By Tom Zdon, Vice President of Business Development & Solutions, Advent – One of the biggest challenges for the managers we’re focused on right now is the issue of dealing with multiple counterparties and its impact on performance, cost of carry and on providing transparency across asset classes.
Traders hold multifarious securities often through financing provided by their prime brokers. In years gone by, this was straightforward enough as managers typically had sole broker relationships.
Post ’08, however, this is no longer the norm. Multiple prime broker and custody relationships mean that today’s hedge fund manager is dealing with numerous margin agreements, managing cash balances across the institution, and attempting to reduce counterparty risk while maintaining relationships.
In essence, they want a workbench of tools that allows them to manage those multiple relationships in an easier, more efficient way.
Prime brokerage models have also become more transparent and yet harder to replicate. This in turn has increased the amount of work that middle- and back-office teams need to get done. Many are working 14-hour days keeping their heads above water, looking strategically across a hedge fund’s relationships and trying to figure out how best to manage them for the benefit of the firm – in particular managing the margin accounts, usually through numerous excel sheets and in some cases using a best approximation model.
Add to this the slew of new regulatory requirements and you will see the cost of operations climbing at a time when profitability is itself more volatile.
Investors too are more focused on the stewardship of their assets and have become savvy in asking to see how a firm manages this aspect of the business – both from a risk standpoint such as avoiding unnecessary margin calls, but also in maximising return on capital.
Achieving operational alpha can be obtained by automating and streamlining workflows. What we at Advent found is that in those firms that cannot do that, there’s a fault line, a pressure point, between the front- and back-office teams. People in the front office look over at the accountants and think ‘that’s a cost centre, they don’t help me or give me what I need to do my trading and portfolio management’. At the same time, the back-office staff are trying to plug holes in gaps, thinking ‘those traders want a different view of their positions every 10 minutes and I can’t keep up’.
What we see in firms that have a cross-asset class system, integrated to their prime brokers with the ability to produce fully cost loaded P&L, is that analysis of data becomes simpler, allowing a firm to focus on maximising trading opportunities.
Better workflow integration and getting a holistic view of the business is something all hedge fund managers are focused on – driven by multi-counterparty expansion, regulatory requirements, and investor demand. Institutional investors are the prime source of hedge funds’ assets and are demanding ever more institutional-quality controls.
It’s not a case of just knowing how well stocks perform, but how much traders are using financing arrangements to make those trades and the impact this has on P&L, understanding the ultimate cost of carry.
Going forward, collaboration across all market players and managers leveraging the strength of their partners to provide a world-class system will be key.