All RFPs are not equal, particularly when it comes to hedge funds.
Two simple facts will illustrate this in the coming years, according to fund managers, consultants and investors: Institutional assets directed toward hedge funds or absolute return strategies will grow; and some hedge funds will fail, for various reasons.
Which is not to say constructing a good RFP will mean the difference between making money and losing money. But it is a critical first step.
Stuart Feffer & Christopher Kundro, partners at London-based financial services firm Capital Markets Company Ltd., recently wrote a report about why hedge funds fail. After examining more than 100 hedge fund failures going back 20 years, they found that half failed because of "operational" problems. These include trade processing, accounting, administration, valuation of assets and reporting.
In their report, they wrote, "(E)xpanding due diligence and monitoring practices to understand `back-office' capabilities can make a big difference in preventing or avoiding these failures."
Part of the due diligence process is the RFP, said Brett Felsman, director of hedge fund of funds Global Asset Management Ltd., London. The Capco study, he said, points to the need for RFPs to increasingly include what he called "non-investment due diligence." This relates less to actual investments, performance and fees and more to contracts with service providers and administrators and arrangements with third-party marketers.
"With a hedge fund, in particular, there are certain parts of the business that are unique to it and deserve attention," Mr. Felsman said. "Everyone does background checks, but we're talking about much more than that."
Number of similarities
Examining a limited sample of RFPs from pension funds and endowments seeking hedge fund or fund of funds managers reveals a number of similarities in structure and in the kind of information being sought, some of it related to the kinds of relationships and contracts Mr. Felsman described.
But there are also differences in the level of detail.
The $500 million Middlesex County Retirement Board, East Cambridge, Mass. - through its consultant, Wainwright Investment Counsel LLC, Boston - recently issued an RFP for hedge fund of funds managers to manage up to 5% of the plan's assets. In preparing the 15-page document, officials there covered many issues, including the structure of management and performance fees, employee backgrounds, compensation, investment process and philosophy, asset breakdown by kinds of investor and investments, risk measurement and management, investment transparency, leverage and performance.
Officials also included questions about past lawsuits against principals at the firm and asked for contact information for prime brokers, administrators, third-party marketers, banks, investors, lawyers, accountants and auditors.
Meanwhile, officials at the University of Wisconsin System, Madison, issued a broad RFP for managers in seven investment strategies, including hedge funds of funds, to manage assets on behalf of the $300 million endowment. The questionnaire was the same for each strategy, with some specific questions about performance fees and strategies directed to fund of funds managers.
University of Wisconsin officials included a question about performance in relation to benchmarks, which Middlesex County did not. But Middlesex County officials asked for more detail about general partners' investments in the fund and portfolio managers' compensation than University of Wisconsin officials did.
University of Wisconsin's RFP asked only whether managers charged a performance fee and if that fee was negotiable, while Middlesex County asked about the structure of the fee, but did not ask if it was negotiable.
Middlesex County officials also asked about the capacity of hedge fund managers used by the fund of funds, redemptions and possible redemption penalties.
It may also be useful to look at what a company specializing in hedge fund investments looks for in terms of information from hedge fund and fund of funds managers.
Altvest, a hedge fund database owned by InvestorForce Inc., Wayne, Pa., sends out a questionnaire to hedge fund managers. Filling out the questionnaire is a prerequisite for being included in the database.
While it isn't an RFP, the Altvest questionnaire asks specifically in what currencies the fund trades, where the geographic focus of the investments is, whether underlying funds are open or closed (some funds of funds say they have access to managers that are officially closed to new investments) and what kind of corporate structure the fund uses (partnership or LLC, for example).
Privately, some hedge fund and fund of funds managers have complained about what they say is inconsistency among RFPs from various investors. They say some investors ask for much more detail than is needed or that the manager would provide, anyway.
Thomas Kellerhals, senior partner at The Westminster Group, an executive search firm in Chester, S.C., said variation among RFPs is sometimes the result of the varying experience levels of the investors. And he also offered this advice to complaining hedge fund or fund of hedge funds managers: Deal with it.
"If you want to do business with institutional clients, you're going to have to do it employing those clients' standards," said Mr. Kellerhals, whose job placements include a number of professional RFP writers. "If you want that business, you are going to see RFPs, period. Therefore you will answer the RFPs correctly, thoroughly and willingly, or you will not get the business. It's just that simple."