Is your Sharpe ratio strong enough to justify a leveraged share class?
Imagine a strategy that generates around 10% net annually with a Sharpe ratio above 1.5.
From a risk-adjusted perspective, that's an exceptional investment program.
The problem is that many hedge fund investors don't allocate based on Sharpe ratio alone.
They often want return potential in the mid-to-high teens while maintaining attractive risk-adjusted returns.
If your strategy consistently earns around 10% a year, it may simply not fit what many of those investors are looking for.
When we launched our fund, we offered only a single share class.
A few years later, we introduced a second, 2x leveraged share class.
Nothing changed about the investment strategy.
We simply wanted investors to decide for themselves which combination of expected return and risk best fit their portfolio.
Some investors preferred the original return profile.
Others were happy to accept proportionately more risk in exchange for the potential to earn proportionately higher returns.
Both share classes invested in exactly the same strategy.
The only difference was the amount of leverage the investor chose.
Our standard share class charged a 2% annual management fee and a 20% performance fee.
The leveraged share class charged a 3% annual management fee and a 20% performance fee.
At first glance, the leveraged class looked more expensive.
Here's what it actually meant in dollars.
An investor with $1 million could invest all of it in the standard share class and pay 2%, or $20,000 a year in management fees.
Or they could invest $500,000 in the leveraged share class, pay 3% on half the capital—$15,000 a year—and achieve essentially the same market exposure.
Same exposure. Lower management fees. And $500,000 of capital still available for other investments.
Once investors ran that math themselves, they acted on it. Roughly 80% of our assets eventually moved into the leveraged share class.
More recently, while speaking with a potential advisory client, I suggested he consider a similar structure.
He has an excellent risk-adjusted track record, yet had never thought about giving investors that choice.
Sometimes the answer isn't generating more alpha.
Sometimes it's giving investors a better way to access the alpha you already have.