So far, very few hedge fund managers are thought to have availed of the ‘general advertising’ and ‘general solicitation’ freedoms opened up by the JOBS Act of 2012. Most still use the private placement exemption that precludes the two general marketing avenues. That could be about to change. Crowdfunding under the JOBS Act started on May 16 (with rather low ceilings on investment) but RueOne is not doing this. RueOne co-founder Jeff Baehr recognises that “crowdfunding provides proof of concept but we want to offer institutional quality investments to institutional quality investors.” Having worked in hedge funds since 1998, he sees a gap in the market on both the demand side and the supply side.
Investor appetite for bespoke deals
Baehr goes on to say: “A 506c offering enables general solicitation and marketing and no longer needs to be under a broker-dealer nor does it now have minimum size requirements. In essence registered investment advisers can now offer private securities to accredited investors, without needing to register the securities.” The potential investor base could be huge as Baehr believes there are 13 million accredited investors in the US, with family offices, and high net worth individuals as well as institutions coming under the heading. Baehr is of the opinion that the new rules will cheapen capital formation and widen access to a diverse range of investment opportunities.
Baehr hears that institutional investors have an appetite for building customised portfolios made up of hand-picked investments rather than going for a private equity fund or hedge fund manager. “Pension plans, family offices and other institutions want to look at individual deals instead of investing in a fund,” he claims.
Alignment of interests
Baehr wants RueOne’s interests to be aligned with those of investors, partly through investing personally in all deals. Though RueOne expects to receive retrocessions of fees on investments, Baehr argues “we are pursuing a partnership model of sourcing deals rather than a brokerage model whereby brokers walk away after getting paid.” In addition, “incentive fees will only apply to realised profits,” confirms Baehr, who expects the overall fee structure to “avoid hidden fees for sourcing, structuring and legal that can apply elsewhere.”
Is this another form of co-investment? There are several distinctions. RueOne can sometimes take control positions or an entire deal. Co-investments tend to be larger whereas RueOne focuses on sub-$25 million deal sizes off the radar screen of bigger investors that offer better risk/return characteristics, according to Baehr. RueOne is notinviting outsiders to invest in a restricted number of deals; they can access anything on the platform. And Baehr’s argument that “co-investments can entail adverse selection risks as the general partner may pass onto limited partners less appealing investments,” has been supported anecdotally by members of his professional network. Instead, “we intend to give investors a direct look at institutional quality deal-flow with potential to pick and choose which deals they invest in,” he foresees. Historically, Baehr thinks that the “heavy lifting in terms of legal due diligence, negotiation, valuation and pricing issues would have been an obstacle to investors executing on their own deals because most investors do not have that capacity.”
RueOne intends to pool multiple investors’ resources in order to spread and share the costs of its due diligence. “RueOne remains investor advisor to each deal and appoints the sponsor as the subadvisor, to add another level of protection,” Baehr explains.
Due diligence is something he has extensive experience of. Before founding MLP and energy infrastructure manager Empiric, Baehr previously worked as the director of research at Aris Capital Management with stints at The Carlyle Group, Deutsche Bank Advisors, and The World Bank. He has hedge funds in his blood – Baehr’s father, Milt, founded analytics software firm PerTrac. Some readers may have crossed paths with Baehr before he entered the hedge fund industry full time. As a teenager he was providing telephone customer support to PerTrac clients after school. This career history informs Baehr’s view that traditional fund structures may not be ideally suited to some types of alternative investments. He was personally invested in funds that were forced to sell due to redemptions, mark to mark risks and comingled assets and liabilities. Valuation is a hot topic and most RueOne assets are expected to be ‘level 3’ under ASC 820. Baehr argues that such assets may not be a good fit for open-ended, comingled, fund structures as there can be arguments about equitable valuation between incoming and outgoing investors. Baehr thinks that a closed end structure, with no subscriptions or redemptions after capital is contributed, could be fairer.
Baehr expects that tailoring terms, including liquidity terms, to individual investments, could also avoid the potential liquidity mismatches that may arise in some funds that house a wide range of assets. “Each vehicle is structured with the right time frame, so there is no danger of a five year investment sitting in a quarterly vehicle and my goal is that we should never be forced to sell at inopportune times,” he says.
Lean and streamlined business model
Baehr wants the process to be as electronic and streamlined as possible. He enumerates how clients are able to “log into the portal and browse a number of direct investment opportunities, view polished summary and due diligence materials including a video Q&A with the manager, request access to the deal room to view transaction specific documentation, view the prospectus and electronically sign the subscription documents. All in all it is an end to end solution.”
Fees will be negotiated each time and Baehr thinks that “the 2 and 20 model is being seen less often.” Baehr makes the commitment that “fees will not be any higher than investing directly into a fund.” Different assets are expected to have different fee structures and fees could come down as deals scale up. “We are committed to a transparent investor-friendly structure where extra fees are not hidden,” says Baehr. He has put some thought into creating a cost-effective structure. “Each deal will sit in a separate Delaware SPV, inside a Delaware LLC. Filing fees are only $150 per year. We use a similar prospectus and add an appendix for each deal. We expect administration and audit fees will be lower than for a fund as a single asset costs less than a fund. Additionally there is no need to worry about subscriptions and redemptions. Crowdfunding platforms have demonstrated the ability to operate with very low cost ratios and we intend to do the same.”
When “big funds are getting bigger and smaller funds cannot raise money for comingled vehicles,” Baehr thinks it will not be difficult to source niche deal-flow. He finds some funds that offer quarterly or annual liquidity are frustrated by being unable to invest in illiquid opportunities. “When a manager finds an opportunity that does not fit their fund they need a way to monetise their illiquid capacity. We can provide that.” Why would they not set up a ‘sidecar’ or co-investment vehicle? Baehr thinks these structures are costly for smaller funds. He also argues that smaller managers could benefit from the imprimatur of displaying deals on RueOne’s platform. The intended model is for other asset managers to act as sub-advisers on deals while RueOne will remain the investment advisor and underwrite, negotiate, conduct due diligence and structure the deals, and manage them to conclusion.
RueOne’s envisaged deal types are eclectic to say the least. They include some well-known asset classes: private equity and debt, venture capital, real estate equity and debt, real assets equity and debt, and asset backed securities. They also include some more esoteric investments that can come under the ‘alternatives to alternatives’ heading: aircraft leasing; patent and royalty receivables; tax liens; trade claims and litigation financing. The platform is not restricted to the US: Baehr expects to eventually source deals globally.
RueOne is seeking senior partners including a CIO and COO to come on board, and expects to register with the SEC when assets surpass $150 million. SEC registration is a process that Baehr has been through twice before, most recently at Empiric. Longer term, Baehr has aspirations to extend the offering to European investors.