Hedge funds rising to the challenge

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By A Paris – Last year was challenging for hedge fund managers. Although the market registered a dimension of recovery, regulation and fee pressure continued to ramp up while performance did not always to live up to expectations. However, hedge fund managers are resilient and are being pushed to innovate, finding ways to rise above these difficulties. This flexibility is bound to prove vital in the year ahead as the industry braces itself for the expected turbulence.

Operational concerns

“We anticipate that hedge funds will continue to face increased infrastructure, reporting and regulatory requirements by institutional investors, a tough capital raising climate and continued fee compression. As such, managers will have to take a serious look at how they are currently operating their business,” says Greg Farrington, President of Constellation Advisers.

In light of this environment, service providers have been witnessing a shift from unregulated structures to funds, generally managed by an AIFM to gain access to the European passport. Daniela Klasén-Martin, managing director, Crestbridge, shares her views: “We anticipate that the regulatory trend will continue and that with increased scrutiny from regulators, managers will have to invest in additional resources covering for independent control functions.”

Regulatory adjustments can also be a significant catalyst for change, potentially forcing a behavioural shift towards broader adoption of electronic trading workflows. Bhas Nalabothula, head of European interest rate derivatives at Tradeweb, comments: “The advent of the Securities Financing Transactions Regulation (SFTR) and Uncleared Margin Rules (UMR) is expected to drive further electronification of markets, similar to the Dodd-Frank clearing and trading mandates in the US, and the MiFID II / MiFIR rules in Europe. In both cases, we witnessed not only growth in new customers joining Tradeweb, but also in traded volume by existing clients moving more of their flow onto our platform.”

Furthermore, the industry is also witnessing existing funds exploring outsourced solutions to either supplement their internal trading operations or at times completely replace them.

Jack Seibald, Managing Director at Cowen, says the firm has experienced this trend directly, onboarding some notable current hedge funds with this service. “The dramatic changes taking place in the structure of the markets, particularly the equity markets, means far fewer issuers now trade publicly, compared to a decade ago. As more and more daily activity is driven by electronic and passive strategies, portfolio managers are increasingly questioning the value of building or operating internal trading desks, when they have the option of outsourcing that function to experienced teams with a global footprint,” he comments.


Artificial intelligence and machine learning can also be a key component in building up hedge funds’ resilience in a tough market. In its 2020 Global Hedge Fund Report, Preqin notes: “Fund managers are increasingly applying artificial intelligence & machine learning techniques to improve operational efficiencies and boost returns… Given the advantages afforded by this cutting-edge technology, it is no surprise to see hedge funds look to AI in a bid to aid performance and gain a competitive edge in the market.” 

Hedge fund managers are also becoming better versed in the details of operational due diligence.

According to Vinod Paul, chief operating office at Align: “Our client base has become educated in what their needs are as a firm and how they deal with operational due diligence and the regulatory changes taking place…. Their needs in this area are changing. We’ve seen a tremendous increase in operational due diligence data requests coming through. These are sophisticated documents and it is evident that the individuals conducting the operational due diligence on the other side really understand technology. You can’t just send them a one pager anymore.”

Looking ahead, George Ralph at RFA expects to see a greater focus on technology risk management among clients: “Really understanding the level of risk using risk assessments and planning for mitigations is going to be critical this year. The cost of not managing risk is too high for firms in this sector; fines from the regulators, the information commissioner, loss of investor trust and possible lost investment, reputational damage and actual lost earnings while systems malfunction or are breached. With data as the new currency, our clients cannot afford to take any risks.”


In terms of investment, the hedge fund industry can still expect inflows. The Preqin report finds that over the next 12 months, more than three-quarters (79%) of surveyed investors plan to allocate the same amount of capital or more to hedge funds. “If the market cycle does turn and conditions get even tougher, star managers will have a golden opportunity to demonstrate their value,” the data provider notes.

According to Nicholas Tsafos, Growth Leader of the EisnerAmper LLP Financial Services Industry Group: “The recent volatility in the equity markets continues to provide a challenging investment environment for our hedge fund clients and their investors. We can help clients deal with the current challenges in the markets by providing value added expertise at a more affordable price point than our competitors.”

Roger Woolman, at SS&C Advent says the firm has seen growth in private equity, private debt and illiquid strategies, in particular. “These asset classes are especially hands-on as compared to other strategies, so technology can be a real game-changer. The white glove approach is augmented by a slick online investor experience and improved time-frames for reporting and transparency. For liquid asset classes, in particular, data management and governance growth are driven by competition for investment allocations, and regulatory pressure”.

Hedge fund allocators are also seen to be moving into the long only space. Laurent Favre, AlternativeSoft CEO says: “The key areas of growth we have experienced are related to the move by teams of hedge funds allocators to add long only funds in their offering (the opposite as well). As a result, we are seeing a trend in the industry of hedge fund teams merging with long only teams within asset management businesses and banks.”

There has also been an increase in the number of managers exploring new legal options and strategies. This trend is also likely to increase as managers look for fresh approaches to achieve favourable returns. So, despite the challenges, the hedge fund world remains buoyant. 

Ben Watford, Partner, Financial Institutions, Eversheds Sutherland says: “Currently we are advising on wide a number of new launches across the launch AUM spectrum from USD50 million into the billions. We are still seeing plenty of interest in the traditional strategies, but we are also working with some interesting new asset classes, most notably in the digital currency and cannabis space. We look forward to developing these relationships over the coming months.”