Six Questions to Ask Your Would-be Fund Manager
In our advisory and
consulting practice, we have the unique opportunity to see a lot of funds
and potential funds and talk with a lot of fund managers and aspiring fund
managers. There are some really good ones and some not so good ones and people
are truly all over the map as to their strategies, capabilities, and
understanding of what they are actually doing.As someone who has been in the small balance real estate lending space for over 20 years and has created and managed multiple funds in this space, it is much easier for us to assess who really understands what they are doing and who does not. But how does a potential investor know how to distinguish one from the other when they all basically look alike? Here are some tips on how to separate the wheat from the chaff.
A great method to follow that is also easy to remember is to use Rudyard Kipling’s “Six Honest Serving Men.” If you are not familiar with the poem, it starts with “I keep six honest serving-men, they taught me all I knew, their names are What and Why and When and How and Where and Who.” So let’s use these serving men (not necessarily in Kipling’s order since we do not need them to rhyme as he did) to formulate some questions that you (an investor) may want to ask of your would-be small balance real estate or mortgage pool fund manager.
First, “How” is your fund structured? This should be the starting point to determine if the manager knows what he or she is talking about. I have met many a manager who cannot describe accurately how their own fund works. They answer questions one way but their documents say something else entirely. If the manager cannot answer basic questions accurately, this is an immediate indication that you do not want to invest with them. Table stakes.
Second, “What” is your asset model? What types of investments is the fund making (or going to make)? Can the manager explain the fund’s asset strategy, both verbally and in the offering documents? Many funds we have seen give the manager sweeping powers and authority to do basically whatever they want with no parameters whatever placed around the model. A good fund manager will be able to clearly articulate the asset model and ideally it will be one that does not have a fundamentally limited market shelf life before becoming quickly obsolete.
Third, “Where” are you going to originate and acquire the assets? Geographic location? From which sources? Where the assets come from matter, as there are pressures and implications on the manager, depending on the answer. Some origination strategies are better than others and a good manager can describe the model’s strengths and weaknesses.
Fourth, “When” will the fund deliver on certain of its key characteristics? How often are the distributions? What is the lockup period? What are the redemption features? How does the manager expect to wind the fund down if/when the time comes? Does their answer make sense in the context of the asset model? What is likely to happen to the fund (and your ability to get paid back) if markets change (which they will)? There are a lot of whens in a fund that no manager can promise, but he/she should be able to tell you how they expect things to work. Their answer should make sense to you and if it doesn’t, this is a warning sign.
Fifth, and now we are getting to what separates great managers from average or poor ones, “Why” is the fund structured as it is? What considerations did the manager go through when architecting their fund in the first place? My experience is that most managers cannot answer this question. They did whatever they did because that is how their attorney drafted their documents, but they typically cannot explain “why” – what the reasons were behind that structure. If they cannot, it means they did not understand what structure they were shooting for when they created it and therefore they cannot be as good a manager as a best-in-class manager, who in fact will be able to answer this question.
And finally, and most important, ask yourself (and the manager) “Who” am I dealing with? How do I know I can trust them? What governance and procedures and policies do they have in place? Are they in writing? What is their track record? Who have they dealt with that I can talk to in order to verify their character and credibility? Have they faced adversity with integrity and persevered? No manager is perfect in their investment decisions (if they are, they haven’t been doing it through multiple cycles). But you want the ones who have the best chance of performance when the going gets rough.
Some managers are honest but not competent. Some are competent and not honest. Some, unfortunately, are not competent and not honest. The very best are both competent and honest and can demonstrate both characteristics to you during your due diligence and decision making process. These are the ones you want and you should demand nothing less when investing your money.
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