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The Evolving Dynamics of the Hedge Fund Industry Technology investments and middle office outsourcing EXTRACTED FROM EY’S 2015 GLOBAL HEDGE FUND AND INVESTOR SURVEY
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op-line revenues remain under attack in the form of fee concessions and a permanent departure from the “2 and 20”
industry model. Further, trade economics are being pinched in the form of increased financing costs, taking a further bite out of the revenues of a manager. Last, the costs of the business are certainly not declining, creating a dramatic squeeze on the margins that a manager yields. This has caused the AUM break-even point to exponentially increase compared to earlier days in the hedge fund industry’s life cycle. In 2015, an asset base of $500 million is often a minimum amount required to support the costs to run an increasingly complex business. So what does it take to be successful and profitable?
Managers need to be more focused than ever on the financial considerations of running an effective business. That means understanding the implications of a lower revenue environment while being cognizant of ways in which the operating infrastructure can be optimised to gain efficiencies and also the impact that successful investments, particularly in technology, can have on the business. Investments in technology can help integrate front to back office reporting capabilities, leading to more timely and less manually intensive exercises. Additionally, while back office outsourcing is near a saturation point, the middle office offerings from various participants have become quite robust and customised to the asset management community. Leveraging these solutions is a cost-effective alternative for managers who would rather have their personnel focusing on other core activities.
Technology investment expenditures continue to steadily rise As a proportion of a manager’s overall expense budget, technology expenses have increased
Fig.1 Hedge Funds
What percentage of your overall expense budget was allocated to major technology expenditures over the past two years? What percentage of your overall expense budget do you expect to allocate to major technology expenditures in the next three to five years?
15% 12% 9.6% 9% 6% 3% 10.2% 11.8% 12.4%
0% Expenditures in past two yearsNext three to five years 2013 2014 2015
dramatically over the past several years. This trend is partly a function of many managers not properly investing historically and having to play catch-up. It is also fueled by the fact that today’s technology environment and the impact it has on the business is rapidly evolving.
In today’s environment, managers must scale their operations. This is challenging as the industry moves to more bespoke products and challenging regulatory demands.
The proposition of continued expansion of technology related costs is daunting; however, it is a reality of operating in a maturing industry. Whether it be driven by goals of developing tools that allow for more timely and customised investor necessitated
reporting, regulatory reporting, risk management capabilities or being responsive to ever-present cybersecurity concerns, it is imperative that all organisations provide the appropriate attention to building out this area of the business.
Managers are investing in technology to support a variety of business functions Though the overall pace of investment in technology is anticipated to slow slightly in the future — 70% of managers expect to make major investments in the next two years, compared to over 80% who invested in the past two years — the magnitude of the spend is forecasted to increase. This is a result of greater business transformation projects, which result in larger front to back office efficiencies.
“We are looking for more customised accounts from our managers, which will really increase the need for improvement in their technology to adapt to the operational and reporting considerations.” (FUND OF FUNDS, NORTH AMERICA)
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While there is diversity in the areas of investment, it is clear that managers broadly recognise the need to evolve their current capabilities and is noteworthy that only 16% have not made an investment in the past, and less than a third have no expectations for further expenditures.
Mid-size managers are outpacing both larger and smaller managers materially in expenditures in most business processes as they invest in infrastructure to support their growth ambitions.
Data management and technology need to be advanced to provide seamless operations and to reduce reporting risk Investment in data management and advanced reporting are vitally important for managers as they continue to grow. Data needs to flow seamlessly from manager to vendor and counterparties and back, to close any gaps between trading, risk and reporting.
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