Hedge funds account for nearly USD 2 trillion of assets under management. The recent regulatory changes recognize their proximity to the mainstay of investment management, and take cognizance of their systemic importance. As against conventional pooled investment vehicles, hedge funds have significantly different investment avenues and strategy, risk appetite, compensation mechanisms and outlook. This creates a very strong case for a specialist team with the right resources, technology and mindset to manage their operations.
The industry’s bespoke set of operational requirements have emerged stronger over the years, especially when evaluated against the backdrop of 2008 and 2009, which were its watershed years. These years saw defining moments for the industry with sharp hikes and decline in the size of assets under management and the number of firms handling them. They also witnessed high-profile cases of frauds, which opened the intense debate on regulation, enhancing compliance, risk management and role of third parties such as auditors, administrators and operations.
A substantial value can be created for hedge funds by independent third-party business process outsourcing (BPO) players in the above-mentioned areas. Based on our extensive experience with multi-billion dollar hedge funds, we have analyzed four high-impact areas:
Valuation: Assigning value to assets can vary from simple data validation streaming to validating opaque pricing sources against complex mathematical models. Independent service providers can create the required scale and level of stock in trade intellect to manage this process. In addition, a non-partisan intervention would always ensure the process is unbiased and not attuned for reflecting a degree of performance.
Investment Mandate Adherence: Hedge Funds need to be monitored for the mandate adherence and alignment to investment policy. It is important to ensure deviations are promptly corrected and repeated occurrences are tracked and highlighted. Essential strengths required for managing this process are in-depth understanding of mandates, investment policies and experience with the investment operating environment (across multiple markets, diverse investment strategies and understanding of thinly traded asset classes unlike a regular pooled investment vehicle). Apart from these traits, it is imperative that management of this function is not influenced by the firm’s superiors or trading staff. A third-party provider can bring-in the much-needed scalable talent, operational rigor, which ensures complete granularity and best practices learned from other clients in the same industry.
Reconciliation: All assets, liabilities, open positions and cash flows need to be reconciled against counterparties, internal books and other service providers (For example, custodians). This process is often termed as rules and procedure driven, while in practice, it needs to be investigation-driven. Funds often invest in specialist back-office resources and systems to ensure issues are highlighted ahead of time and the same can be addressed. However, the challenge is to run this function across extended hours of operations, in multiple time zones and across different market timings. External service providers can provide significant impetus to this function from the start by drawing on existing expertise on various functionalities and asset classes. They can manage a rigor in this implementation, which ensures gaps / breaks across various books are identified and highlighted.
Reporting: Funds are required by their investment agreement to report their investment activity and outcomes thereof, at designated intervals to the investors and other stakeholders. This process requires aggregation of data across from various sources, validation of the same and creation of reports per agreed formats. The challenge for funds is typically the periodicity of this activity. Leading providers can create scalable and flexible operating models to adhere to such reporting requirements and also increase the depth of reporting.
The outsourced model when applied to hedge fund operations can create multiple efficacies, apart from addressing the ever-growing concerns around transparency, operational risk and enhanced compliance.
|