A model of institutional credibility

They may use different words to describe it, but institutional credibility means a great deal to hedge funds. The fund-raising process now involves much more detailed operational due diligence than in the early days of the industry. Today, many investors will walk away from funds that fail to meet institutional standards of operational integrity.

To achieve institutional credibility, hedge funds need their operating model to rise to a range of challenges.

It must:
•    Increase operational efficiency – reduce operating costs, strengthen infrastructure and support
      multiple strategies and complex instruments.
•    Enhance risk management – manage regulation, increase transparency and ensure an
      integrated approach to risk.
•    Support scalability – prepare operations for growth and focus on strengths.

According to a survey by Aite Group, nearly 80% of hedge funds recognise the importance of their investment management platform in achieving all these goals.

Operationally speaking, though, less can be more. One of the challenges most frequently cited in achieving high standards of operational integrity is the proliferation of different systems and processes. In the same survey, 40% of hedge funds reported using more than five different technology components for portfolio management and accounting. But they also appear committed to keeping their operations as lean as possible, acknowledging the benefits of a single system with front-to-back functionality.

Despite this awareness, 38% of surveyed hedge funds find operational efficiency very challenging – though for what it seems may be new reasons. When the global financial crisis saw a sudden fall in AUM, hedge funds were forced to reduce resources in a short period of time. Survey responses confirm that this critical phase of adjustment is over. More than cost pressures, it is now a lack of regulatory clarity that prevents firms from putting the necessary operations in place. The result is a sort of operational “limbo”, as the industry waits for the future regulatory framework to be stabilised.

So, it is regulatory uncertainty that stands in the way of efficiency and also makes regulatory issues “very” or “extremely” challenging for survey respondents. Notably, the regulations causing the greatest concern are FATCA (for 74%), Form PF (60%), AIFMD (47%) and OPERA (37%). Given the broad geographic pattern of responses to the survey, these figures highlight that regulatory changes in one jurisdiction now often affect market participants globally.

The pressure on operations may be growing, but firms are finding ways to share the burden. Just over half of candidates outsource at least part of their investment management infrastructure, mainly to reduce costs and simplify operational processes.

For hedge funds, cloud or managed services are also a cost-effective route to ensuring the operational stability that investors and regulators demand. Alternative technology models, in other words, give firms new opportunities to achieve sound, scalable, institutional-grade infrastructure – but without institutional-sized investment. By securing the operational strength they need to raise assets, deliver performance and control costs, hedge funds can both stay lean and position themselves for growth.

* Keith Fielden is hedge funds product manager at SunGard Financial Systems, which provides software and IT services to institutions across the financial services industry, helping to automate the many detailed processes associated with trading, managing investment portfolios and accounting for investment assets.

SunGard’s clients include a broad range of users, including asset managers, traders, custodians, compliance officers, treasurers, insurers, risk managers, hedge fund managers and plan administrators. It has recently launched its Hedge360 Risk Reporting Service designed specifically for hedge funds.