Over the past two years, three trends have emerged across all-sized hedge funds regarding outsourcing. The first: outsourcing more services than before Covid-19 for cost-effectiveness; the second: an increase in use of cloud providers and data solutions; and finally: closer attention to cybersecurity risks.
Over the past two years, three trends have emerged across all-sized hedge funds regarding outsourcing. The first: outsourcing more services than before Covid-19 for cost-effectiveness; the second: an increase in use of cloud providers and data solutions; and finally: closer attention to cybersecurity risks.
Hedge funds of all sizes are looking to streamline their reliance on their internal systems, a trend which has become more apparent within the past 18 months.
There’s little doubt that Covid-19 and the new work-from-home model has accelerated this growth, leading hedge funds to realise that they can operate just as well – or even better – in a virtual environment. Meanwhile, industry participants say the unfolding situation between Russia and Ukraine, which is heightening cybersecurity risks and concerns, is likely to further drive outsourcing trends.
Outsourcing has gone through several phases throughout the past few years, starting with valuations before moving into tech and operations. According to KPMG and AIMA’s annual Global Hedge Fund Survey in 2020, some 71 per cent of hedge funds polled thought that they could achieve better cost efficiency if they outsourced certain operations.
“We work with a number of larger managers and, as with certain smaller hedge funds, they’re also looking to have us do as much as we can and outsource work to us,” says Jeff Boyd, Northern Trust’s head of hedge fund services.
Many tech-related functions are being outsourced by hedge funds, whether that be with regards to data solutions or even to team members.
“A lot of roles, including the chief technology officer, chief information security officer, and chief information officer roles are being outsourced because hedge funds don’t have the bandwidth to understand where regulation matches technology, so it makes more sense to outsource,” explains George Ralph, global managing director, RFA.
Turbulence
KPMG’s research shows that 38 per cent of US hedge funds and 41 per cent of European hedge funds outsourced technology functions during 2020.
The report also showed that 13 per cent of hedge funds with an AuM over USD1 billion were likely to outsource their CTO, while 17 per cent of hedge funds below USD1 billion were likely to do so.
Larger multi-manager firms typically have much more complex workflows with regards to how capital is moved between portfolio managers and also the speed at which things change strategy-wise, so their outsourcing needs are a little different, according to Clear Street COO Andy Volz.
A big part of the reason for increased outsourcing also stems from the turbulence and change experienced globally in the past 24 months, but also partly as a result of tech advances.
The new mode of work resulting from the pandemic has brought the importance of cloud systems, cybersecurity and remote technologies into sharper focus. As a result of Covid-19, 46 per cent of North American hedge funds and 51 per cent of European hedge funds have re-evaluated their firm’s cloud strategy.
Thomas McHugh, CEO and co-founder of Finbourne Technology, believes the perception of managers having their systems and functions in the cloud has shifted from being seen as an objection to being viewed now as a strength. He adds that financial markets and the investment management industry are now in a “post-perimeter” environment as a result of the Covid-19 pandemic.
“The focus used to be on keeping everything in the building, harden the perimeter, and make sure that nothing gets through the firewall. People now realise that does not work. Company staff are not in the building anymore – they are now in multiple locations, including their homes, given the move to a hybrid working model,” McHugh explains of the new environment. “As a result, that has entirely changed people’s view of SaaS and cloud solutions, from being something that they once perceived as a risk to something now absolutely necessary for security.”
Industry observers note that the growth of internal systems will often struggle to match and scale up to the evolution going on in the wider industry, which is why service providers are becoming increasingly important.
Ralph says the product most in demand currently is data management, “because people understand the value of data.”
Boyd adds: “There are more and more cloud providers who are taking really large datasets on a daily basis and maintaining this data on behalf of hedge funds in a cost-effective way.”
“As we build out our platform, we’re using more modern tools like Snowflake, Kubernetes, and others so that our clients can access better data and better reporting – ultimately we want to give them the resources and tools they need to make better market decisions,” says Volz.
“Hedge funds who are USD5 billion or smaller in size are looking to outsource or partially outsource almost everything they do. They have everything in the cloud, with all of the LMS providers… who are all hosted; it’s dramatically less expensive to have somebody host the software for you.”
Volz adds: “Private cloud companies are better equipped to secure a network than an in-house IT team; I think that’s widely accepted. So everything from total cost, to level of security and ease of implementation are all reasons to outsource.”
Cyber risks
Cybersecurity is also becoming an increasing concern for firms over the past two years, with the KPMG/ AIMA survey showing 74 per cent of firms being concerned about larger threats of cyber-attacks such as phishing emails, when staff are working from home; the new style of work which has developed as a consequence of the pandemic leads to greater vulnerability.
Consequently, almost 20 per cent of hedge funds surveyed by KPMG and AIMA have outsourced their cyber, confidential information and data.
“Phishing attacks use event-driven tactics, such as the Ukraine crisis, to target firms to click on links. The raised emotional state of the world, coupled with working from home and an increase in volume of emails hasn’t helped with this problem,” observes Ralph.
He adds that, at the beginning of the pandemic crisis, Google reported an average of 350 per cent increase in phishing websites.
The response to this? Other than outsourcing cybersecurity efforts, Ralph recommends more regular cyber training and investment in specific areas such as vulnerability scanning, endpoint security, multifactor authentication and data protection software.
As hedge funds increasingly rely on external providers and services, the importance of having strong governance functions at the heart of the business to monitor the performance of those outsourced functions is also increasing.
“If you go back as recently as a decade ago, there really was a dearth of high-quality, reliable providers that you could lean on to deliver data and analytics tools, and a lot of people did reinvent the wheel, and necessarily so. But things have changed,” says Patrick Trew, chief risk and compliance officer at Maniyar Capital.
“We are very thoughtful in where we choose to partner with third parties, but the quality is here now and, in fact, it’s mushrooming. Every month, every year that goes by, you see an enormous change in the array of potential vendors.”
As investment managers and hedge funds face greater regulatory burdens, coupled with ever-rising quantities of data and a potential spike in cyber-attacks as a result of the Ukraine crisis, firms are set to see the cost of operating their businesses rise in the coming years.
McHugh explains how tech outsourcing – in the form of artificial intelligence and machine learning – as well as regulatory and treasury outsourcing, can serve managers better. But he stresses that “it’s not just technology for technology’s sake.”
“We try to bring efficiency. We’d like hedge funds to stay profitable and not be weighed down by the cost of maintaining what is an ever-increasing burden of regulation,” he notes. “There is also the spectre of increasing demand from investors around operational due diligence. How funds tackle this, for example by building a scalable technology foundation to support their AUM growth, will be critical.”
Finbourne’s product platform has been designed to be usable both by emerging and start-up hedge fund firms just as easily as large, global asset managers and asset servicers, he says.
“You often find that there is almost a price of success – a hedge fund can start off in Excel and then as soon as they actually need to launch, they need to find a system. After they become successful, they need to change that system for another to achieve scale,” McHugh adds.
“As everyone moves from being Excel jockeys to being Python experts and data scientists, we aim to make that a one-step process where the fund stays in control of their investment data. This is where our solutions deliver both scale and value in a faster time to market, speeding up the process of onboarding, while meeting investor due diligence and regulatory checks with ease.”
Read the full A Tech Revolution: How machines are reshaping hedge fund investment Insight Report here.
