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Saturday, September 30, 2023

Six Reasons to Start Your Own Investment Management Firm and Six Factors to Consider before You Do

The decision to embark on an entrepreneurial journey, especially in the hyper-competitive investment management industry, can be an overwhelming one. It is almost impossible to make all the right choices when starting your own investment management firm. But while such perfection is something we should strive for, we need to recognize that we may never truly achieve it.

Smart people learn from their mistakes. But you can also do what most wise people do, and learn from the mistakes of others. 

Our experience in facilitating the successful launches of investment management firms, among other companies, affords us some perspective on these very lessons. We hope the framework we outline empowers you with the clarity and confidence you need to move forward.

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Portfolio managers are often motivated to create their own investment management firms by a confluence of factors. While this is a personal, individualized choice, most successful founders are similarly driven. Based on what we know, we recommend you ask yourself to what degree the following descriptions apply to you:

Reasons to Start Your Own Investment Management Firm 

1. You have an entrepreneurial spirit and seek to maximize your positive impact for investors

You may also want to have a larger influence on society or the asset management industry. In your heart, you have always envisioned owning your own business and now have the experience to take the first step.

2. You have a distinct and unique value proposition.

Your investment thesis is differentiated and proven. There is opportunity for alpha and you can capitalize on that opportunity in a repeatable and sustainable manner.

3. Your current firm is changing course, focus, or mission.

The environment that helped drive your past success will not exist in the future. This may be out of your control, but it could compromise your ability to offer optimal value to investors. For instance, your employer might be divesting a certain asset class or exiting a certain strategy. You have the skill and talent to manage that asset class or strategy on your own.

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4. Your current firm is winding down.

You know that when it comes to starting your entrepreneurial journey, it is now or never, especially with the support of your former employer and colleagues. This may include synergistic collaboration with associates who also are starting their own firms.

5. You appreciate that running a business is much different than managing money, and you want to do both.

Successful founders have the skillset to run a book of assets, manage a business, and optimize talent. Do you possess that skillset? Do you know how to make advantageous and deliberate moves that strategically position your organization for longevity, sustainability, and profit?

6. You appreciate the extent of the rewards.

First-time hedge fund managers consistently outperform established managers in their first three year to five years, according to Preqin data. In addition, in the aftermath of 2020’s volatile first quarter, the smallest hedge funds rebounded more quickly in the second quarter than their larger peers, while mid-sized hedge funds rebounded on par with their larger competitors. In an industry driven by metrics, new and growing managers are displaying their aptitude and resilience.

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What to Consider before You Do

1. Are you limited by your obligations to your current or prior firm?

For example, are you bound by an onerous non-compete, employee and investor non-solicits, or restrictions on the ownership of the intellectual property you developed for the firm?

If you’re considering becoming a founder, your first step is to understand the scope and length of your existing restrictive covenants. Answering the following questions may provide clarity:

  • Can you afford both economically and opportunistically to sit on the sidelines for the full length of your non-compete?
  • Is your anticipated investor base invested with your current employer? If yes, can you realistically launch a fund with a different or more limited investor base while waiting for your non-solicit obligations to expire?
  • If you can’t bring your team along, can you successfully implement your strategy with a new one? 
  • If you rely on trading algorithms, they likely belong to your current employer. Can you make your strategy work without them?
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2. Are you legally entitled to market yourself with your investment track record? If yes, will your current or prior firm allow you to?

Unless otherwise negotiated, an investment track record belongs to the firm and not to any individual employee. As a result, if you’re a prospective founder, you must negotiate with your current firm — either at the outset of your employment or, more likely, upon your departure — for the right to use your track record.

If the current firm permits it, under applicable law, you may market your new firm with that track record only if:

  • You are the person primarily responsible for the prior performance. (Many interesting issues arise when you were a member of an investment committee, were subject to veto by a more senior investment professional, etc.)
  • The new fund’s portfolio and strategy are sufficiently similar to that used to generate the prior performance, making the prior performance relevant to prospective investors.
  • All products managed in a substantially similar manner at your prior firm are included, unless the exclusion of a product would not result in materially higher performance.
  • The prior firm keeps all books and records necessary to substantiate your track record, as required by applicable law.
  • Any marketing materials disclose that the past performance relates to products managed by a different firm.
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3. Can you identify and retain the best talent, including non-investment professionals, to run the back and middle office?

A solid chief financial officer and chief compliance officer contribute to the success of any emerging manager. Surround yourself with talented C-level employees with attributes that complement and enhance your own and you prove yourself a strong asset manager. A solid team gives you the bandwidth to focus on building and managing the portfolio rather than on the more mundane necessities of running a firm.

4. Do you have the patience, connections, and disposition for fundraising?

Fundraising and investor relations require a particular aptitude and level of emotional intelligence. Do you have it? It can be a daunting process that takes time, persistence, and a knack for tactful negotiation. So if you’re a manager who does not enjoy or excel at this, you may want to pair with a co-founder who does. You both can do what’s in your wheelhouses while growing the firm through both portfolio appreciation and new subscriptions.

5. Do you have a distinctive brand, including an authentic digital presence?

Fifteen or 20 years ago, a website was optional. Today, it is the foundation of your brand identity. When starting a new venture, your internet reputation defines how investors will initially perceive you and directly affects their decision to engage your firm. Online reputation management (ORM) refers to strategies and techniques that influence what information about your business can be found online. A stellar digital presence creates opportunities and provides a competitive advantage that will help mobilize your community of employees, clients, partners, and other stakeholders to support your success. Reputation is everything.

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6. Do you have the fortitude to tolerate the risk?

Only half of hedge-fund investors would consider evaluating an early lifecycle hedge fund, and even fewer would actually invest with one. While many industry participants enthusiastically invest with emerging managers, and some even earmark portions of their portfolio for such investments, this statistic reflects the challenge that new managers face when raising capital, particularly from institutional investors.

Make no mistake: Starting your own firm will not be easy. So keep these considerations in mind before you make the leap.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / krisanapong detraphiphat

Sameer S. Somal, CFA

Sameer S. Somal, CFA, is the CEO and cofounder of Blue Ocean Global Technology. He is a frequent speaker at conferences on online reputation management, fintech, search engine optimization, relationship capital, networking, and ethics. Fundamental to his work at Blue Ocean Global Technology, Sameer leads collaboration with an exclusive group of PR, law, digital marketing, and web-development agency partners. He helps clients build, monitor, and repair their digital presence. Somal is a published writer and internet defamation subject matter expert witness. In collaboration with the Philadelphia Bar Foundation, he authors continuing legal education (CLE) programs. Somal proudly serves on the board of the CFA Institute Seminar for Global Investors, College Possible, and the R.J. Leonard Foundation, an organization dedicated to educating, initiating careers, and personally mentoring young adults who are aging out of the foster care system. Somal was named an Iconic Leader Creating a Better World for All by the All Ladies League and Women Economic Forum. He is also a cofounder of Girl Power Talk.

Eileen Overbaugh, JD

Eileen Overbaugh, JD, advises hedge funds and other pooled investment vehicles in connection with capital raising, structuring, formation, investor negotiations, and ongoing operations. Offering the benefit of extensive experience, she negotiates seed and strategic investments, funds-of-one, managed account arrangements, and other alternative investment relationships. She also regularly advises asset managers and institutional investors with respect to co-investments. Her practice is focused particularly on the business arrangements between the principals of asset management firms, including governance of the investment manager and general partner entities. Overbaugh also structures and negotiates employee compensation and employee separation arrangements for both asset managers and their most senior employees. She works closely with clients to understand their business goals and commercial needs. She provides efficient, practical legal advice to a variety of clients, from family-owned enterprises to multinational asset managers. Her principal areas of focus include: fund formation, hedge funds, investment management, private equity, governance.

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