EY (Ernst & Young) last year published an operational efficiency survey and in it, they found that 40 per cent of respondents had already outsourced their middle office functions (26 per cent), or planned to over the next two years (14 per cent). Aside from the cost benefits, managers have to demonstrate that their operations are institutional-grade quality. Investors now ascribe the same level of importance to a manager’s operational infrastructure as they do the investment thesis and track record.
This is driving managers towards the adoption of managed services. One of the primary reasons for doing so is the regulatory environment managers must now operate in.
Managers have to report under a swathe of regulations ranging from Dodd-Frank and CPO-PQR in the US, FATCA, AIFMD and EMIR in Europe, not to mention daily short selling reports to the Hong Kong financial regulator, the SFC, for those managers trading Hang Seng stocks. Such is the complexity of data management and aggregation to file these reports, it makes increasing sense to rely on specialists who have the solutions and knowledge in place to cope in this new regulatory environment.
“The in-built cost efficiency of using managed services, and the fact that our team has exposure to so many strategies and asset classes, means that hedge fund managers can rely on our extensive expertise to to significantly improve their operations.
“Consequently, we see more interest among managers to outsource their middle office services. If I were an investor putting money with a hedge fund manager not only do I have prime brokers and administrators looking over the manager’s shoulder, now I have someone else taking care of the middle office. That makes the manager a far more appealing proposition,” comments Dae Kim.
Another reason, as managers look to control costs, is to use the appointed service provider as an extension of their operations team. Take a small to mid-sized hedge fund, they may have a COO and CFO with a small team and this could potentially expose themselves to ‘key man’ risk, if the operational staff for example, were to leave the firm. Managed services mitigates this risk by having the necessary resources and hedge funds’ expertise for a manager to draw upon, as and when needed.
The ability to rely upon an outsourced middle office team that is part of a fully certified industrial-strength infrastructure, Hedge360, certainly puts the manager in a positive light. Outsourcing middle office functions to meet regulatory and investor reporting demands is a logical step and a trend that Kim expects to see grow.
“We provide managed services for technology infrastructure, managed services for middle office outsourcing, managed services for risk reporting and we will continue to add more,” confirms Kim.
One of the major appeals of managed services is that hedge fund managers can benefit from economies of scale. A firm like SunGard has huge numbers of experienced professionals that know how to interpret data across different strategies and use SunGard’s hedge fund software effectively. Why would a manager want to burden themselves with expanding their operations team when they can use a specialist?
“If you consider a client who chooses to use Hedge360 internally, just the training involved in running the operation and being proficient is a large undertaking. To become an expert in using all the different software would take months. When it’s outsourced, there is no training. The middle office people we have on our staff are experts at using SunGard software.
“This is why hedge fund managers are starting to ask themselves, ‘Why are we doing this?’ It adds no value to their firm. Investing is the only reason they get paid. These guys are top of the food chain when it comes to trading markets but they’re not operations experts,” says Kim.
Managed services, and what it means, tends to differ depending on the size of the manager and where they are in their life cycle.
A hedge fund that’s been in business for five or 10 years and managing more than USD5bn will have already built out a large proportion of their operational framework. Consequently, these clients tend to require more technology-based managed services says Kim: “Where we handle technology integration, we handle their hosting requirements by running a data centre on their behalf; for example, technology outsourcing is much more appealing to larger established managers.”
Middle market managers, those running between USD1-5bn of assets, will have operations and technology staff but recognise that in order to get to the next stage of growth they need to create scale. Areas such as system redundancy need to be addressed. “From a cost-efficiency perspective, they are looking for an outsourced provider who can do middle office processing and technology outsourcing.
“Start-up and emerging managers want the least amount of operational headaches. They are willing to consider a total managed services offering where we take care of everything operationally, leaving them to focus purely on the investment strategy,” explains Kim.
Another benefit to using managed services, especially for start-up managers, is time to market. The idea of having to hire and train operations staff is less palatable than going directly to an outsourced provider who already has all the controls and procedures in place.
One point that Kim likes to remind the Hedge360 team is that the environment they are trying to create should mirror the type of institutions that managers have spun out of, i.e. Goldman Sachs or Morgan Stanley, where IT and Operations teams are at their beck and call and the resources are first class.
“They need to feel like we have everything for them, that we can fully support their needs. That’s been a big factor for us with our managed services offering and that’s why middle office outsourcing has become so important to us.
“Five years ago, a manager asking for SSAE 16 certification for infrastructure never happened, now it’s becoming the norm. They want certification for our data centres to provide to their institutional investors because without those independent certifications they won’t invest as the operational risks are perceived to be too high.
“The same outsourcing trend that we saw with technology and hosting a manager’s data centre is now being applied to the middle office,” says Kim.
In that sense, managed services is helping managers achieve institutional credibility.
