Not all requests for proposal are equal, particularly when it comes to hedge funds.
Two facts will illustrate this in the future, say consultants, fund managers and investors: Institutional assets directed toward hedge funds or absolute-return strategies will grow, and some hedge funds will fail.
That isn't to say constructing a good RFP will mean the difference between making money and losing money, though it is a critical first step. Stuart Feffer and Christopher Kundro, partners at London-based financial services firm Capital Markets Co. Ltd., recently wrote a report about why hedge funds fail.
After examining more than 100 hedge fund failures of the past 20 years, they found that half failed because of "operational" problems, including trade processing, accounting and administration.
The report states: "Expanding due-diligence and monitoring practices to understand `back-office' capabilities can make a big difference in preventing or avoiding these failures."
Part of the due-diligence process is the RFP, says Brett Felsman, director of hedge funds of funds with Global Asset Management Ltd. in London. The Capco study, Mr. Felsman says, points to the need for RFPs increasingly to include what he calls "non-investment due diligence."
That relates less to actual investments, performance and fees and more to contracts with service providers and administrators, and arrangements with third-party marketers.
"Everyone does background checks, but we're talking about much more than that," Mr. Felsman says.
A number of similarities
Examining a limited sample of RFPs from pension funds and endowments seeking hedge fund or fund-of-funds managers reveals a number of similarities in structure and in the kind of information being sought. But there are also differences in the level of detail.
The $500 million Middlesex County Retirement Board in East Cambridge, Mass., through its consultant, Wainwright Investment Counsel LLC in Boston, recently issued an RFP for hedge-fund-of-funds managers to oversee up to 5% of the plan's assets.
In preparing the 15-page document, officials there covered many issues, including the structure of management and performance fees, employee backgrounds, compensation, investment process and philosophy, and asset breakdown by kinds of investor and investment. Officials also included questions about past lawsuits against principals at the firm and asked for contact information for prime brokers, administrators, third-party marketers, banks, investors, lawyers, accountants and auditors.
Meanwhile, officials at the University of Wisconsin System in Madison issued a broad RFP for managers in seven investment strategies, including hedge funds of funds, to manage assets on behalf of the university's $300 million endowment. The questionnaire was the same for each strategy, with some specific questions about performance fees and strategies directed to fund-of-funds managers.
University of Wisconsin officials included a question about performance in relation to benchmarks; Middlesex County didn't. But Middlesex County officials asked for more details about general partners' investments in the fund and portfolio managers' compensation than did the university officials.
The University of Wisconsin's RFP asked only whether managers charged a performance fee and if it was negotiable, while Middlesex County asked about the fee structure but didn't ask if it was negotiable.
Middlesex County officials also asked about the capacity of hedge fund managers used by the funds of funds, redemptions and possible redemption penalties.
It may also be useful to look at what a company specializing in hedge fund investments looks for in terms of information from hedge fund and fund-of-funds managers.
Altvest, a hedge fund database owned by InvestorForce Inc. in Wayne, Pa., sends out a questionnaire to hedge fund managers, and filling it out is a prerequisite for inclusion in the database. While it isn't an RFP, the questionnaire asks about the currencies with which the fund trades, where the geographic focus of the investments is, whether underlying funds are open or closed, and what kind of corporate structure the fund uses.
Privately, some managers have complained about what they say is inconsistency among RFPs from various investors. They say some investors ask for much more detail than is needed or that the manager would provide, anyway.
Thomas Kellerhals, senior partner at The Westminster Group, an executive search firm in Chester, S.C., says variation among RFPs is sometimes the result of the varying experience levels of the investors.
"If you want to do business with institutional clients, you're going to have to do it employing those clients' standards," says Mr. Kellerhals. "If you want that business, you are going to see RFPs, period. Therefore you will answer the RFPs correctly, thoroughly and willingly, or you will not get the business. It's just that simple."