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Asset Management

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Measuring the Quality of Your Investors

The current economic downturn and skittish investors have left administrators and managers concerned about maintaining a stable capital base and avoiding mass redemptions.

The current economic downturn and skittish investors have left administrators and managers concerned about maintaining a stable capital base and avoiding mass redemptions, says Ron Kashden, president of TKS Solutions in this contributed blog entry.One reaction to today's environment has been for funds to initiate liquidity gates and longer notice/lock-up periods; however, managers can take a proactive approach by reviewing their investors and cultivating a naturally stable capital base.

While managers are used to using quantitative methods to review their portfolio, currently there is not an analytical framework for managing their capital base. Investor quality metrics are among the more vital statistics. Armed with accurate measures, managers can better cultivate a stable capital base and make the investment process easier.

The measurement of the quality helps pinpoint potential capital base issues and formulate a plan for achieving a more stable base. Investor quality is usually thought of containing the following attributes: size, longevity, frequency and sensitivity. By applying various weights, relative to the manager's concerns, you can derive an overall measure of the quality of the capital base. For example, if the main concern is the possibility of the majority of the fund withdrawing at one time, then investor concentration should carry the most weight. If slight downturns triggering redemptions is the prominent concern, then the focus should be on sensitivity.

Size is the amount of capital that an investor has in a fund. Size = investors balance / total capital balance. While this may seem straightforward, the implications of investor size are not. A fund that has a few substantial investors comprising the majority of the capital is going to be captive to the whims of those investors. Like its portfolio, for its investors, the fund's goal should be towards diversity and away from investor concentration. A diversified capital pool containing many types might require more support by investor services, since each investor may have different needs.

Longevity is the length of time an investor has been in the fund. Analyzing longevity is most useful when combined with other characteristics, such as type and geography. Using the combined metrics methodology makes obtaining ?desirable? investors a more focused effort.

Frequency is the number of times an investor makes additional contributions. When frequency is paired with the investors' cash, accurate forecasting of future subscriptions can be performed.

Sensitivity is the measurement of an investor's tendency to redeem if the fund suffers a loss. This is the least direct metric, because it is difficult to determine what timeframe affected the investor's decision. Mechanically the redemptions can be associated with the funds returns, while a manual review should be performed to verify patterns.

A manager is forced to be more sophisticated because of the consolidation of hedge fund managers and an increasingly difficult investment environment. The trend of applying discipline, now present in investment decisions, needs to carry through all aspects of operating the funds. Accordingly, a more prominent concern is effectively managing the capital pool. Funds will look to their back-office systems and administrators to give them the rich analytics they need to operate effectively rather than just churning out simple investor statements.

Ron Kashden, who has over twenty years experience in financial services technology and accounting, is president of TKS Solutions. Prior to joining TKS, he served as CFO of Tiedemann Investment Group and before joining Tiedemann, Kashden headed software development for SAC Capital Management. The current economic downturn and skittish investors have left administrators and managers concerned about maintaining a stable capital base and avoiding mass redemptions. Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology. View Full Bio

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