Emerging hedge fund managers are finding it harder than ever to raise capital. They lack a sufficient track record, face compliance restrictions and suffer from insufficient internal resources and low assets under management. Many emerging fund managers register as investment advisers and then use first loss programs to solve their capital raising issues..
What is a first-loss platform?
A first-loss program works something like this. An investment adviser contributes 20% of the capital for an account. The provider of the first-loss program puts up the remaining 80%. The investment adviser receives a higher than normal performance fee on its 80% but its capital absorbs all losses (on 100% of the capital). In the event of losses, any gains are reallocated to the investment adviser until the investment adviser is back to its starting allocation.
Why do it?
As a hedge fund manager, you need potential investors to be able to trust your trading skills. There’s a few ways to do this:
- Track Record. Many investors feel more comfortable putting their money with a fund manager that has experience and some won’t put their money with a fund manager unless they have a track record.
- Your own money is in the fund. Having your money in the fund means you have some skin in the game. This gives a degree of comfort to potential investors who will think that you will do a better job since your money is at risk too.
- Structural signalling. Most often, investors have managed accounts, which they are able to monitor at their convenience. Providing the opportunity to quickly and efficiently liquidate their accounts is an advantage.