Private equity firms and hedge funds are masters at making money. Yet a great reputation can never be bought – only earned and protected. Here’s how to do it.

Regarding reputational risk, not all business models are created equal.

While people are predisposed to like a pet store, private equity firms and hedge funds rarely inspire warm and cuddly feelings, even when they create value for investors.

And that makes intelligent reputation management even more important.

Private equity and hedge fund models are structured to create complex risk issues that must be fully understood to be effectively managed. While both models share some risk management similarities, they also diverge on a few key points.

With that in mind, let’s examine their risks and learn how firms and funds can help ensure reputational issues don’t impede their ability to operate successfully.

What Are Some of the Most Common Reputational Risks Hedge Funds Face?

Reputational damage is often an existential issue for hedge funds. In the worst-case scenario, attracting or retaining investment capital can render it almost impossible.

Some of the most common risks hedge funds face include:

• Poor performance. This often leads to negative publicity, which can breed anxiety among investors.
• Hedge funds also face risks related to day-to-day operations. Mismanagement is a frequent source of reputational risk.
• Hedge funds also face regulatory and compliance risk. Should a fund run afoul of regulators, fines and penalties are often accompanied by negative news coverage, reputational harm, and a loss of investor confidence.
• Hedge funds may also have reputational problems via association with a company or industry in which they invest. 
• Hedge funds also face broader reputational risks that affect most organizations. These risks include things such as cyber-attacks or unflattering media coverage.

Risks for Private Equity Firms

Private equity firms can have their reputation sullied by the actions of a portfolio company. On the flip side, they are also at risk of reputational harm if they are viewed by the public as having treated a portfolio company, or its employees, unfairly. 

Given that private equity firms typically operate under an expected timeline for exiting (generally 3 to 5 years), if a timely exit is not possible, the firm may face risk from unhappy, liquidity-seeking investors.

Like hedge funds, private equity firms also face reputational risk from: 

• Poor performance
• Involvement in controversial investment sectors
• Negative press coverage
• Cyber-attacks
• Regulatory/legal issues

How Does Reputational Risk Differ for Firms and Funds?

While there is considerable overlap, private equity firms and hedge funds do have risk differences.

• Because hedge funds are more public-facing, they are more likely to see negative coverage from the media or experience social media backlash. They may face criticism, warranted or unwarranted, for market speculation or be perceived as an oppositional force to retail traders.
• Historically, hedge funds have been more likely to be pilloried for poor performance, while private equity firms have drawn criticism for their use of debt financing and management of portfolio companies. Because private equity firms often increase value or make failing companies viable by cutting costs, they face perception risk created by employee layoffs and other moves.
• Hedge funds and private equity firms face different regulatory requirements, which creates differing levels of risk for non-compliance.

Now that we’ve addressed what causes risk and how those risks differ, let’s explore how to best manage those risks and repair reputational harm when it occurs.

How Can Hedge Funds and Private Equity Firms Address Reputational Risk?

While there is no “one size fits all” solution for mitigating risk or managing the fallout from negative events, there are some common strategies firms and funds can employ.

First, managing risk is a complex endeavor. Private equity firms and hedge funds face significant risk exposure by the nature of their model, which includes associations with large numbers of investments/portfolio companies.

Understanding the operational risks outlined above – and having appropriate processes in place to mitigate risk from things such as compliance or cyber-security – is imperative.

However, even the best-run firms and funds are not perfectly insulated from risk. So when a situation arises that creates the opportunity for reputational harm, it’s essential to have a playbook ready.

• First, transparency is critical. Firms and funds should be upfront about the problem and assume responsibility where needed. Trying to be coy or evasive undermines trust to a less considerable degree.
• Next, create an action plan to address the issue causing reputational harm and communicate that plan to investors, the media, company employees – anyone with a relevant interest. Explain how the plan solves the issue and prevents similar issues from occurring in the future. Scrutiny of such plans is often intense, so you must carefully craft each plan. A plan perceived as insufficient can create additional reputational harm.
• Firms and funds coming out of a period of reputational harm will be under the microscope. Improving performance – and staying free from controversy – can help ease concerns and attract new investments or deals. The truth is that a well-performing fund or firm will likely lose any reputational taint much faster than one that struggles to deliver results.
• Finally, in severe cases, professional reputation management is often needed. While public relations professionals can help manage perceptions, most funds and firms would be best served by partnering with a company specializing in reputation management. Service providers have the requisite experience and domain expertise to create a holistic solution.

The Takeaway

Investing in your firm’s reputation might deliver the most significant ROI of any move you make this year. By aggressively managing reputational risk, firms can protect their downside while building durable competitive advantages.