Bridger Pennington breaks down three critical fund risks: concentration risk from hidden overlapping exposures like owning Amazon directly and through index funds, management risk tied to team credibility and conflicts of interest, and operational risk covering HR, accounting, and compliance. He shows how these play out across stocks, hedge funds, real estate, and venture capital.
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What's up guys? In today's video, we're gonna talk about the 3 biggest risks when investing in funds. All right, so this is kind of both from the investor perspective of things you should be watching out for, but also from the manager's perspective of how to mitigate risk for your investors. So first up, you hear it all the time, diversification, right? Kind of the parallel of that is concentration risk. It's a huge thing that you need to be thinking about as a fund manager, And how you can mitigate that for your investors. So let's let's talk about a couple examples. So if I owned Amazon stock, but I also owned pieces of the S&P 500, and I also owned like a technology ETF, my exposure to Amazon is not just through individual Amazon shares. It's also I get look-through exposure through the S&P 500 and technology ETF. So my concentration in Amazon is. is a lot higher. So it doesn't just go for stocks. Let's talk about hedge funds. If I were investing in a hedge fund, there are similar strategies that trade large-cap, you know, companies that are in the S&P 500. And are they trading the same option strategy? You know, I wouldn't wanna allocate to 2 different funds that have the same exact option trading strategy. So not only does this apply to stocks and bonds, but it also applies to real estate funds. So if I'm an investor, like the biggest thing in real estate is kind of like geographic risk. One of the largest things, you know, you hear them say location, location, location, 'cause it matters. So I don't wanna be overexposed or have too much of my investments going just into Texas or just into Florida or just into a certain type of real estate like multifamily or single families. Investors are constantly looking for uncorrelated assets. Doesn't just apply to stocks or real estate. So venture and private equity. This is one that people tend to overlook, but institutional allocators that are investing into private equity or venture funds, they are constantly, you know, thinking about their exposure to different sectors and making sure that they don't have too much exposure to any individual company. 'Cause a lot of venture funds, like if a company's raising money, they're gonna raise $5 million. They don't raise that $5 million from just one investor. They're gonna go raise, you know, $1 million from 5 different investors. Most likely. As an allocator, you don't want to be investing into 2 different venture funds that like to joint venture together and like to co-invest into the same types of projects. Diversification can be really big, right? And, uh, concentration risk. So same thing in private equity with the company exposure. I would say that's probably one of the biggest things that people should be thinking about when they're investing is the concentration exposure that they have to different assets. Seeking uncorrelated assets. So the second thing is management risk. When you are investing into funds, these are active managers. Venture capital, private equity hedge funds, for the most part. I mean, we did a video on how some can be passive, some can be active. For the most part, they are active managers. So you need to pick a good manager. What makes a good manager? I think just really good experience, right? Obviously, if you have the credibility, if you don't have a good track record or anything, got to lean more on your deal. But a manager just isn't one. Person. Managing entity is a group of people. So if you yourself, you do not have the credibility to feel confident in front of investors, then go bring on advisors and an investment committee and partners that have the credibility to make your team look more professional and well-rounded. You don't want 5 people that do the same exact thing and have the same exact resumes, right? You want to diversify your management team. So management risk is a big deal though. Like, people want to see how long have the partners worked together, do they know each other, are there any Conflicts of interest. Does each one of these managers? Do they have other businesses that they're operating, or are they solely focused on this fund? Do they have any sort of conflicts of interest that might you know dissuade me from allocating to this investment? Now it's good to keep in mind, and I mention this almost in every video: you got to understand your investor. The high net worth person, they're probably not going to look into all these things. Yeah, they're going to want to see that you have a good credible team, and they're probably going to look mostly at your track record. An institution, they will thoroughly investigate your team, your. Track record, like everything that you have done, make sure that it's legitimate and valid. But management risk is a huge issue, right? If a core partner walks away, it can quickly force a fund to liquidate or, you know, lose the investment. So that's the second thing. So first, you know, concentration risk. Second, management risk. And lastly, I'd say is operational risk. And this is largely for emerging managers because that's who we work with here. So operational risk is a big thing for emerging managers. Do you know how to run a Business. People forget that all the time, but a fund is a business, okay? And you are going to have the same business needs. You're going to need HR. You're going to have to learn how to fire and hire people. You know, you're going to need to know your accounting and taxes. You're going to need to know your finances. You're going to need to know just all your incomes and expenses. So can you properly forecast and anticipate those expenses and make sure that you have the income to support those? Your investments team, are they being sufficient with compliance, you know, working with your filings and your annual filings and making sure that, you know, all your I's are dotted and your T's are crossed. There's just a lot to do, you know, to do with running a business. And then, you know, with each individual sub-asset class, do you know how to operate those systems at scale? So again, concentration risk, management risk, and then finally operational risk. There are so many other risks, you know, other than just, you know, concentration risk, management risk, and operational risk. You'll have like political risk and just The asset risk, you know, cryptocurrency and real estate have very different risk levels. Your strategy risk, like there are so many more, but I think these three are pretty much covered from a high level of what investors should be looking for and managers and how to mitigate those for your fund. Now, the SEC comes out with a bunch of questions on their website and a bunch of guidelines that kind of walk through things that you should ask a manager to find out about their management risk, things you should ask group about their their track record. So the SEC along with like ILPA, the Institutional Limited Partnership Association. Like there are a lot of resources out there where you can go and see like what do managers need to have to qualify for an institutional investment. Obviously there's a ton of risks associated with investing, but I hope, hopefully this was helpful for you guys as you're launching your funds.
