Types of hedge fund investors – who are those participants?

Many people worldwide are interested in hedge fund investment, but not everyone ends up actually investing money in them. Hedge funds are alternative investment methods that are not suitable for everyone at least because of their high minimum investment barrier. There are certain types of people and organisations the hedge fund managers are most interested in. All hedge fund investors can be grouped into 2 large categories: institutional investors and individuals, but there are many investor profiles within each category.

Individual Hedge Fund Investors

Early investors (friends and family)

Many hedge funds were started as limited liability partnerships of close friends or former colleagues. Primary hedge fund partners usually invest their own money into hedge fund and people from their close circle follow their example. Besides friends and family, early hedge fund investors may include former investment partners and business angels.

When to pitch: before launch

How to acquire: Networking

Key points: Pay less attention to paperwork and more to personal trust; Are more interested in growth then in diversification

Pros Cons
Investors of this type are easier to convince, because they know primary partners personally Contribute smaller investment amount then other types
May contribute the major portion of initial hedge fund capital

Business owners / Entrepreneurs

Due to high dividend taxes in many jurisdictions, businesses often prefer to invest their cash surplus, rather than take out the dividends. Such investors may be interested in alternative investments such as hedge funds.

When to pitch: at the final fiscal quarter or anytime

How to acquire: Networking; Manually study corporate financial reports; Corporate investors databases

Key points: Huge number of potential clients (no matter which business niche)

Pros Cons
Faster decision-making process (compared to institutional investors) May not be interested in long term commitment
Easy to get contact information

High net worth individuals (HNWI)

High net worth individuals are people with net-worth over $1 million dollars, not including primary residence. These investors often show interest in new hedge funds but will require more detailed information than early investors. Many of them are still open to invest into new venture, but at least formed LLC or other type of partnership and defined fund structure and strategy are a must before attempting to reach HNWI.

When to pitch: before or upon launch

How to acquire: Networking (friends of friends); Contacts in hedge fund databases; Via professional money managers (by asking them to recommend fund to high net-worth clients); Make connections on high-profile charity events

Key points: May accept higher risks with small portion of their portfolio; Are open to invest into a talented fund manager

Pros Cons
Are open to invest into funds with smaller initial capital Hard to identify and/or get their contact information
Usually become long-term investors

Seed capitalists / venture capitalists

Seed capitalists are looking for startups and organisations to finance in exchange of certain benefits (such as portion of future profit or fund shares). Venture capitalists usually are open to contribute from 5 to 100 million dollars at a launch stage or later to help fund reach the principally new level.

When to pitch: when trying to achieve new growth stage (before launch or later)

How to acquire: Find local or global communities of venture capitalists; Identify matching venture capitalist firms and approach one at a time

Key points: Are overloaded with offers from other funds and companies; Have very thorough selection process

Pros Cons
Large investment amounts Want to own fund shares or large portion of future profit
May invest upon launch
May invest into unknown money manager

Family offices

High net worth individuals often have a family investment manager or management team. As the name suggests, family offices are usually formed between family members (for example 6 grand children of multibillionaire) who hire one financial money manager to run their portfolios. But the term family office may also refer to a group of colleagues such as Microsoft millionaires.

Family offices often stay on the conservative side of investments and have large parts of their money invested in stocks and real estate. However, if they allocate 10 to 20 percent of capital for riskier and alternative investments this may become a significant contribution. Smaller family offices usually provide quick access to money, while larger offices may have strict requirements but offer larger investments.

When to pitch: family office practices and principles vary greatly from one office to another, so pitching makes sense on all stages of fund growth

How to acquire: Referrals; High-profile charity events; Family office conferences; Family office databases

Key points: Invest to stay hedged and to increase potential profits; Run by either family members or professional money managers

Pros Cons
Are more accessible then institutional investors May be more conservative and prefer funds with famous brand names
Typically contribute from 1 to 25 million dollarsh

Financial consultants and money managers

Although these people are not investors themselves, they have influence on hedge fund’s potential clients. As third party agents, consultants and managers may charge fees for their recommendations, but also may bring a lot of clients. Since upon recommending someone they risk their own reputation, advisors prefer to work with established funds with at least a short history. Important question to answer before approaching this group is whether the fund is interested and can afford their commision.

When to pitch: usually after launch, when the fund already has acquired initial clients, has some assets under management and at least short track record.

How to acquire: Basic online research followed by direct pitch email; Networking; Cold calling

Key points: Cautious, not willing to risk their reputation

Pros Cons
Are easy to find and approach Are expensive
Have access to a lot of potential clients

Institutional Hedge Fund Investors

Institutional investors are different funds (pension, insurance, sovereign funds, etc) and endowments. They are the dream clients of any hedge fund. Professional money managers with access to large amounts of money, institutional investors usually represent pension funds, insurance companies, sovereign wealth funds and other financial organisations. Institutional investors rarely risk large portions of their portfolios. Depending on the organisation, they may assign 10 to 20 per cent to alternative investments such as hedge funds. Why do institutional investors invest in hedge funds? Although increased profits are important, their primary goal is diversification. If the fund works with stocks and gold, they may be looking for emerging market fund or an event-driven fund to hedge the rest of the capital from sudden draw downs.

Institutional investors provide nearly two thirds of all the money invested in hedge funds. However, they are less likely to invest into new ventures and would prefer to check track records for 2 to 3 years.

Funds of funds

As the name suggests, these funds specialise on investments in other funds. Funds of funds have strict security procedures and run background check on the fund and its manager. Decision making process is slow and may take the team up to 18 months to review investment opportunity.

When to pitch: 2 years after launch or when the manager and the strategy have enough data to prove their efficiency

How to acquire: Basic online research followed by direct pitch email; Cold calling

Key points: Managed by strong team of professional investors

Pros Cons
Are easy to locate Slow decision making process (usually between 6 and 18 months)
Invest large amounts of money May exit the fund at any time on a short notice

Nonprofits and endowments

Money managers of nonprofits and endowments have to have conservative portfolios. List of organisations they work for includes schools and other nonprofit organisations. These investors invest on the long term into low risk assets.

When to pitch: only after the fund is well-established and matches high institutional investors standards (usually 2-3 years after launch)

How to acquire: Basic online research followed by direct pitch email; Cold calling

Key points: Slow money turnover, established standards and verification procedures

Pros Cons
Long-term investors Long decision making process
High investment volume

State and corporate pension funds

Pension funds mission is to keep and grow their clients pension savings. These investors often have strong team of financial analysts on board. Decision makers don’t receive direct profit from fund’s investments. Their primary mission is to have company’s board of directors satisfied with their moves.

When to pitch: when the fund has established reputation and success history (usually 2 years after launch)

How to acquire: Research funds and connect with their teams of analysts; Fund analysts databases; Cold calling

Key points: Decision makers aren’t personally motivated by profits

Pros Cons
Long-term investors Long decision making process
High investment volume Strict leverage limitations and risk tolerance requirements

Sovereign wealth funds

Sovereign wealth funds are state-owned entities whose goal is to invest national capital. Sovereign wealth funds invest globally and unlike pension funds don’t have liability obligations. These funds invest giant amounts of money into largest hedge funds (initial investment may vary from 500 mln to 1 bln dollars).

When to pitch: when the fund is capital intensive and ready to accommodate investments of this size

How to acquire: Preqin Sovereign Wealth Fund Review; Other lists of Sovereign Wealth Funds

Key points: Managed by professional investors with wide variety of tools for analysis

Pros Cons
Access to giant capital Rarely interested in funds with less than 5 bln dollars under management
Long-term investment horizon Investment strategy must be capital intensive to adjust to this investor
Complicated security checks and slow decision making processr

Investments in hedge funds are considered aggressive and require higher risk tolerance. But despite high return potential many investors opt for hedge fund not in pursuit of huge gains, but for broader diversification. This is especially true for institutional investors, most of which are ok with average growth.