Did somebody say, 'pension fund money'?

We'll keep it brief, as you'll all want to know the tricks of the trade in enticing institutional investors to your fund. So, five experts in this field, what are the main considerations for hedge fund, and fund of hedge funds managers, when sealing contracts with or dealing generally with institutional investors, hmmmmmm?

joseph bachman, etheoisHedge fund managers tend to come either from proprietary trading or institutional fund management. The latter will likely be attuned to requirements of institutional investors, whereas the former are not. Some key considerations for hedge fund managers include a clear statement on the source of "alpha"; diversification benefits of absolute return strategies (often uncorrelated with major asset class returns) within long-term institutional portfolios; and justification of fee levels, in particular the performance fees (emphasise high-water marks if relevant), remember that institutions are used to negotiating on fees in the range 10bps (for index tracking strategies) to 100bps for full-on active management. This latter rate will be on a regressive scale as the assets under management (AuM) are increased. We estimate that the average institutional fee for a £100m mandate must be around 50-60bps. Hold this against a typical hedge fund (single manager) fee of 2% annual management fee and 20% performance fees; liquidity (monthly or even quarterly) should not be a problem since institutional money tends to change managers slowly (a manager would normally expect to have at least three years to demonstrate his return potential). While these periods are not "hard coded" into the mandate it would be exceptional for the manager to be given less time; and review frequency and access to the portfolio manager/trader. Institutional fund managers are used to quarterly reviews of performance at face-to-face meetings with their clients. This would be unusual in normal hedge fund space, but may be a condition of awarding the mandate. Institutional funds (at least pension funds and certain endowments) tend to be "governed" by trusts (hence the boards of trustees who oversee the investments). The Trust deed determines what is, and more importantly, what is not permitted within the fund, for example, use of derivatives or gearing. Such clauses, if they exist, would probably prohibit creating segregated accounts for the relevant institution while not necessarily ruling them out as a "shareholding" within another portfolio. Other institutions have different constitutions, for example, UK local authorities, and so their pension funds are set up under Parliamentary statute, the Trustees of such funds have limited power to delegate investment authority (cf House of Lords determined that the London Borough of Hammersmith and Fulham lacked capacity to transact in derivatives linked to interest rates). All this merely highlights the need for a hedge fund to do appropriate due diligence on the prospective institutional investor since courts will not uphold ignorance of the client legal status as a defence.Peter Ludvigsen, Nedgroup InvestmentsMake sure it's a good deal for the institution as well - earn your fee! Only managers able to bridge the gap between what's currently on offer and what institutions actually demand will be successful in this competitive market. True and genuine portfolio diversification products are in demand - trying to shoot the lights out won't be enough in an environment where most traditional hedge fund strategies are becoming highly correlated with traditional assets. Meet expectations through innovation and documented skill-sets in niche strategies, where true alpha is produced. On top of a suitable risk/return profile which highlights the opportunity cost of not investing, hedge funds will need to be able to fulfil a number of key criteria. These include solid business management with engrained culture of integrity; operational excellence and thorough risk management capabilities; disciplined and explicable investment process; and a sophisticated client service giving access to key decision makers, and a willingness to provide transparency.andrew gibson, iamThere are two considerations critical to all relationships, both within the hedge fund world, and life - one is to be a good communicator and the other is to manage expectations. When dealing with institutional investors the relationship often starts a long time before the actual investment. Success is found by ensuring timely and accurate communication of information at all times to establish oneself as responsive, credible and reliable. The responsibility for managing expectations of institutional investors starts with an open approach to handling good news and bad, keeping clients in the picture at all times, particularly when markets are tricky. By establishing a clear reporting framework, including an appropriate frequency, it is possible to ensure all requisite data requirements are addressed and provide a forum for more detailed discussion of the portfolio and news updates.phil irvine, liability solutionsWhen hedge funds (or FoHFs) sign contracts with institutional investors, generally the onus is on investors to consider risk factors in the contract. For the most part the investor is entering into a contract with an offshore entity where many normal protections in the onshore world do not exist. As a general rule despite the investor being sold, the benefits of a fund as one with a carefully controlled risk process, the prospectus and subscription documents will state the investment is speculative and potentially high risk. The reason is, the fund prospectus is normally designed to protect the fund rather than the client. As the situation is caveat emptor, among the factors to consider, give particular notice to:

• Using leverage and derivatives at portfolio level. Many prospectuses allow use of leverage or bridge finance for FoHFs, normally to facilitate investments into and out of the fund, but many funds do use derivatives to enhance or protect the overall portfolio. Clients need to be clear on the possible risks that can be undertaken at this level.

• Expenses. Given the healthy fees, the industry as a whole charges, some investors might be surprised certain expenses that are normally paid for by the manager in the long-only world are paid for by the hedge fund/FoHF.

• Redemption. There is no set industry standard for redemption terms and notice periods. Other related issues include evaluating exactly what monies will be paid after redemption and when, lock-in periods, and gating terms.

Additional areas that should be clearly understood include use of outsourced providers, levels of segregation of duties, pricing policy, use of master-feeder structures and whether side letters have been issued to other investors in the fund and what, if any, are the potential repercussions of this during stressful periods.amit popat, mercer global investmentsThere are a number of key areas that have been significantly affected by the 'institutionalisation' of hedge funds such as clarity of the investment process, risk management, transparency, liquidity, and fees. Strong past performance is not sufficient to satisfy the concerns of an institutional investor. They (and/or their advisor) will need to understand the return stream and how the manager has added returns over the beta of that strategy. Clarity and transparency of the investment process is essential. Secondly, understanding the investment risk and non-investment risk is demanded by institutional investors. They will generally be looking for greater transparency of the portfolio and a more direct relationship with the principal individual(s) driving the portfolio returns. In terms of the non-investment risk, close scrutiny of the business, review of the documentation and subscription terms is a minimum. On-site visits to review the operational infrastructure are very common and, in many cases, side letters may be demanded. Long lock-ins are not favoured, particularly in what are considered to be highly liquid strategies for example, European long/short equity. Finally, fees are a topic close to the heart of institutional investors. In the main, they are not willing to pay the 2% and 20% that is common within single managers with a supplemental 1% and 10% that is often charged by a hedge fund of fund manager. Institutional fee structures are often much lower at both the underlying and fund of hedge fund level. A much lower base fee with no, or a low, performance fee, with the performance fee being applicable on the return over cash (only if the high water mark is exceeded) would be appealing.