How To Run Your Hedge Fund Business Amidst Market Turbulence

Hedge funds have become mainstay asset managers and with current market turbulence, many are experiencing pressures around the following key themes:

  • Returns have not been satisfactory and this has disappointed investors and employees.
  • Management fees are adequate to cover operating costs only for the largest asset managers. 
  • Past decisions on people and technology – viewed with fresh lenses – no longer make business sense. 

In this environment of reduced resources, what can the COO of a hedge fund do?  Many firms start at a certain size (say $200 – 500 million in AUM) and grow to become multibillion dollar firms  With increasing profits coming from both management company fees and performance fees, these growing firms spend significant amounts of cash to achieve robust business operations that are acceptable to institutional quality investors.

The problem?  Firms are not focused on creating the most optimal business operations.  These small, flourishing firms will purchase an accounting system, an order management system, risk systems, and a data warehouse in addition to building middle office staff based upon the fund strategy, investor systems, etc.  Each of these operational decisions is typically an addition to a simple starting point, resulting in the creation of a complex (and inefficient) operating environment.  

With increased growth or demands of supporting additional product lines, firms typically continue to hire staff or buy various systems, further complicating their operating environments. These complex and labor intensive environments are dependent upon key technology or key people, and consequently, have made it even more difficult for firms to be nimble

So, what is the solution?

First and foremost, it’s all about data.  The best firms today are very focused on managing their data and reporting needs well. Aggregating and making data useful are critical to managing transparency with regards to investor and regulatory demands. Data is also essential to maintaining operational efficiency, developing operational metrics, and can provide the upper hand in making investment decisions.

Secondly, firms have to realize that there has been a tremendous change in technology solutions available to them today as compared to what was available five years ago.  Two examples: 1) A firm can run on a high quality private cloud and can pay per user per month a sum that would be trivial compared to building and managing their own IT infrastructure; or 2) A fund can receive market risk reports and performance attribution reports that cost less than half of any possible options they currently have in place.  

Lastly, not only is it important to do things better and faster, but it is also fundamental that firms change their business processes.  For example, instead of having a team reconciling between multiple fund administrators, similar to what a large manager may have, it is more fruitful to reduce the number of administrators and have a good handle on data via a shadow solution.  The result: Flexibility to change systems and vendors as the business evolves.  This flexibility is what allows firms to move from the prior, complex operating environments to those that can adapt with and thrive in changing market conditions.

The bottom line is that there are many new tools, partners, and techniques available today that if a five year old firm were to deploy, it would be able to run more efficiently, have a lower operating cost and become more agile in the process. After all, alpha production comes periodically, so funds need to incorporate more agility into their business model to respond accordingly.   

 

Works Cited:

  • http://www.barclayhedge.com/research/indices/ghs/Hedge_Fund_Index.html
  • http://www.cnbc.com/2015/10/20/hedge-funds-see-worst-year-since-financial-crisis.html
  • http://www.bloombergview.com/articles/2015-10-27/hedge-fund-performance-fees-are-shrinking
  • http://www.businessinsider.com/hedge-funds-returns-in-2015-2015
  • http://www.investopedia.com/articles/professionals/021115/how-advisors-can-fight-shrinking-management-fees.asp
  • http://www.finalternatives.com/node/28892