Moore Capital and Sticky Capital

In his annual letter to Moore Capital investors, Louis Bacon wrote about his fund's new marketing strategy:

Bacon also said it's looking to attract longer-term investors after its performance was restrained by redemptions during the financial crisis.

Moore Capital has a new marketing team, which "has had very good success in attracting what we hope is sticky capital from more institutional investors," he wrote in the letter.

Bacon is a rock star among hedge fund rock stars. His fund has returned over 20% for over two decades. My understanding is that he charges above-market fees and has a long lock-up. If even he needs stickier capital, imagine how difficult it is for everyone else. And how important.

My working hypothesis about attracting sticky capital is that it is a two-part process. The first part involves, as Bacon notes, attracting more institutional investors with a long-term capital base. This is not easy, but it is simple: everyone knows who these investors are. You might think of this as "structural stickiness": that portion of an LP's propensity to redeem capital from your fund that can be explained by the type of investor it is (pension, endowment, fund of funds, high net worth, etc). The way to increase the aggregate structural stickiness of your capital base is to attract LPs in the right categories. Simple but not easy.

The second part of the process is more amorphous and intangible. It is the effort to increase an LP's "non-structural stickiness," which can be defined as that portion of an LP's propensity to redeem capital that cannot be explained by its category. High non-structural stickiness can overcome low structural stickiness. That is, an investor in a category known for being flighty can sometimes be your most loyal investor. Consider Warren Buffett's father-in-law:

"Doc Thompson was the kind of guy, he gave me every penny he had, basically. I was his boy."

That was in 1956, and it worked out well. Non-structural stickiness is a function of persuasion, positioning, and underwriting.

I've created a new category called "The Search for Sticky Capital" in which I plan to explore these issues further, the search for both structural and non-structural sticky capital. I will explain what I mean by "persuasion, positioning, and underwriting." The presence of sticky capital is a significant source of competitive advantage for a hedge fund, so the ability to attract it and create it is crucial.

I confess I am a novice in this area, so I welcome any thoughts you may have.

P.S. On the flip-side, from the perspective of a prospective investor in a hedge fund, sticky capital is also very important. You want to spend time learning about how a fund goes about increasing the stickiness of its capital, both structural and non-structural.

Comments

[Nick Gogerty]

Sticky capital is about 2 things.

1. trust in process (faith that a process is being executed consistently.)

2. isolated investment process (the thesis that the returns generating process is isolated from news/noise or spikes that cause fear and capital flight).

Buffet had to structure his business to overcome flight even though his process is isolated. Many of his firms sell products and services that are bought and perform literally as long as the sun comes up in the morning and yield some effective margin due to moats and competitive dynamics coupled with repeat consumption behaviors.

Buffet actually positions himself and uses capital unstickiness to his advantage by paying the premium of having large capital sitting around. The pool of unused capital thus gets sticky when everyone one else is unsticky.

Trust in process and isolated process are difficult to establish. Most investors including FoFs and hedge funds have limited understanding of black boxes or the dynamics generating their returns, maybe 10-15 yrs history. If they only have history instead of understanding the returns generator, they flinch in the face of events, even though those events may be isolated relative to the process generating their returns.

[Nick Gogerty]

oh I forgot to mention Buffet in his original investment life only allowed redemptions and reported once a year.

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