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Back to articlesHedge Fund Operations: What are your Options?
Right now, prospects for the hedge fund industry are as high as they have been at any point in the past decade, with all reports showing high confidence levels and positive new inflows from allocators. New hedge fund launces have outweighed closures for four quarters in a row, after two years of contraction. However, managers are having to navigate new marketing rules post-Brexit, increasing scrutiny from the regulator with more stringent conduct rules and the imminent prudential regime for investment firms which will impose additional reporting, disclosure and risk management requirements on UK investment firms.
Hedge funds can only navigate these choppy waters properly if they have a solid operational foundation, with the right operational model and team in place. Combined with ever increasing costs and downward fee pressure across the sector new, emerging and established managers are all looking for the optimal (and cost efficient) operations model.
When speaking with prospective clients I am often asked who/what is the competition. Now I don’t like to talk about competition because it really comes down to what is the best fit. So, I reframe the conversation around what are the options, lay out the pros & cons of each, emphasise the importance of the relationship (you know that gut feel) and perverse as it may sound OSMO may not always be the best fit and we will be honest about that. I’ll try to succinctly outline the options as I see them:
In-house Operations Team
The traditional employed ops team model is tried and tested. Bringing operations skills and expertise in-house means there is focused, full time resource dedicated to the smooth running of the firm. There are of course many benefits to this option;
- Full resource on-tap to cover anything that comes up any time
- Maybe they can pick up some other tasks such as investor servicing, research, etc
- An extra person in the office to make it a more sociable place, help with the phones, etc
But recruiting, retaining and nurturing these operational experts is time consuming, difficult and costly. Training and development is essential as the role is ever changing and evolving to keep up with the latest regulatory requirements and technology advances.
How do firms ensure they are attracting and developing a broad range of talent?
It is widely agreed that the sector should focus on developing a more diverse and inclusive talent pool, but doing so takes time and effort. And once trained, how do you keep the team in place? Millennials and Gen Z individuals place more value on employers that give back to society and the environment.
But what happens if your highly trained team members with the greatest knowledge take a holiday or go off sick?
The risk of key man dependency is high, particularly in a small team, where the Ops function isn’t duplicated.
Also, with a small ops team, what happens if the firm adopts a new trading strategy or diversifies its offering with new asset classes? If the skills aren’t there already, they need to be learnt or brought in to support those.
Staff turnover, especially amongst more junior staff, is an increasing “issue”, as the pandemic has changed the way we all look at our working environment and career prospects. The downside of having an ops person who can also do a bit of research or other tasks means they get hungry for more and can become unsettled in the ops role. Although we do believe a career starting in operations is a great foundation for moving forward in the Hedge Fund sector.
Funds/strategies that trade a wide variety of assets, especially heavy OTC, and a broad range of trading counterparties are probably best suited to this route.
Using a Fund Admin
This ultimately depends on who the Fund Admin is, as there are broad differences in their offerings. Fund admins can offer a variety of services to support fund managers with fund accounting, NAV calculations, fund expenses, valuations and trade matching, among other things. Fund admins can be cost effective and supportive, taking the burden of fund admin and accounting away from the investment teams.
Rightly or wrongly some of the cost can end up as a Fund cost via the Fund Admin fee. We have seen the outsourced middle office/operations fee charged in a variety of combinations;
- Fully included within the Fund Admin Fee
- Two separate billing lines – Admin Fee and Middle Office, and perhaps the standard Admin Fee is sometimes used to offset some of the middle office expense
- Middle Office fee a sperate line and billed direct to the manager
From a cost perspective it may be attractive to make this a Fund cost, but this can be detrimental to the wider objective of raising assets and delivering returns, as the running costs (OCF/TER) of the Fund will be increased, excluding some potential investors as well as acting as a drag on performance.
Responsibility and ownership lines however, can be blurry, with many fund admins taking some level of oversight, but handing over responsibility to other service providers at different points in the trade lifecycle.
Many fund admins have defined expertise that works well for a single account and can be a very good option, but we have seen an inflection point when an SMA is added with a different Fund Admin. Many of the benefits are lost as complexity is increased, with further blurring of the responsibility lines.
The Fund Admin route is often a good one, but the issues we typically see are:
- Service Gap - there is still usually a requirement to have some inhouse operational coverage as they will not typically maintain and update your Portfolio Management System (PMS).
- Coverage – outsourcing to the Fund Admin can work great but until you launch a second fund or gain an SMA with a different Fund Admin. Similar to the gap above the Fund Admin might not always be able to cover the new account if they are not the Admin
- Service Scope - this is quite tightly defined and therefore again a requirement to maintain some inhouse resource for those bespoke tasks and those services that cannot be covered
Managed Ops Services
Managed operations services are growing in popularity and can offer a cost effective model for smaller managers. These cost savings are often brought about by having offshore teams deliver the services and reduce the number of PMS licenses required for the manager. Managers should weigh up whether the cost savings brought about by using a managed operations service are balanced against the limited buy-side experience and knowledge of the teams.
Will the team have enough expertise to liaise effectively with your counterparties? How do you effectively govern and monitor the services? If the whole function is handled by a managed service team, oversight and governance levels may not be as robust as they need to be.
This route can work really well as a compliment to the existing operations team/COO, as the managed service provider can pick up many of the lower value, repetitive tasks and will ensure the PMS is fully up to date and reconciled.
Like the Fund Admin option there are similar drawbacks in terms of the service gap. The provider will have excellent knowledge of the system (or at least you should certainly hope so), but may not be able to cover all operational aspects of your firms’ requirements. This can mean you will still require some in-house resource to oversee the gaps. The biggest downside, in my view, is that you are very much tied to your PMS provider as they become an integral part of your operations. The managed service providers tend to be on the larger side, with higher staff turnover and can often have a bigger corporate agenda with growth ambitions that might not align with your own plans. A smaller, boutique manager might not get the right amount of attention if not in the top ten client list.
The reality is that most managers would need a combination of all of the above solutions, with some in-house staff plus either fund admins or managed services. There is another way to operate effectively and that is to use an experienced, on-shore operations team as an extension of your own.
OSMO’s Outsourced Operations
We created OSMO because, in our experience, and certainly at the time we did not believe the current market offerings were satisfactory. So we set-out to be what we believe is best market practice.
OSMO’s team of buy-side professionals cover the whole operations function, acting as an extension of your business and leaving no gaps. We liaise and interact effectively with other service providers and counterparties, using our deep sector experience to provide institutional-grade operational support. Our team uses industry best-practice systems and can manage your own in-house systems too, ensuring complete transparency and oversight of the process.
An outsourced operations partner such as OSMO can be a great fit for those managers who have little or no inhouse operational resource, or limited operations experience, as we can partner with you to be a complete outsourced solution. We work with managers to establish an efficient operating model that is pragmatic, cost efficient and compliant.
In my opinion the key questions to answer when evaluating the above options are:
- What can’t the provider do? What will we be left with?
- What is the value proposition? Cost is obviously important but does it deliver good value?
- Is this a partnership? How flexible will the service be as the business grows and evolves?
- Who is delivering the service? Is there a dedicated resource who will know your account or will you be supported by an ever changing team?
If you are considering your options then please get in touch and we are always happy to share our views.
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