Tradex Monthly Review Series: Asset Size & Shareholder Base

As part of our Monthly Commentary Series, Tradex will discuss our operational due diligence focus on Asset Size & Shareholder Base. This is important to understand before making and while monitoring an investment. Richard Travia, the Director of Research at Tradex Global Advisors, will be interviewed on June 18th on The Traders Network, KFXR/1190 AM to discuss the subject. A replay can be accessed on the “Investor Communications” page on www.thetradexgroup.com, will be posted on Tradex’s Twitter page @Tradex_Global and will be posted on the Tradex Global Advisors, LLC LinkedIn page. Please follow us on our new social media pages to get the most up to date information on Tradex Global.

• Tracking assets under management has been a key risk management tool for the Tradex Principals over the last ten years. Tracking AUM of the underlying hedge fund investments allows investors to monitor trends in assets which may be leading indicators to specific hedge fund level operational concerns, robust opportunity sets in specific strategies and/or specific hedge funds, strong or deteriorating performance or some other factor which other investors may have noticed before you.

•  Tradex has always believed that a large increase in AUM over a short amount of time requires particular close scrutiny. Outperformance by managers trading smaller assets is well documented, and when assets rise quickly it is important to ensure that the focus remains on performance and that the operations improve at a requisite speed versus the growth.

•  Tradex Global’s operational due diligence and ongoing monthly fund monitoring spends a significant amount of time focusing on shareholder base. Listed below are some questions that Tradex analysts think about when reviewing the shareholder base of its underlying hedge fund investments:

• How many investors are there? 

• A large number of investors may indicate a large retail or high net worth focus.

• A small number of investors may indicate a concentrated investor base or a deficient operational infrastructure.

• Is the shareholder base diversified?

• A geographically diverse investment base may be more stable than a geographically concentrated base.

• A diverse set of investors by type is important. For example, Fund of Hedge Funds tend to be very dynamic and performance sensitive, while high net worth individuals tend to make very long-term buy and hold decisions. Pension Funds tend to do extensive up front and ongoing due diligence, but also tend to make large allocations.

• How much of the AUM is proprietary capital?

• A large investment by insiders may show a sign of confidence in the strategy, team, etc. A large insider concentration may dilute any influence investor groups may have over control of the Fund.

• Some cultures may frown on co-investment (ie. Japan) as they see this as a conflict of interest.

• Additional investments or unplanned, non-tax related redemptions may be forward looking indicator for the opportunity set.

• Who is the largest investor?

• A large investor as a percentage of overall AUM may cause business risk. If the large investor decides to redeem, it could cause business sustainability issues, or may cause management to take outsized risk in order to generate higher rates of return on the lower asset base. In other cases, a large strategic investor may lend stability to the asset base.

• What are the terms of the largest investors? 

• Large investors are more likely to hold preferential investment terms (reduced fees, enhanced liquidity, increased transparency, etc.). These preferential terms may put smaller clients in a disadvantageous position in certain circumstances. If a large investor who holds preferential terms redeems from the Fund, a cascade effect may occur with other investors.

• What is the breakdown between assets in commingled products versus managed accounts?

• Managed accounts tend to be large in size and also tend to hold preferential liquidity rights versus the commingled assets. A redemption by a large managed account might affect market pricing for assets in the commingled product, and may cause business sustainability issues for the Manager.

• A large number or an outsized percentage of managed account assets may indicate an operational deficiency.

• Managed account investors may have differing levels of leverage than the commingled product, causing tracking error and potential for greater performance based risk.