Capital Raising for Hedge Funds: Looking Ahead

2020 has provided the global economy with the worst economic crisis in more than a decade, nearly equivalent to the global financial crisis of 2008-2009. The COVID-19 pandemic, coupled with political turmoil, has been a constant presence in the media cycle. Yet, despite the uncertainty and economic headwind, the stock market has remained resilient.   

Powered by an accommodative Federal Reserve and massive stimulus bills, the market in certain sectors sailed to new heights. Many asset classes, including alternatives, continued to outperform their benchmarks. Although returns varied across the board, the overall performance of alternative assets in 2020 has allocators thinking to the prospects of 2021.

Capital Raising Expectations – Cautious Optimism for 2020

Hedge funds not only had one of their best years for absolute returns, but also one of the strongest performing years for relative returns. According to Morgan Stanley research, hedge funds were bullish for most of the year, which resulted in a net alpha return of approximately 16.1% -- the highest in over a decade. However, it is worth noting that 2020 also saw the highest dispersion between manager performance. The gap between strong performers and bottom performers expanded to levels not seen since 2009.  

Given the strong performance, allocators are expecting to maintain or in some cases increase their current allocations to alternative investment strategies. Private equity allocations are expected to grow to at least 50% of overall alternative investment allocations.

Brett Hickey, founder and CEO of Star Mountain Capital, a New York-based alternative investment management firm which specializes in the U.S lower middle-market, has had recent success raising capital. He attributes this success to the firm’s specialized investment strategies and strong relationships with their investor base. “Allocators are looking for long-term trusted relationships, high degrees of transparency, active lines of communication, and most importantly specialized investment plans with a track record of achieving sustainable long term returns,” he said.

Challenges Facing Fund Managers

Not all investment firms have found success meeting capital raising targets. According to a recent article in The Wall Street Journal, Blackrock, the largest investment manager by AUM, had lofty ambitions in the private equity fund space when they tried to raise a $12 billion dollar fund in late 2020. Now, Blackrock has lowered their fundraising goal by approximately 50%. Blackrock’s aggressive leap into the private equity space this year after its initial foray into private markets in 2018 seemed to have some allocators worried. As Blackrock has had continued success in fundraising during 2020 in various asset classes, it would appear allocators are hesitant to commit a substantial amount of capital, in the current environment, to unproven investment strategies.  

The current COVID-19 crisis has also proved challenging for newer fund managers. Both the lack of conferences and limitations on travel, prohibiting face-to-face due diligence meetings, have made it difficult for newer managers to gain access to the investor market. It appears that given the current environment, allocators are most comfortable with continuing, and in some cases increasing, allocations to their existing base.

Greg Royce, CEO and chief investment officer for Maximus Long Short Equity Management, a New York-based manager that runs a low-net exposure fundamental value strategy with a focus on industrials and materials, notes that his firm had to adapt to the challenges imposed by capital raising during a pandemic, as did most businesses. The recent success of the fund has him enthusiastic about their future positioning. “Our strategy presents an opportunity to investors given the lofty valuations across asset classes at the start of 2021,” he said.

Advice for Managers Looking to Raise Capital in 2021

Gabrielle Knable, a director at The Maeson Group, an asset management consultant firm which works with fund managers through allocators’ due diligence processes, shared the following insights: “As not all managers are the same, fundraising challenges differ by strategy and asset class, and overcoming those challenges don't have a one-size-fits all solution,” she said. “Rather, we believe the key to successfully raising capital lies in understanding the value of one's performance record, the mindset of the allocator and the competitive landscape. Further, managers assume differentiation and exceptional performance, often without any real education of what else exists or where they rank.”

It is evident that the current economic environment has presented both challenges and opportunities to alternative investment funds looking to raise capital. Well positioned managers will look ahead to 2021 with optimism as they look to navigate the global pandemic while the prospects for increasing their asset base look more promising now than five years ago.