costs, and/or minimum AUM requirements can bring huge challenges to a new manager. In many cases, the monthly and annual costs or minimum AUM hurdles associated with these services may make the fund launch impractical. Exhibit 5 shows the estimated costs for operating a fund. As the exhibit illustrates, the total costs for man- aging a fund, including operational fund costs and back- office management, can easily exceed $800,000 without paying lavish salaries. Moreover, competitive pressures are pushing fee income down, thus squeezing the overall margins to the emerging managers. Depending on the location of the emerging man- ager’s business, costs can quickly escalate. High cost-of- living areas, such as Boston or New York, might require rents above $100,000 for small spaces. Landlords will demand a three- to five-year minimum lease and expect personal guarantees. This means that emerging man- agers will have a legal liability in excess of $300,000 for just office rent alone. Key members of the team will also not be cheap. Experienced salesmen and portfolio man- agers might each command salary + bonus well above $250,000 a year. When emerging managers accumulate all of the start-up legal costs, office rent, administration, fund accounting costs, external audit, equipment, data- bases, management personnel, and other related expenses, they will likely be surprised and overwhelmed. If successful, an emerging manager can generate extraordinary wealth for their clients and themselves. But, it comes with enormous financial risk. If unsuc- cessful, excessive rents, high overhead, fund expenses, and up-front setup costs can drain lifetime savings and wreak havoc on a manager’s life. Because many of the expenses come with a personal guarantee, not many individuals will choose this course. Personal sacrifices may be far too great for many families, and difficult choices can become exacerbated by quarrels regarding future directions. Of course, there are safer approaches to launching a fund, but these also come with risk. Emerging managers may decide on a “middle step” toward fund launch. For example, they could proceed in the direction of becoming a professional money manager without the massive up-front costs or personal guaran- tees. Managers can work out of a home office rather than procuring professional space in a commercial office PARADOX OF FUND LAUNCH
building. For many, it may appear to be a logical step for a variety of reasons, including convenience and cost. Managers can also delay the hiring of other team mem- bers, forgo the registration of a fund, access data for free at a library in lieu of buying, and avoid account admin- istration/fund accounting. Costs will drop dramatically. Unfortunately, by pursuing this low-cost strategy, the manager will be signaling to outside investors that the business is not yet real. Institutional investors will not invest with a stay-at-home manager who lacks data or staff. This does not mean the emerging manager does not have talent. But for many investors and consultants, appearances matter. With so many other investment managers to choose from, it will make it appreciably more difficult for the emerging manager to raise new capital from non-family and friends. Emerging managers must learn how to control costs and allocate scarce working capital efficiently. This means having to constantly balance short-term versus long-term goals. Underlying stock market volatility and family worries only add to a manager’s angst. Not surprisingly, on days when the manager’s portfolio per- forms well, the manager looks ahead and becomes more willing to expend for the future. The behavior tends to revert on bad days. This is the paradox of emerging managers. They need to take calculated business risks in order to be successful, but if their judgment is in error, they can destroy their personal and professional life. Their entire net worth can be wiped out with a poorly timed choice. Decisions regarding a fund launch hinge on a variety of factors—many of which cannot be accurately forecasted or anticipated. Break-even becomes a challenge right from the start. Exhibit 5 shows that a professional money man- agement operation with registered investment vehicles requires more than $0.8 million in annual revenue just to meet total costs. A hedge fund would need less. An emerging manager can reduce expenses by eliminating some office hires, eschew a professional office, and shift to a more basic fund accounting/administration system, but costs will likely still exceed $600,000 a year. This means that, given a management fee of 1% a year (or 100 basis points), a fund will need at least $60 million of assets under management to break even. INDUSTRY TRENDS—DECLINING REVENUES SQUEEZE MANAGERS
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