PDI CFOs 2019: Why expanding into an adjacent asset class is like ‘starting from square two’

Broadening product offerings was a topic of discussion at our forum among managers looking to grow in an increasingly competitive market.

Private Debt Investor’s second annual PDI CFOs and COOs Forum brought many of the operational brains in the asset class into the same space to swap notes and share insight.

One treasurer of an investment firm said limited partners are looking to reduce the number of managers they work with, and implementing new strategies can be a beneficial way for managers to scale. But there are a few things for GPs consider before taking that leap; here’s what we overheard.

  1. Be ready for some big questions

“If you are an investment manager, you have to be able to say why you should launch a new-strategy fund because you will have to answer that to your investors,” one hedge fund chief financial officer said.

When thinking of expanding into an adjacent strategy, it’s key to remember that investors are going have questions about the decision, this person said. Existing investors will want to know about the status of the strategies in which they have already invested, and LPs can get apprehensive when there appears to be a style drift from a long-term manager.

“There are a lot of people managing money. There has to be a real tangible reason to move into a new asset class, and a lot of times there is,” the CFO added.

Despite potential LP scepticism, this person said, launching a new strategy makes sense for a firm that may have sector expertise but has no dedicated fund product in the potential expansion area. Another reason to enter an adjacent strategy may be that a firm’s current fund offerings restrict a firm from investing in certain other strategies.

  1. Although adjacent, it is a new strategy

“Even if it is an adjacent business, and it doesn’t seem like a new business, it is a new business; you have to spend the time and take the money to make it big, because you want it to be big,” one hedge fund CFO said.

A private equity firm director mentioned that when their shop expanded into credit, they hired a third-party accounting firm to find out what existing operational functions the equity shop could use for its debt fund. The accountant also examined what additional financial and operational resources the equity shop would need as it moved into credit.

They found that the firm needed to build out new functions such as loan-servicing capabilities. In addition, the buyout shop had to figure out how its investor relations team would sell a credit vehicle.

A hedge fund CFO added that, to ensure the new strategy is a success, a firm should transfer a senior employee to focus on the strategy. If needed, a firm could also make an outside hire if the expertise does not exist in-house.

3 Consider which investor you want

“The investor community is geographically-specific. You’ve got Europe, the Middle East and Asia. Your product [set] needs to be designed to go off in those investor communities,” one treasurer at an investment firm said.

Each geographic region comes with its own regulations, compliance expectations and currency hurdles for GPs. If you are targeting a different strategy, disparate regions may have different rules for it. For example, the treasurer noted Europe is a more relationship-driven business culture than the United States, and firms should be sure they are able to navigate that.

When thinking of expanding into new products, this person said, firms should structure the product so existing investors in multiple geographic regions can commit capital to the new fund. Should a manager not allow for that elasticity, it would have to forge all new investor relationships.

A treasurer added that many LPs are looking to consolidate the number of managers they work with and implementing a new strategy that can accommodate a large number of investors makes sense for GPs.

4 You might be thought of as a new manager

“When launching into an adjacent asset class, [LPs] view you as a first-time fund and it is an automatic no,” a hedge fund CFO said.

A private equity firm director said their firm experienced this firsthand when raising its debut credit fund. The firm had many LPs treating them as a first-time manager and not giving the new fund the time of day, despite a prolonged relationship between the firm and the investor.

The director added that when they expanded within their equity strategies, they had no issues fundraising, but the expansion into credit was much tougher sell to investors. A hedge fund CFO added that when entering a new strategy, GPs may be dealing with new faces within their LP organisations. This, essentially, maybe akin to starting over.

“With large investors, there are different groups and different partners for different asset classes. You don’t start from square one, but you do start from square two,” this person said.