New York (HedgeCo.net) – You are starting a hedge fund, or you have started, are successful and assets are growing, returns are solid. A tough feat in the current market environment, but you are worried. Auditors are constantly calling, the administrator’s reports are late and are hard to understand, and the prime broker does not agree with either one of them. Then, the lawyers are requesting more information. Funny, all of your advisors told you to outsource everything, you don’t need a back office. However, the confusion and annoyance is distracting and surely costing you money. You, as a fund manager, are now facing the CFO dilemma, for which there is a solution.

The hedge fund CFO dilemma: The fund manager must produce returns and raise capital while at the same time respond to investors and other interested parties who are asking for due diligence reports, audits, and offering documents. The original plan included the outsourcing of these functions to administrators, auditors, and compliance professionals; however, everything is not clicking as expected, the manager feels the pressure of responding to these demands and it seems to be costing more than expected. As the management fee is squeezed further and further, the clamor for a full-time financial professional –a CFO, a controller, or just an accountant—is rising. Unfortunately, the budget for it doesn’t exist, and besides, how do you hire the right person?

Out of these conflicting tensions, an experienced hedge fund financial professional devised a solution. James Conant founded Hedge Fund CFO, LLC to fill the void in the management team of most small and medium-sized hedge fund managers. After ten years as the CFO of a fund manager involved with both equities and commodities over a range of investment structures and domiciles, Conant recognized that the CFO function was vital but at the same time, the talents of senior financial professionals were underutilized. “Typically,” Conant states, “a high level of experience and savvy is necessary to deal with difficult valuation questions, audit relationships, ensuring administrator performance, and tax matters, but these may not require the full-time presence or participation of the CFO in the management company.” Once the CFO expands his role to operations, administration, and compliance and created a stabile organization, a talented person in the CFO role will still find idle time on his schedule.

Conant realized that the dichotomy of necessity of the CFO function versus the underutilization of the talent produced an opportunity. Most fund managers, especially those with under $100mm in AUM, struggle with the cost of a full-time CFO and the effective utilization of that person. Most managers, especially those launching a fund, elect to skip the filling of this function or simply hire a very junior person. Mistakenly, they believe they can cover the function themselves or rely on outsourced administration. According to Conant, “this assumption produces operational issues, critical errors, and high charges from service providers such as administrators and auditors.” Additionally, investors could raise concerns about operational and audit risk—who is effectively monitoring these risks while the manager worries about returns on the portfolio?

The opportunity to create Hedge Fund CFO LLC arose as his CFO role continually diminished during the steady, gradual decline of the fund manager that retained him in the traditional CFO role. Assets had declined from a peak of $700mm to only $10mm, but the manager pushed him to remain with the firm, recognizing the vital role being filled. Ultimately, affordability became the issue and a compromise was necessary. Conant proposed offering his services to other managers while still being responsible for his duties to the original manager, and with his manager’s concurrence, he founded Hedge Fund CFO LLC. In searching for new clients, he found several small funds under $100mm who were struggling with an economically feasible solution to the “CFO dilemma,”— as Conant describes the problem.

Managers could not afford to pay the high price and commitment entailed by the hiring of a strong, senior financial professional, but they had the need for those services. According to Conant, “scaling and flexibility” were critical to their decision to retain him. He does not require a fixed term and charges the client a fixed monthly retainer, which is adjusted periodically as circumstances warrant, for completely fulfilling the CFO function for the firm. Neither Conant nor his clients felt like dealing with hourly charges and time tracking, thus a fixed monthly fee. This fee structure also fosters an environment in which the services of Hedge Fund CFO LLC are considered as part of management, not an outside service provider. Conant feels this feature is critical—“my advice and services are aligned with management, and with a fixed retainer, conflicts over time and fees are eliminated.” Conant constantly visits his clients’ offices while also servicing a great deal of their needs out of his own office—“with administrators in Bermuda and India, auditors in New York, and prime brokers everywhere, physical presence is not essential” he claims.

Conant quickly found that newer and smaller managers did not have the same rigorous standards for timeliness and accuracy in financial reporting and the urgency for problem resolution with other service providers, as compared with larger, established fund managers. “Managers without the experience and training in these functional disciplines (accounting, operations, and auditing) are at the mercy of their outside service providers, who are well intentioned with their client but may not have the necessary motivation nor expertise to deal with other providers,” states Conant. Many issues require a significant level of professional expertise, that is typically unavailable to a portfolio manager, and require advocacy by a senior professional closely aligned with the interest of management. “The lack of focus and advocacy creates problems in resolving issues of timing delays and higher costs, not just the lack of feeling more comfortable,” claims Conant. In addition, as the funds grow, investors have increasing concerns over operational, administration, and audit risks, which in Conant’s view: “should be zero, there are enough risks in a fund that are difficult to control—returns, volatility—and investors and managers should not have to be concerned with those risks are easily controlled with the proper resources.”
An indirect benefit of this approach to filling the CFO function has been the ability of Conant to leverage the knowledge of different operational approaches, different administrators, and auditors. “Every manager or administrator believes his operational or administrative method is optimal, and they have very little experience with alternatives,” according to Conant. The ability to find and evaluate alternatives has been a critical enhancement. “The ability to constantly review different prime brokers, administrators, and auditors becomes a valuable resource for my clients,” claims Conant.

Furthermore, the diversity of clients eliminates any dependence on any one of them for revenue. “Most CFOs are honest and insist on propriety in reporting results and enforcing internal controls, but if you are dependent on that manager for your paycheck, bonus, and financial well-being, the line is always being pushed and the gray area becomes larger.” Conant continues, “the appearance of independence is always crucial and the further you can prove that independence enhances that view.” The ability of Conant to dismiss any client if necessary, he feels is critical and adds veracity to claims by clients of propriety of the firm.

After launching the firm in early 2008, Conant has spent the last year working through the validity and logistics of the service with his small group of clients. In the difficult environment for hedge funds during this period, his clients have had mixed results on their investing returns, but there has been solid success with his services to validate the premise of his firm. “My intention has been, and will continue to be, to offer my services on a personal and professional basis, thus I will have a limited number of clients,” he states. There are alternatives to solving some of these issues he addresses, but they still involve the engagement of yet another service provider—with a revolving staff and the lack of dedication to the manager.