The Alternatives Investor Education Imperative
This open research note was originally published June 17, 2013 on Storify, a defunct blogging platform for journalistic story creation using social media — often live posts from face-to-face events. It is the second in a series of stories deemed worth saving in The Social Spring project — this one for foreshadowing the 2019 tipping point in alternatives investor education.
Retail investors are increasingly demanding the alternative investment strategies of hedge funds and other alts managers for a wide range of objectives. At the same time, the traditional hedge fund business model has been fading since the 2008–2009 financial crisis and hedgies are looking for long-term growth opportunities beyond defined benefit clients.
More broadly, the social media revolution brought about by digitization, social networks and search engines democratized media — introducing dramatically more efficient modes of marketing, as well as new levels of risk for both investors and alternative investment managers. Unbeknownst to most, every hedge fund is now a publisher.
Alts mutual funds and hedge funds alike have converged on the retail growth opportunity — some with a modern educational content marketing focus and some stuck in a dimming era of product-focused marketing. Two mutual fund thought leaders, and one from a hedge fund of funds, explored this convergence in depth — along with the likely implications of the looming SEC advertising rule changes due to the JOBS Act — at the 2013 Morningstar Investment Conference.
Hedge fund business model undergoing revolution
The hedge fund industry has been undergoing a revolution after losing sight of what the word “hedge”actually means, according to Dennis Heinke, director of institutional product strategy at Franklin Templeton. Hedge funds had a 93 percent S&P 500 correlation in 2011. Were they really a true hedge or just a beta manager? This is leading to a mature discussion on the appropriateness of fees vs. value.
“A light bulb has gone off in the hedge fund industry. And it’s a bit of a wake-up call… after 2008 there was a humbling of hedge funds,” added Davis. A lot of managers are questioning their business model and client focus as the defined benefit pool shrinks, and more managers develop defined contribution plays. [UPDATE: Kris Frieswick covered this aspect of the conversation in more detail in On Wall Street.]
Education needed to align products & investor goals
The unbridled growth of alternative products without sound brand stewardship and client education is one of the greatest risks both hedge funds and investors face. A mismatch between investor problems and manager products and solutions is the result. According to Kamal Bhatia, head of the alternatives product team at OppenheimerFunds, this is largely due to the fact that many alternative investment strategies are just trading strategies, when long-term sustainable value is needed. The industry needs very honest education about what alts do and don’t do for client portfolios — and risk/return profiles.
There are a number of investor goals that are a good fit for alternative investments, such as income, protection and growth. Traditionally, in 60/40 portfolios and their age variations, investors hedge against equity risk using bonds. Hedging against equities with bonds is great until bonds enter a volatile period themselves. Bhatia stressed “the need to look outside the box” to alternative investments that can be a better fit such as real estate or energy investments.
Heinke jumped in, “We still trip over communicating. It’s up to us to educate people so they know what they’re buying. Are you buying an alternative to equities or fixed income?” But the timing is right because clients need the diversification and hedge funds need the clients — and can communicate with them now.
For help improving alternatives education, Oppenheimer Funds partnered with CAIA, the Chartered Alternative Investment Analyst (CAIA) Association. “They’re unbiased and independent. I strongly believe we need to progressively provide the conduit for that independent thought,” Bhatia said.
Post-JOBS Act Hedge Fund Marketing
No one really knows how the JOBS Act will change hedge fund marketing and who it will benefit. But it was a great question to wrap up the session with clear takeaways: “It looks like hedge funds are going to be able to start marketing for the first time under the JOBS Act. How might that change things in relation to this convergence and especially client education, which was a good point you brought up?”
Hedge funds must institutionalize with marketing, as transparency increases communication requirements. Heinke: “Part of the requirement to run a hedge fund now is to have a marketing team. That goes with my convergence comments. It increases the cost of doing business, and it institutionalizes the market. It actually does away with the fraudsters in the market who aren’t communicating. It increases the requirements around databases and increases consulting’s information levels and client information levels in the marketplace as the larger institutional caliber hedge funds do start to market their products.”
Develop in-house marketing infrastructure, strategy content
Horejs agreed that “not only will [hedge funds] need to develop that in-house marketing infrastructure… they’re going to need to offer [marketable] strategies”.
Hedge fund marketing game changing, fallout ahead
Bhatia built on that thought, adding that, “It is increasing the costs of offering these products, because, very bluntly, the traditional marketing staff hasn’t been trained to talk about this or understand the risk/reward of these strategies. It is very clear in our industry the delta between what someone who is doing marketing at a hedge fund was paid versus what someone marketing a stock/bond fund was paid.”
The industry is changing quickly already, Bhatia added, “And I clearly see a big effort and expense on the part of managers to up the quality and up the training for the average salesperson. It is key and it’s going to happen, because those are the interfaces to their clients.” Increasingly salespeople are expected to carry a designation like a CFA or CAIA, “And it’s a very simple reason, you can’t just walk in with a pitchbook and a fact sheet and say ‘That’s it.’ It cannot go on like this. We talked about the manager side, but the sales and marketing side is going through this big change where the game is being upped and there will be fallout from that.”
Takeaways
Now that the SEC has voted to lift the general solicitation rule, hedge fund and other alternative investment managers should carefully develop content marketing strategies and reevaluate key marketing risks before going after the $10 trillion in tappable accredited investor wealth more aggressively.
The Economist published a pithy piece on hedge funds, private equity firms and other likely beneficiaries of the new SEC rules currently being written to execute the JOBS Act. Carlyle estimates that there’s $10 trillion in tappable accredited investor wealth — two times the wealth invested in hedge funds and private equity funds combined. So there’s room for growth.
The newfound ability to market is likely to benefit smaller hedge funds most, “up-and-comers that struggle to get noticed.” Interesting, because others have hypothesized that the Blackrocks of the world will be the biggest winners. A hedge fund marketer friend at a smaller fund also expects bigger firms to benefit more.
Perhaps both could win — with the exception of poor performers which could be brought to light through increasing transparency, content competition and investor education.
Hedge funds who fail to master client education and content marketing will face increasing risk as they compete with more interactive managers to protect and grow assets.
