There is no doubt that outsourcing, as a concept, has become accepted practice within the hedge fund industry. Not only does it help start-up and emerging managers drive efficiency gains, more importantly it is not viewed negatively by institutional investors. They appreciate that cost controls are crucial to managers in the early years of building their business. But too much outsourcing can be a bad thing, as Devet Capital’s Irene Perdomo (pictured) tells Hedgeweek.
Evidence that outsourcing is being embraced was quite clear in a recent emerging manager survey produced by AIMA, in conjunction with GPP, a London-based boutique prime broker.
To explore this trend in greater detail, Hedgeweek and GPP hosted a breakfast briefing at the Reform Club on 13 September, 2017. The event featured an esteem panel that included: Sean Capstick, Head of Prime Brokerage, GPP; Praveen Joynathsing, Director, European Capital Introduction, Societe Generale; Phillip Chapple, COO, Monterone Partners; Erik Serrano Bernsten, Co-founder and COO, Stable Asset Management and Tushar Patel, CIO and Managing Director, HFIM.
There was broad consensus among the panel that more could be done to outsource functions within a hedge fund business, provided managers struck the right balance of maintaining effective oversight with a robust risk management framework, to reassure investors.
The survey itself canvassed the views of 135 global small and emerging managers – defined by AIMA as those with less than USD500 million in AUM – found that legal services is the most popular outsourced function, with 62 per cent confirming the fact. The second and third most popular outsourced roles are the Chief Technology Officer (44 per cent) and Chief Compliance Officer (31 per cent).
The most popular roles that remain in-house are what one might expect: Chief Operating Officer (88 per cent in-house), marketing, investor relations and business development (79 per cent in-house) and Chief Risk Officer (15 per cent in-house).
The survey findings suggest that, with respect to the CCO role especially, hedge funds could do more on the outsourcing front. Indeed, when seeking allocators’ thoughts on the whole issue, the survey reveals that the majority (61 per cent) have no problem with a manager outsourcing the CCO role, whilst an overwhelming majority (96 per cent) are happy to see the marketing/capital raising function outsourced.
“Hedge funds of all sizes need to keep a close eye on costs. This is ever more so for the Emerging manager focused on growing AUM and revenues. Most allocators in our survey have no issue with outsourcing. This is a great way for the Emerging Manager to contain costs,” commented Sean Capstick, Director and Head of Prime Brokerage at GPP.
However, before getting carried away, it is worth stating that for any serious hedge fund manager, outsourcing can only ever go so far.
Speaking with Hedgeweek, Irene Perdomo (pictured), Principal & Founding Partner of Devet Capital, a London-based market neutral statistical arbitrage asset manager with USD115 million in AUM, agrees that it is important to use outsourcing as a way to keep costs down and to help pay salaries to core staff. “But when it comes to compliance support, we don’t need it 24/7 so we prefer to outsource this function, rather than pay a salary.
“We have outsourced three functions in total: compliance support, legal counsel and accounting,” confirms Perdomo.
She notes that even though Devet Capital outsources, the team always keeps close control to ensure that everything is being done properly. In other words, outsourcing is fine but it absolutely doesn’t mean one outsources responsibility at the same time.
“That would never work. We keep a close eye on what is going on, and leave them to focus on what they do best, but we control everything. We review everything,” she says.
Of the four functions that could, in theory, enjoy a greater level of outsourcing – the COO, the Compliance/Legal support, the Chief Risk Officer and Marketing/IR – Perdomo is quite emphatic in her response. In her view, only the Compliance/Legal support would qualify, stressing that the other three roles are core roles that could never realistically be farmed out.
“The Compliance/Legal support can certainly be outsourced to control costs. There are plenty of service providers but you have to be careful, from a pricing perspective, what you are signing up to. It depends how you negotiate your costs. There are some people who don’t do it and prefer to hire someone and pay them a basic salary. And there are others who outsource but agree to bad deals. I know of one emerging manager who hired a compliance officer and paid them GBP1,400 per day for a specific project.”
When confirming to Perdomo that 44 per cent of survey respondents outsourced technology, her voice rises in surprise. To caveat the point, Devet Capital is a highly systematic fund that uses technology to gain an edge in the market. Not all strategies have such reliance.
“We control all of our systems internally,” states Perdomo. “In my view, you cannot drive a car from the back seat. You should know your business and how to run your business. You need to know about IT, especially if you’re a systematic fund. Technology is a big part of our business. We would not look to outsource the CTO function because then, what are we managing exactly? What are investors going to think?
“When I hear that someone uses an outsourced CTO, I am surprised because for me, it is a core part of the fund management business. What can you expect them to do, that you, as one of the partners of the business, could not do better yourself? In my opinion, this is not an option.”
She emphasizes that trading, technology and risk management are core functions that will always remain in-house at Devet.
As mentioned earlier, though, investors are more open to outsourcing because, ultimately, they want to invest in managers that they know have a sustainable business. In order to achieve sustainability, one has to control costs. Devet Capital feels it has struck the right balance in this respect. If a manager were to overly rely on outsourcing it could set the alarm bells off.
“Technology, trading/risk management and research are the three most important elements of our business. These are core functions that we would never outsource. I’m not a backseat driver, and this is exactly what investors expect. They expect you to know what you’re doing and to be in complete control of those core functions.
“None of our investors has ever complained about us outsourcing the Compliance support, or the legal counsel. They’ve never even asked about it, in fact. All they know (and care about) is that we have a sustainable business,” confirms Perdomo.
She believes that the Chief Risk Officer is another in-house function that no serious manager should ever countenance outsourcing.
The portfolio manager has to first be a risk manager, and second a trader, in Perdomo’s view. If a trader isn’t capable of managing risk, that is nothing short of a disaster. “Why would you put on positions and not know the risk? Trading and risk management are like the clouds and the sky; the two go together. For an emerging manager, why would they ever think of outsourcing the risk function? It’s nonsense,” asserts Perdomo.
The Hedgeweek/GPP hedge fund outsourcing report will be available for readers to download by mid-October.
