Q&A: Hedge Funds Need To Step Up Transparency, Risk Management To Lure Investors

Jul 27 2009 | 11:28am ET

When it comes to analytic and workflow solutions for investment professionals, PerTrac is the undisputed 800-pound gorilla of the asset management industry. The firm boasts more than 2,000 clients in 50 countries, including institutional investors, family offices, private banks, service providers and money managers. 

While the firm is best known in the hedge fund industry for its PerTrac Analytical software, which tackles the quantitative side of investment management by helping money managers track and analyze investments, that is only one spoke in the wheel. Two other software systems complete the firm’s PerTrac suite: PerTrac CMS—which helps managers keep track of communications with their investors and service providers—and PerTrac Portfolio Manager, which helps funds of funds and institutional investors manage information relevant to their portfolios.

And while growth in the money management industry has slowed, PerTrac has continued to roll out innovate new products, such the snappy sounding P-Card, which promises to help smooth communications between managers and investors.

FINalternatives recently sat down with PerTrac’s president and CEO, Gerald Mintz, and his colleague, managing director Meredith Jones, to discuss how the hedge fund industry is changing, and more specifically, how new pressures on the industry are forcing managers to increase transparency, strengthen due diligence and invest in technology.

FINalternatives: How did last year’s tough market conditions and high-profile scandals affect the alternative investment industry?

Mintz: The industry has really gone through a severe shock—some people have fallen out and other people will likely still fall out. I would say that all of the trends in the industry argue toward people having more automated, third-party systems. There’s less confidence in a marketing report that is produced by a manager’s own Excel template and own calculations than one produced by something like PerTrac that has a known name. There is a strong desire for people to have tools to track and document due diligence.

Also, traditionally managers were reluctant to share information with investors, but investors are now demanding that they get more information about the underlying risk. Investors want things like sector exposure or strategy exposure or regional exposure, and they want to be able to aggregate that information and make decisions.

Liquidity mismatches are also a big deal for people—making sure that the promised liquidity of, say, a fund-of-funds product actually matches the liquidity of the underlying investments. For example, if an institutional investor is co-mingled in a fund with high net-worth investors, that may not be such a great thing. Some of the high net-worth investors may want to cash out and that would force redemptions, while the institutions might say, ‘Don’t redeem; hold on.’ So, I think all of those shifts are going to cause people to want to track each of those things more carefully going forward.

FINalternatives: What changes are happening in the industry now, and how are they driving demand for technology?

Jones: I’ve been in the industry since before Long-Term Capital Management blew up, and I’ve watched the progression of how the industry has matured following each crisis. After LTCM, after the tech wreck, and now, clearly, after the market meltdown and Bernie Madoff, there’s been a period of rapid maturation in the markets and in the alternatives space. What we’re beginning to see right now is an accelerated process focusing on transparency. You can’t see a survey these days where they don’t rank transparency and risk-management right behind performance, whereas before, performance was far and away the most important thing that investors were looking for.

FINalternatives: How is the looming potential for increased regulation affecting funds?

Jones: In terms of internal systems, certainly regulation could have a large impact on that as well. What’s required by various governments will drive to a large extent how the industry has to evolve with respect to technology. The way they do business, who they talk to, who they don’t talk to; all of those kinds of things. A lot of things are up in the air right now. Clearly, with the whole regulation issue, there have been some proposals on the table, but nothing concrete. I think all of those things are going to push toward transparency as well. We’re moving further down the transparency line and we’re also moving toward daily and weekly estimates so that people have a better view as to what’s going on in their portfolio.

FINalternatives: Are you seeing any new hedge fund launches?

Jones: I did a prime broker event and, of the 25 groups that were there, four of them were new funds that were just starting out. But they’re taking a more cautious approach, and they’re also taking the time to get some systems in place. It’s not just two guys in a townhouse running a fund anymore. We’re probably looking toward the late third or fourth quarter for the number of new funds to starting ramping up again.

Mintz: I think what Meredith said that is a really important point to emphasize is that barriers to entry are higher because investors are looking for proper risk systems and transparency, at least in terms of where the assets are, and making sure you’re not dependent on one prime broker.

The Lehman situation certainly scared a lot of people with the assets kind of held in limbo. And then on the fund of funds side, people are looking to see what’s your value-add. If it’s due diligence, prove to me that you have a really rigorous due diligence process and systems around that. If it’s portfolio construction, show me that you’ve got a good handle on risk and you can give me a portfolio that’s going to perform well and not give me as much kind of a dispersion that I might get if I just picked a set of funds.

So, in each case, managers are going to have to put in systems and procedures to show investors that it’s worth investing in them. That, of course, will raise the cost of a launch. So, it argues that funds have to be a little bit larger to be able to afford those kinds of systems. I think the bar has been raised for what you need to run a fund.

FINalternatives: What is the future of the industry?

Mintz: I think you’ll see more outside administration, and I think more focus on custody of the assets. We may see more in managed accounts, which is one way to address some of the custody and liquidity issues.

This article first appeared in FINalternatives Hedge Fund Technology & Trading. Download Complete Issue: Hedge Fund Technology & Trading (PDF)

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