The appetite from investors for new fund products is strong, competition for capital allocation is increasing, as a result the industry has seen more and more funds seeking the services of third party marketers to source investors and increase their distribution network. Carbon360 conducted a survey of third party marketers titled "Capital Introduction Trends in 2006", to investigate the following macro themes industry trends:

• What are the most sought after strategies in 2006?
• Who and where are the investors based?
• What aretheir primary concerns?
• What type of funds do third party marketers work with? What is a typical fee structure?
• How do third party marketers source potential
• Due diligence – what and how is it conducted?
• Industry concerns and needs.
• How will the industry evolve over the next five years?

Most sought after strategies by investors in 2006

In addition to traditional long/short funds we find investors are very interested in more industry/sector specific strategies.

• 67% US Equity L/S
• 47% Emerging Markets
• 47% other: This includes: Multi-Strategy, Event driven/Merger Arbitrage, Asset Backed lending and Japan and India focused strategies.
• 33% Global Macro
• 7% Fund of Funds/CTA/FX and Distressed

Who are the investors?

Our survey results confirmed the changing landscape of the investor base now dominated overwhelmingly by institutions.

• 94% Institutions
• 31% High NetWorth Individuals
• 7% Family Offices/Pension Funds

Where are the investors based?

As might be expected, third party marketers mainly sourcetheir investors in the US and Europe, but are increasingly looking to Asia and Australia as sources of new capital allocation as hedge funds grow in these regions.

• 80% US
• 50% Europe
• 19% Pacific-Rim
• 7% Australia

What are investors most concerned with in relation to the managers they fund?

While it is no surprise performance drives investor decisions it is curious that in light of recent hedge fund blowups more investors are not as concerned with the infrastructure of the fund they are investing in.

• 100% Performance
• 56% Reputation
• 31% Infrastructure/Transparency/Risk Management/Consistency in the application of theprocess.
• 19% Preservation of Capital

What type of managers do third party marketers work with?

Third party marketers appear to have the most traction with relatively newer funds.

• 94% Managers with a track record less than five years.
• 69% New Managers/Startups.
• 62% Emerging Managers with a track record less than one year.
• 62% Managers with a track record greater than five years.
• 6% Funds that deal with top level providers – (i.e.) Auditors, Lawyers, Administrators, Prime Brokers.

What is a typical fee structure?

Although fee structures appear to be standard based on a supply/demand model it is important to note they can be customized depending on the manager(see additional comments). Therefore our survey results do not reflect 100% participation to this question.

Managers with a track record of less than five years:

• 64% charge 20% of management and incentive fees.
• 9% charge 20-25% of management and incentive fees as long as capital is invested.

• 9% charge 25% of management and incentive fees.
• 9% work on a retainer basis

Emerging mangers:

• 60% charge 20% of management and incentive fees
• 20% work on retainer, commission and performance based fee
• 10% charge 20-25% of management and incentive fees as long as capital is invested.

Managers with a track record greater than five years:

• 64% charge 20% of management and incentive fees.
• 9% charge 20-25% of management and incentive fees as long as capital is invested.
• 9% charge 25% of management and incentive fees.
• 9% work on a retainer basis.

New Manager:

• 43% charge 20% of management and incentive fees.
• 28% work on retainer, commission and performance based fee.
• 9% charge 1.5% of the management and 20% of the incentive fee.
• 9% charge 25% of management and incentive fees.

How do third party marketers source potential managers?

In an effort to source potential managers and investors, third party marketers work with "advisors" who have industry knowledge.

• 100% find managers through referrals.
• 25% from cold calling.
• 12% from networking.

How do third party marketers source potential investors?

• 87% find investors through referrals.
• 60% from cold calling.
• 47% from experience/long term relationships/networking or advertising.

Due diligence

As might be expected, background due diligence is of paramount concern as operational and process due diligence take a back seat.

What is conducted?

• 100% conduct background due diligence.
• 81% conduct operational and compliance due diligence.
• 13% conduct process and performance reviews.

How is this conducted?

• 100% conduct on-site visits to the manager, with some conducting quantitative, accounting, middle and back office analysis.
• 75% work on a referral basic.
• 69% conduct a literature/public records search.
• 56% utilize contracted research.

Industry concerns and needs. How are marketers contemplating the evolution of industry in the next five years?

We received the most feedback in this section of our survey. Based upon the responses received three themes are evident:

• The majority of third party marketers feel the alternative asset class industry has grown at a pace that is unsustainable. As a result, many funds will not be able to survive and there will be a tremendous amount of consolidation within the industry.
• Stricter and more oversight of all hedge funds, broker-dealers and marketing firms is expected. Third party marketing firms who are not NASD broker-dealers will be required to register and comply with securities laws. Additionally, there will be more SEC regulation of broker-dealers who perform Capital Introduction.
• Fund of Funds will see redemptions as institutions, high net worth individuals and pension funds will go directly to hedge funds themselves as a way of reducing fees.

Conclusion

Assets under management in the hedge fund arena have grown at a pace that is unsustainable. As a result the hedge fund industry and, in turn, third party marketers and perhaps Prime Brokers will exhibit some form of contraction in the coming years.

Interestingly, based upon the results that we received the overwhelming majority of third party marketers work with new or emerging managers. Those are the very managers where we expect to see the majority of the above mentioned contraction take place. In an effort to gain assets under management and in turn survivability, new and emerging managers represent a captive audience for third party marketers as these managers can outsource their marketing/investor relations efforts and focus on managing the performance of their funds.

Additionally, and most important, with funds under stricter SEC guidelines we expect more stringent due diligence will be done down the line from the third party marketer to the Prime Broker and to the investor.

Jackie Mandel is a senior business consultant with CarbonBased Consulting and Carbon360. CarbonBased Consulting (Carbon) together with Carbon360 Research (Carbon360) is an established research and advisory firm focused exclusively on the asset management industry.