“Making Entrepreneurship Last” – Building a Going Concern Investment Fund

By Emanuel Kastl, Fulbright Visiting Scholar at the Wharton’s Sol C. Snider Entrepreneurial Research Center; PhD Candidate at Cass Business School, City University London

The year as Fulbright Visiting Scholar at the Wharton School has profoundly impacted my research. Wharton offers a stimulating environment of world-class academics, insightful PhD courses, extensive data resources and a vibrant research community. Since the research is at the interface between disciplines, I discussed my ideas and preliminary results with academics from the fields of entrepreneurship, strategic management, finance, as well as business economics. I obtained valuable feedback by presenting my research at the Wharton School’s Sol C. Snider Entrepreneurship Center, as well as in the PhD student seminar series. My research benefited from taking PhD courses on quantitative methods and organizational theory. During my time at Wharton, I joined the Wharton Investment Management Club, which in combination with conferences at the Mack Center, provided valuable practitioner insights.

In my doctoral research on the interface between competitive strategy and finance, I explore how organizational factors affect firm performance and firm selection in the global hedge fund market. Hedge fund managers, as the entrepreneurs of the finance industry, require efficiency and innovation to succeed. With an average age of a little less than six years, the life span of the typical hedge fund management company is quite short. Hence, it seems to be an important question, which organizational factors help to build a sustainable business behind the likely short-lived success of a specific hedge fund ‘product’ (i.e. a specific investment strategy). Here is a glimpse on the preliminary insights, which my ongoing research provides:

  • From the perspective of the hedge fund manager, a diversified fund offering is beneficial. Diversification does not hurt hedge fund firm performance (in terms of returns and alphas), while it is positively related to capital flows from investors and firm survival. On the firm level, capital flows are the key variable to maximize for the hedge fund entrepreneurs. Capital inflows increase assets under management, the main determinant of hedge fund firm revenues (i.e. dollar fee income) and survival.
  • Managing the transition from private to institutional investors – transparency and a broader product offering go hand in hand. Most hedge fund firms build a track record with money from their founders or with seed capital from high net worth individuals. Even if the initial investment strategy makes for a killer product, it is likely that competitive advantage is fleeting as knowledge on innovative investment strategies diffuses and market conditions change. For a successful transition in the hedge fund firm’s client base from private to ‘big ticket’ institutional investors, a shift in focus from the specific hedge fund product to the overall firm seems to be key. Institutional investors, such as pension funds or university endowments, tend to look for hedge fund investments that are offered by transparent firms with well established procedures, not ‘mom and pop’ stores. In particular, two factors are worth mentioning:
  1.  Establish beyond minimum required transparency with regulatory agencies, as well as transparent investment procedures, which are supported by reputable service providers (e.g. prime brokers). This level of transparency will not give away the fund’s ‘secret sauce’ while it will allow institutional investors to understand the hedge fund firm’s way of investing and potential competitive edge. Position-by-position disclosure of the fund’s investments (e.g. via managed accounts) demands more caution and may make the hedge fund vulnerable to negative competitive consequences, such as front running or predatory trading.
  2. Branch out the hedge fund product offering to be prepared for the time when competition in the original investment strategy or geographic focus increases and investment opportunities dry up.

 

EKastl_CroppedBio: Emanuel Kastl is a Fulbright Visiting Scholar at the Wharton School of the University of Pennsylvania and a third year PhD researcher at Cass Business School, City University London.

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