Thursday, 29 September 2016
Last updated 13 hours ago
Mar 25 2014 | 10:12am ET
By Chris Momsen
Executive Vice President, Advent Software
The good news: worldwide, hedge funds reached an all-time high in assets under management in 2013. The not-so-good news: hedge funds as a whole underperformed the S&P 500 by a significant margin. Traditional long/short equity strategies, however, were a bright spot, doubling in performance over the previous year. As funds have regained investor confidence and gathered more assets, they now face the challenge of improving returns. At the same time, they face intensified competition for institutional assets, greater demands for transparency, and the challenges of assimilating complex regulations.
Based on conversations with our clients and industry experts, we have identified five trends in the alternative marketplace we expect to be top of mind during 2014. While not a scientific survey, we believe that our informal poll provides a clear snapshot of key issues.
Trend #1: Collateral Management and Optimization
The regulatory mandate to clear OTC derivatives through central counterparties is progressing – albeit at different paces in different parts of the globe. Under the new market structure, firms that trade in swaps are expected to face larger margin commitments, more frequent calls and tighter asset eligibility requirements for collateral. In the bi-lateral, all-cash days, managing collateral was fairly straight- forward and usually an afterthought. But in the new multi-counterparty environment, effective collateral management is becoming imperative for profitability, risk management and regulatory reporting.
As collateral becomes a bigger factor in total trading costs, firms need systems that help ensure they are not putting up more than they have to or being overcharged.
Firms will be seeking solutions that automate and alleviate the added operational burden of validating and comparing different counterparties’ margin requirements. Buy-side firms will also be looking for solutions that help optimize the placement of collateral, matching their asset inventories and preferences with sell-side eligibility schedules.
Trend #2: Institutions Rule
Institutional investors continue to fuel growth in the alternative marketplace. Globally, institutional money has taken a dominant share of hedge fund AUM and institutions wield enormous influence over managers. The trend is likely to benefit funds that have the operational infrastructure to withstand rigorous due diligence and meet high expectations of transparency.
Pension funds and other institutions have shifted away from funds of funds in favor of direct hedge fund investments. However, they still seek to avoid the commingling of their assets with other investors and the liquidity problems they ran into in the financial crisis. This would seem to bode well for the continued growth of hedge fund managed accounts, as investors seek to utilize hedge fund strategies while exercising greater control over investment mandates and visibility into fund holdings.
Trend #3: Differentiation Matters
In Advent’s 2013 survey of 150 institutional investors and consultants on how they choose hedge funds, quality of operations, transparency of reporting and risk management were the second, third and fourth most important criteria (after integrity of people) in the selection of a manager. Moreover, a clear majority of respondents place high to very high importance on a firm having a system of record for its investment decision-making process.
Managers will be looking to find ways beyond performance to differentiate their businesses in a very competitive marketplace. Three-fourths of the survey respondents said few firms are able to differentiate themselves based on their strategies. However, a robust infrastructure that mitigates operational risk, combined with a research management system that demonstrates and documents a disciplined decision-making process can be powerful differentiators in the quest for institutional capital.
Trend #4: Outsourcing and the Cloud
Globally, the regulatory climate around the cloud remains, well, clouded – but gradually clearing. In Europe, a new regional regulatory regime intended to standardize cloud practices is expected in 2014 or 2015. As the regulatory framework becomes clearer, and as best practices in cloud security coalesce among providers, investment firms will likely have greater confidence in cloud-based solutions and accelerate their adoption.
The economics of cloud computing remain compelling. Firms that shift all or some of their operations to the cloud stand to see a dramatic drop in IT overhead, accompanied by a big boost in efficiency. Cloud solutions also give fund firms massive scalability to grow their business without straining resources. Firms interested in outsourcing will need to do their own due diligence on providers in order to find one with deep experience in the complex instruments, security issues and regulatory requirements unique to the alternatives market.
Trend #5: Regulation and Compliance
No analysis of trends in the alternative marketplace would be complete without acknowledgement of the evolving regulatory environment. The world’s economies have largely rebounded and some markets hit record highs in 2013. Yet six years after the crisis, and well after the passage of Dodd-Frank, EMIR, AIFMD, FATCA, UCITS V and a host of more localized reforms, many of the rules are still being defined and sorted out. (As of the end of 2013, the SEC reported that it had written or passed roughly 75% of the 90 new rules called for by Dodd-Frank.)
U.S. hedge funds have now had experience with Form PF reporting and will be looking for ways to streamline the process in the future. In Europe, AIFMD is now in force, requiring hedge funds to register in each EU country in which they market – which may put a damper on marketing activity this year. Implementing the processes needed to comply with regulation – and the attendant costs – will continue to be a trend affecting the industry in 2014. And, we suspect, for a few more years to follow.
Chris Momsen is Advent Software’s EVP, Sales and Solution Management, responsible for aligning Advent’s innovations with client requirements to deliver best-in-class solutions. Before this he had global responsibility for strategy, product marketing and sales of Advent’s solutions for the alternative asset management industry, including the Geneva® platform.