Decoding Lux Funds: The Insider's Playbook Chapter 1: The 10 Biggest Mistakes and Success Factors When Launching a Fund in Luxembourg

TL;DR Summary: The following article provides a comprehensive guide for fund initiators, focusing on crucial aspects that determine the success of a fund project. It describes the 10 most important steps from a thorough research on competitors, identifying key differentiators, understanding the target investors, realistic AuM estimates to the continuous monitoring post-launch. This analysis is not merely a recounting of errors and triumphs; it is a distilled essence of practical knowledge, designed to equip you with the acumen necessary for success.

Questions covered:

1. What are the key questions to ask during peer group research on competitors?
2. How much seed capital do you need and when will your fund be break even?
3. How to define the right distribution strategy and how long does it take to launch a fund in Luxembourg?

In next week’s post I will reveal the 10 things your fund service providers do not want you to know and why.

Based on my experience I have prepared an exclusive cheat sheet with a comprehensive checklist on how to create a fund. If you are eager to dive in, send me a personal message, and I will happily share it with you. I am excited to help you make your fund creation process a smooth and successful experience!

Read below article (4 min read)….

The 10 Biggest Mistakes and Success Factors When Launching a Fund in Luxembourg

Disclaimer: The views and opinions expressed in this article are solely my own and do not necessarily reflect the official policy or position of my employer.

I. How to Define Your Product: What You Order is What You Get

Mistake: Embarking on a fund creation journey without a clear and concise checklist.

Success Factor: Develop a laser-focused fund profile that aligns with investor interests and market opportunities. Clarity is the cornerstone of confidence for your future investors.

Before you go to your first meeting with a service provider (be it a legal advisor, management company, custodian bank or any other), you should have answered the following questions and be able to present the precise vision of your product to your audience.

1)????? Learn from the competition! Peer group research: Questions to ask yourself:

a.????? Who are the 5 most successful competitors (same asset class, comparable/similar strategy) that I will face with my product?

b.????? What is the fund structure of their choice?

c.?????? What is the fee structure (management fee etc)?

d.????? What are the fees charged by their management company, custodian etc?

e.????? Where do they distribute (countries)?

The beauty of this process is not only what you will learn a lot about your direct competitors, but also that you can find all the information you need online (for UCITS) in the respective prospectus and the annual reports that are part of the mandatory publications for UCITS funds. This research phase will be probably more productive than any conversation with a service provider that you could have trying to get the insights you need.

2)????? Differentiator and story line: now that you have done your initial research and know your competitors, you may probably ask yourself the logical question “where do I stand in this (crowded) space? What is my key differentiator and what is my story line?”. Answering these questions will be crucial for identifying the profile of your target investors. My advice: list and address all the weaknesses of your product, be critical and pragmatic, because your future investors will definitely be!

3)????? Who will buy my fund?: As you can see, the wording that I chose here is not “to whom you want to sell your product?”. The reason for that is that – in my experience from the last thirteen years – 95% of fund initiators tend to answer “obviously, I want to sell it everywhere and to everyone”. And this often means that there is no clear target investor profile, which can be fatal, because it translates into a chaotic and inefficient sales strategy. So, answering the question “who will buy this fund?” already requires a systematic analysis of countries, investor groups and sales channels as they have completely different preferences and selection criteria (e.g. fund of funds vs family offices vs retail) and they must be addressed in a different way.

4)????? What is the realistic AuM potential of my product?: now that you have found out what the competition is charging, have in mind who your target investors will be and what the market wants, you are ready to do the math and determine in a simplistic way, based on the distribution channels you will be using (e.g. own sales force, fund platforms, IFAs, placement agents etc) what the (estimated) realistic AuM projections for your product are. Make sure to run those numbers against the fund expenses that you will find in your competitors annual reports as they are a good proxy for your potential profitability.

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II. Misjudging the Market

Mistake: Launching a fund without thorough market analysis.

Success Factor: Conduct extensive market research to understand the economic climate and investor sentiment, ensuring your fund proposition is compelling and timely.

An essential part of your research on the above points should be directly linked to understanding the market environment and monitoring changes in investors’ appetite very closely. Do not surrender to the temptation of being short-sighted when it comes to judging the attractiveness of your strategy in the current market only. Try to look beyond the current market cycle, as the technical time needed to launch a (UCITS) fund in Luxembourg can be anywhere between 6 and 9 months. This time span might sound shockingly long, but this is the unadulterated truth, and you should plan accordingly to avoid misguiding your investors regarding the product timing and availability. I recommend investing in a detailed flows report from a provider of your choice, displaying the flows in your strategy cluster across your target markets, incl different investor groups over the last 18-24 months. This will give you a good understanding of the dynamics over time.

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III.? Starting without seed capital and committed investors

Mistake: Undercapitalizing the fund, jeopardizing its stability and potential for growth.

Success Factor: Ensure robust initial capitalization that will sustain the fund through its early stages and instill investor confidence.

I cannot emphasize enough the importance of having committed investors who will provide the seed capital at launch and will stick around during the early stages of the product. Nothing, and I really mean nothing, is as powerful in terms of marketing, as a solid capitalization and an existing investor base. I have seen countless products with very attractive strategies, smart portfolio managers and convincing track record, but poor initial capitalization that has ultimately condemned them to remain so-called “micro funds” for some years and then eventually be closed.

As a rule of thumb, for a UCITS fund to be break even and be able to survive the critical first 3 years and attract more investors with significant interest, it should have a seed capital of approx. EUR 25mn at launch and reach at least EUR 75-100mn at the end of the first financial year (FY1). The magical threshold of EUR 100mn is not only your entry ticket (as a main eligibility criterion) for productive conversations with institutional investors, but also corresponds to the AuM point, at which the minimum (fixed) fees of your service providers become less painful, and your fund is break even.??

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IV. Incorrect Fund Structure

Mistake: Choosing a fund structure misaligned with strategy and investor profile.

Success Factor: Select the right fund structure that is optimal for your target investors and investment objectives, balancing flexibility and control.

Oftentimes, fund initiators do not take the time to understand what a regulatory regime (such as UCITS) really means, what the rules and limitations are and experience significant difficulties with reconciling their strategy, kind of potfolio instruments, exposure limits etc with the restrictions imposed by regulation. In some cases, the changes needed to transform a strategy to meet all regulatory restrictions can be detrimental to the performance or the room for maneuver of the portfolio managers. This is why, understanding the regulation applicable to your asset class and strategy is crucial. I strongly recommend that you familiarize yourself with the respective regulatory guidelines before you start working on the implementation of your fund project. Regulatory summaries from Big 4 or any large law firm in Luxembourg can be useful sources.

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V. Ignoring Service Provider Quality and Focusing on Price Only

Mistake: Opting for service providers based solely on cost.

Success Factor: Vet and choose service providers with proven track records and brand. Quality and reliability trump cost-saving in the long run.

Over the years, I have had tens of conversations with clients who had to learn this lesson the hard and expensive way. They all had different backgrounds, strategies, and products, but what they had in common was their regret of having reduced their service provider selection criteria to basically just one: cost. When speaking with them, I came to realize that they often did that based on a wrong assumption, i.e. that “all service providers do the same, it is a commodity service”. This is fundamentally wrong! And while I will be dedicating one of my upcoming posts to this strategic topic, I would like to summarize the main points here:

-???????? factors such as brand name (you want to be associated with recognizable and reputable partners),

-???????? manpower (you want to make sure they have enough people to deliver everything they promise),

-???????? proven track record (you do not want your fund to be a guinea pig of your service provider),

-???????? client portfolio (actively ask for client references!) and

-???????? a dedicated client director (accountability and a clear point of contact) will make the difference in your day-to-day operations.?

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VI. Skimping on Marketing and Distribution

Mistake: Underinvesting in a solid marketing and distribution plan.

Success Factor: Create a strong marketing and distribution strategy that resonates with your target audience and leverages Luxembourg’s position as a global fund hub.

Your distribution strategy is what will make or break your success. As simple as that. Against all beliefs that performance is everything, empirical evidence shows that the mere existence of a strong performance does not necessarily guarantee high AuM. Actually, the opposite is the case – research shows that a large portion of the funds with the highest AuM growth are ranging around average in terms of performance. Why? Because of the powerful distribution engines that they have. My sincere advice is: never trust a one-size-fits-all distributor (be it a platform, a placement agent etc) offering you to cover all markets and all investor groups for you. This never works and is related to significant product overlaps creating conflicts of interest. Instead, identify your primary target markets, understand which distribution platform dominates there and get your fund listed on it and then appoint a local placement agent/capital introducer to approach the relevant audience together. Do not rely on generic support from your fund service providers – be on the ground, face investors and establish a personal contact. This will be your core asset over the lifecycle of your fund.

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VII. Overlooking Investor Relations

Mistake: Neglecting ongoing investor communication and relations.

Success Factor: Establish transparent, regular communication channels with investors, building trust and loyalty.

Once an investor has placed an order for your fund, the job is not done – it has just started. Your investors (no matter how big or small their tickets) expect regular updates, open communication, and regular face-to-face visits. Do not underestimate small investors, as they can be valuable advocates, providing positive referrals and insightful market intelligence, especially in tightly-knit investment communities. By nurturing these relationships, you not only retain investors but also empower them to become ambassadors for your fund.

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VIII. Underestimating Legal and Regulatory Challenges

Mistake: Overlooking the complexities of Luxembourg's regulatory landscape.

Success Factor: Engage with your service provider early on to navigate regulatory requirements effectively. Compliance is non-negotiable.

Investment fund regulation is not a static matter. It changes rapidly and requires permanent vigilance. Make sure to receive regular updates from your service provider and be aware of the implications. They may have a direct and material impact on your strategy, investor base and/or future plans for follow up products.

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IX. Inflexible Operations

Mistake: Creating rigid operational frameworks that cannot adapt to change.

Success Factor: Implement flexible operational processes that can scale and adapt to market changes and regulatory updates.

Be ready to change your operational setup at any time, if need would be! What sounds like an unstable solution can become your trump during the lifecycle of your fund. To be able to amend your product and adapt it to the needs of your clients, you need to have a setup in place that can absorb and implement such changes quickly. If you need a dedicated share class, a change in the investment policy or a new fund currency – you should make sure that your management company has regular filing dates with the regulator for prospectus changes and updates and you are not stuck in a queue for a quarter or more. What’s more, as the consolidation of the service provider landscape in Luxembourg is an extremely dynamic process, you should have a plan B in case your service provider(s) are taken over or merged with another player and a client review results in change of conditions or a decrease of service quality due to brain drain. I recommend conducting annual service reviews and running a beauty contest to compare different offers every 3 years. This will keep your service provider motivated, and you will be equipped with a plan B, in case you need it.

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X. Complacency Post-Launch

Mistake: Assuming the work is done after the launch.

Success Factor: Maintain diligence with continuous monitoring, reporting, and adjusting of the fund's strategy and operations post-launch. The launch is just the beginning.

Launching a fund is like starting a relationship – once you are together, the real work on making the relationship grow and flourish just starts. Similarly, a fund launch is nothing but the starting signal of a long-term project that requires dedication, close interaction, and a trust-but-testify-approach towards operational matters. Both your service provider and you will need to establish an operating memorandum, defining the responsibilities, timelines, deliverables, and escalation procedures, so that both sides have a guideline to refer to whenever quality issues or inconsistencies arise. You should insist on such a document to be able to plan your internal resources accordingly but also to be able to control the milestones of the product and identify any deviations immediately. Remember, the inner life of your fund should be always seamless to your investors!

In fund formation, precision and preparation pave the way to success. Avoid these pitfalls and embrace the recommended strategies for a smooth and predictably successful launch.