid fixation on the fact that hedge funds have underperformed the S&P 500. This week's blog looks at the the facts and fiction around hedge fund performance, including:

1) how hedging impacts performance;

2) time window analysis considerations; and,

3) how in hedge fund investing, performance averages can be misleading. 

Labor Day Hiatus

The MJ Alts blog is taking the week off from laboring under our own strong opinions. Watch for a new blog next week. 

Will Accreditation Changes Turn Emerging Managers into Submerging Managers?

Most of my non-industry friends don’t know what I do. They all know that I do research in finance, but to most, my alternative investment research focus is as mysterious as if I was a pre-Snowden NSA operative. This is in part because many of them consider finance to be frightfully dull. However, the primary reason for their lack of knowledge is something called "accreditation."

The SEC restricts data on and investments in hedge and PE funds (as well as other private investments) to those folks that are “accredited investors.” For decades, being an accredited investor has meant either having a million dollar net worth (excluding your primary residence) or an income of $200k/$300k (single/married). These income and net worth standards are used as a proxy for financial savvy. If you have enough in the bank, then you must understand money, the SEC reasons, and therefore you are allowed to take more risks with your cash.

However, even as I type, the Securities and Exchange Commission Investor Advisory Committee is weighing changes to accreditation standards. Some of the considerations on the table include raising the income threshold to $500,000 and the net worth threshold to as much as $5 million. In addition, there has been mention of a financial literacy requirement, such as passing the Chartered Financial Analyst exam. The monetary requirements would wipe out a huge portion of the HNW investor community, while a CFA requirement would take out a significant portion of the rest. For example, increasing the net worth requirement from $1 million to just $2.5 million would reduce the accredited HNW investor base from 8.5 million to 3.4 million people according to some studies. (http://www.cnbc.com/id/101933881)

While I understand the urge to “protect” investors, I happen to think these changes are unwarranted and may potentially have a significantly negative impact on innovation and diversity, and ultimately returns, within the alternative investment industry. And frankly the proposed changes just raise a lot of questions for me.

Why this particular threat?

There are a number of financial arenas in which enhanced knowledge, wealth or sophistication could make a material difference in outcomes. For example, according to one study, 15% of all bankruptcies are caused by credit debt, including credit cards, large mortgages, and car payments (http://assets.clearbankruptcy.com/infographics/leading-causes-of-bankruptcy.jpg).

In 2010, there were nearly 1.6 million bankruptcies. So approximately 240,000 Americans potentially could have avoided bankruptcy if the government controlled how much credit one could obtain, how much creditors could extend, or how well people have to understand credit before taking on such burdens.

Likewise, look at day traders. In order to manage a pattern day trading account, one must maintain a mere $25,000 balance. Yet, one study showed that four out of five day traders lose money, while another determined only one out of every 100 day traders consistently make money. Let’s assume that roughly 10,000 people in the U.S. day trade as their primary job. Of those professional day traders, 100 consistently make money and the other 9,900 consistently lose. Why not regulate this more closely? Maybe require a CFA?

And don’t get me started about gambling or the lottery. According to a Gallup Poll on Gambling, 57% of American adults reported playing the lottery in the last 12 months, with 65% of those falling into the $45,000 to $75,000 income bracket (http://www.naspl.org/index.cfm?fuseaction=content&menuid=14&pageid=1020#LotteryOdds) Your chances of winning the lottery? Less than getting injured by your toilet this year, according to National Geographic. How many folks do you think really understand those odds?

Hell, the average investor can contribute to a Kickstarter campaign for potato salad (over $40,000 raised) or a Chipolte burrito ($1050) which are both completely stupid investments AND utterly unregulated. Or what about Bitcoins? Mt. Gox lost over $409 million for its clients.

In short, there is no end to the ways you can “invest” your money. And any way you slice it, there are plenty of ways that these investments can destroy your wealth. Why doesn’t the federal government care about the “sophistication” required to understand, withstand and mitigate other "investment" risks, particularly ones that have a lot lower chance of success?

Isn’t this a self-limiting problem?

 If this is aimed specifically at hedge funds and private equity, the issue of high net worth investors putting all of their cash into “risky” investments is somewhat limited by the structure of the funds themselves. With high investment minimums (generally between $250,000 to $1 million), it is unlikely that a “lower level” high net worth investor will be able to make more than one investment, if that. For some who are early stage “friends and family” money, those investment minimums may be waived, but then the potential “damage” is mitigated as well. Most managers don’t want a fund filled with small investors (more work, less capital), so they tend to limit small investments. The market forces alone seem to be pretty efficient at limiting the hedge fund investments of your average millionaire in this case.

Won’t this submerge emerging managers?

 One of the arguments to make these accreditation changes is that no one has really squawked about them yet. Of course, this doesn’t take into account that the funds that have the financial wherewithal to actually make a fuss probably won’t even notice. There are about 500 funds that have more than $1 billion or more under management. There are about 5,000 funds that manage less than $100 million. As you look across this size spectrum of funds, the importance of the high net worth investor decreases as the size of the fund increases. Generally speaking, larger funds tend to be better influencers and squeaky wheels. Its likely HNW investors just aren’t a very important part of a large fund's business model any more.

And for those that say HNW isn’t important to the entire industry, it is true that about 65% of the AUM in the hedge fund industry now comes from institutional investors. It’s also true, however, that virtually none of that is in the emerging fund (small, new, women or minority owned) manager category. The 35% of assets that are controlled by HNW and family offices remains vitally important to this group of fund managers. Without access to a significant pool of HNW capital, and specifically early stage “friends and family” capital, many emerging funds might never, well, emerge.

Why do we care? Smaller managers can produce higher returns. Smaller managers can provide liquidity to parts of the market that are ignored by larger funds. Smaller funds may innovate where larger funds may care-take. Limiting opportunities in the emerging manager space is a key step towards the homogenization of the industry.

Will there be any unintended consequences?

Angel investors who help small businesses launch, fund innovation and create jobs would be swept up in this as well.

Of course, I imagine the SEC cares about as much about my opinion on accreditation as my non-industry friends do. So after today's blog, I'm only talking about beer, boats and BBQ. At least until after Labor Day. Enjoy the long weekend, y'all!

Unsolicited Advice: The Pitch is Back

I've decided to dedicate one blog per month to providing unsolicited capital raising advice. This is the first in the my "Two Cents From The Peanut Gallery" asset raising series. 

Over the past three years, I have had the opportunity to speak with more than 200 emerging managers about their marketing efforts. In my prior life, I was engaged in manager selection for a fund of funds. Needless to say, I’ve seen a lot of pitch in my day. And unlike pop music, for emerging managers there ain’t no auto tune when it comes to finding the perfect pitch.

During the actual pitch or in the midst of a capital raising triage exercise, I often hear the same refrains:

“We haven’t focused on our pitch book.”

“We have a pitch book, but we really don’t use it.”

“No one is going to invest with us because we have a good pitch book.”

And I couldn’t disagree more. A very good, if not great, pitch book isn’t a “like to have.” It is a “need to have.” And here’s why:

1)   Your pitch book helps you refine your message. Many of the managers I worked with who chose not to focus on their pitch book gave disjointed or rambling presentations in person. It wasn’t at all unusual for a manager to get caught up on their bio for example, and skimp on telling me about their secret investing sauce. Thinking through and honing your written pitch establishes a cadence and sequence to your fund raising message. It’s also what helps you refine your message so you can clearly articulate your competitive advantages. Having a pitch book in this case isn’t about taking potential investors on a death march through the deck, it’s about taking the time to think about what you want and need to say to differentiate your fund, while checking all the boxes you know investors care about.

2) Your pitch book helps an organization “sing from the same hymnal.” It’s true that many emerging fund managers may be simultaneously wearing their fund’s money management and marketing hat. It’s also true that lean emerging fund organizations usually draft a variety of players into roles outside of their core competency. I have often seen emerging hedge funds where the portfolio manager(s), IR staff and CFO’s all get into the fund raising game. Having a strong pitch book helps anyone from your organization that finds himself or herself in front of a potential client tell the same story. Otherwise, each individual is likely to spend the entire meeting focused on what they know, and not make the key points that generate investor interest.

3)  Your pitch book works for you when you’re not there. Investors get hundreds of pitches from emerging managers. Sometimes a manager gets a full hour of undivided attention, and sometimes you get a scant 20 minutes at a “meet the managers” event. Often, emerging fund managers may get only a few minutes of distracted attention at a cocktail party or industry luncheon. Whether you get an hour or 90 seconds, the pitch book you provide during or after this meeting is your fund raising proxy. If you have a great deck that clearly articulates your competitive advantages, your performance, your strategy and your organization and operational infrastructure, you will have a much easier time getting future meetings and pushing follow up with an investor. If you don’t, getting back off the slush pile post meeting or conference can be difficult.

4) Your pitch book forces you to think about your brand. The emerging manager landscape is like the MMA of the investing world. In the hedge fund space alone, industry watcher Preqin has found the 500 largest managers control all but roughly $33 billion of invested capital (as of June 2014). Today, there are more than 5,000 managers with less than $100 million in assets under management, and on average these funds raised less than $500,000 each in 2013. To say the emerging manager landscape is competitive is hyper-hyperbole. While it is true that no glossy pitch book will make up for lackluster performance, craptastic operational controls or an alpha-less strategy, an institutional quality deck can help differentiate your firm and fund. The mistake many managers make is to think their brand is simply their bio, strategy or performance. It’s not. Your brand is not just the data about your fund, but the way in which you present it. Over the past 16 years, I’ve seen clip art, quote overload, typos and other pitch book missteps not just lengthen the capital-raising cycle, but stop it in its tracks. With online graphic design services like www.logomyway.com and www.inkd.com, and with the increased accessibility of professional design services firms, there’s no excuse for not building a strong brand.

Think of it this way, all other things being equal, an emerging manager who is thinking holistically and long-term about growing a business is more likely to get the investment than one who slaps materials together.

In the coming weeks, I'll be talking about how emerging managers can execute a marketing plan like Sherman marching through Georgia.  In the meantime, don’t forget to follow me on Twitter (@MJ_Meredith_J) for news and views on emerging managers and more.   

The Truth Behind Hedge Fund "Failures"

A recent Financial Times article entitled "Most Hedge Funds Fail" got me thinking about hedge fund failure rates and the reasons that hedge funds close. To put some perspective around the topic, I've created a quick video blog that talks about the different kinds of hedge fund "failure" and encourages perhaps a bit more moderation in our choice of terms.

aboutmjones.com blog post - analyzing hedge fund failures from Meredith Jones on Vimeo.

Investing and The Law of Unintended Consequences

In Nashville, we have a weekly paper called “The Contributor” that is sold exclusively by badged homeless individuals on various street corners around town. The paper costs $2, and I make it a point to stop and buy one once a week or so. Now before the bleeding heart liberal accusations start flying, let me explain. “The Contributor” contains some of the world’s best advice couched in its “Hoboscope,” written by one Mr. Mysterio. It’s worth the price of admission every time.

In a recent Hoboscope, Mr. Mysterio provided the following nugget: “Assuming the worst will happen might make you cautious, but it never really makes you safe.” In investing, at least, truer words may never have been spoken.

We all know investors are motivated by fear and greed. I would postulate that our fear wins every time. Maybe it’s the fear of losing money. Perhaps it’s the fear of not keeping up with investing peers. It could be the fear of headline risk, or of paying “too much” for an investment. But our fears feed our investment decision-making, creating cautious investors who somehow remain far from safe.

Take me, for example. For the last several months I have been sniffing disaster on the markets like a dog with his nose out the car window. Having lived through LTCM, the tech wreck and 2008 as a professional investor, my thoughts often fly to all the bad things that can happen to my little nest egg. At the moment, and for much of recent history, I’m primarily in cash. In the meantime, however, I’ve missed significant market gains, which compromises both my current and future earnings. I’m certainly cautious, and I’ve avoided my worst-case scenario, but I haven’t made my financial situation significantly safer due to that particular trade.

Look at the institutional investor community. One of their greatest fears is that of headline risk a la the Art Institute of Chicago and Integral Investments. As a result, many choose to pile their assets into a very small number of large and established managers (the 500 or so that contain 90% plus of the hedge fund AUM).  Studies, including my own from 2006-2011, Preqin and eVestment, have shown that smaller funds tend to outperform their largest counterparts cumulatively and across more time periods, and that new funds have outperformed cumulatively and across all time periods.  However, just like no one ever got fired for buying IBM, it’s unlikely you’ll be fired for investing in Bridgewater or Paulson. But does sub-optimizing returns in a world of growing liabilities truly protect us, or does it just spare us the humiliation and/or hard work of investing in or potentially being wrong about a smaller or newer fund?

And finally, think about the investors that remain all too focused on fees. Overpaying for an investment is a capital crime for a host of investors. They hope to simultaneously optimize returns by saving a few basis points and avoid the headline describing how much they paid their portfolio managers last year. Unfortunately, their fear can result in negative selection bias (only investing with lower cost funds or funds who will cut fees), going direct in an investment arena where they may not have sufficient expertise, or eschewing certain investments altogether. The illusion of safety is created, where their caution may in fact be creating its own set of risks.

Regrettably, I can’t tell you how to solve this conundrum. Let’s face it: I’m no Mr. Mysterio. I can only advise that when we think through our worst case investment scenario, we focus on all of the factors that need to be in place to make us truly “safe.” Not just on the one or two problems that keep us up at night. 

Adding Diversity to Diversification

A few recent articles got me thinking about diversity vs diversification:

·      June 5 -  Forbes reported that 15 large hedge funds were all in the same stock.

·      June 29 – The Financial Times reported on the alarmingly high correlation of hedge funds to the equity markets (0.93).

·      July 14 – Preqin study shows a mere 500 hedge funds control 90% or more of assets.

In essence, we’ve likely got a bunch of investors concentrated in a very few hedge funds that are highly correlated to the equity markets and who own the same stocks. Picture me making Macaulay Culkin’s face in “Home Alone.”

Diversification is a tricky thing. Investopedia describes it simply as a “risk management technique that mixes a wide variety of investments within a portfolio.” But maybe we need to think of diversification on a deeper level.

Homogeneous groups tend to think alike. They also tend to overestimate their problem solving skills and consider a narrower range of information.

They may also be less open to new ideas. The universe of hedge funds contains more than 10,000 funds. At the present time, there are fewer than 500 hedge funds managed by women and minorities. If you look in the dictionary under “homogenous” I bet there may actually be an illustrative photo taken at a hedge fund conference.

So I’d like to suggest that investors expand their definition of diversification. Maybe it’s not all about the asset allocation mix of stocks, bonds, futures, real estate and other asset classes. Perhaps it’s not even the number of funds you invest in or the mix of strategies you have. Maybe, just maybe, diversification includes the way in which the money managers collect, interpret and evaluate market data and the cognitive alpha they create for you.

You don’t think there’s a difference?

Talk to some women and minority managers about what they own. You might be surprised at how far their portfolios are off the beaten path. And then look at what the indices tell you. The HFRX Global Hedge Fund Index has produced a year-to-date net return of 1.77% through June. The HFRX Diversity Index has produced a 3.61% net return through the same period.

So the next time you’re meeting with a potential (or existing) hedge fund investment, look around the room. If you see a room filled with Matrix-esque Smith replications, you might want to go further down the rabbit hole to think about how market and company information is gathered, processed and acted upon by the fund. What does the fund own and how do those underlying portfolio positions interact with your other funds holdings? Are you really diversified or just in a lot of funds?

Or, of course, you can always take the blue pill. 

https://www.youtube.com/watch?v=uGQF8LAmiaE