Against a constantly evolving backdrop of advancing technology, heightened regulatory barriers, and increasingly complex business operations, the nature and profile of the hedge fund chief operational officer has transformed over the past decade.
The scope of the hedge fund COO’s remit is expanding, and their day-to-day duties are increasing, which in turn is changing how the role slots into the broader hedge fund business today. Traditionally a predominantly operations-focused individual familiar with the back- and middle-office and handling trades, industry participants say COOs at cutting-edge hedge fund firms are now becoming critical figures within the overall model.
This is partly due to the changing nature of the hedge fund space itself. In contrast with other industries and sectors, the business landscape within financial services – and hedge funds in particular – never stands still, with automation just one of many major drivers of change, market participants say.
“There is never a normal business-as-usual state. There are always focus points, there are always ‘to-dos’,” says Phillip Chapple. “If it’s not market events that are changing risk, it’s regulatory changes, or new systems and automation, or how to implement controls and risk management.”
Elaborating further, he continues: “It’s unique in that it’s a constantly changing role. It’s such a wide remit, with so much to do, that no two hedge fund COOs’ jobs are the same. You tend to wear many different hats, and you’re covering many different processes, and everyone has their own areas of expertise.”
Survey data appears to back up this perspective. More than half (54%) of hedge fund ops heads see their role as a true blend of people, process and technology management today, according to Hedgeweek research. That compares to almost 70% two years ago, a dip partly attributable to the growing presence of tech and increased processes, which are accounting for an increasingly larger part of the role. Specifically, operational leaders who see their role as predominantly process management has risen over the past two years, from 25% to 31%. The rise of technology, meanwhile, is also playing an increasingly vital part within the COO sphere, with those who see their position as predominantly tech management increasing from 5% to 8% over the past two years.
Shift
This shift in the COO role is also a reflection of the longer-term institutionalisation of the hedge fund industry itself, industry participants say. “There is an overarching trend, especially as many hedge funds have got bigger and bigger, where they look more like normal financial institutions, banks or otherwise,” says Scott Radke, chief executive officer, at New Holland Capital. “As a result, the scope and the responsibility of the COO has become dramatically greater than for the smaller hedge funds that we may have had in the past.”
Reflecting on longer-term industry shifts, Andrew Beer, managing member and co-portfolio manager at Dynamic Beta Investments, points to expanded regulatory and client demands stemming from the greater professionalisation of the business.
“In the early 1990s, the typical hedge fund would have the skilled stockpicker who would manage the portfolio. If you raised $10 million from family and friends, and were charging two-and-twenty, you’d have $200,000 of revenue and this would be enough to hire a jack-of-all-trades COO. The pair of them would be sitting in a small rented office space, hoping to grow to $100 million or $500 million,” Beer recalls.
“Back then, this was really a cottage industry. You had to do things like trade reconciliation, but you didn’t have to register as an RFA, so you did not have the whole SEC compliance burden.” By the turn of the millennium, however, the increased institutionalisation of the industry meant funds of funds and other institutional consulting firms began to favour hedge funds with larger operations and more staff.
“By that time, if you wanted to kind of get up and running, you had to demonstrate your COO, your CFO, the head of trading, the head of risk; you had show that you were registering with the SEC and so on,” Beer continues. “Basically you were trying to do well in this beauty pageant with institutional investors, and differentiate yourself from all the funds of the prior model, which was basically two guys in a room. The due diligence standard went up a lot, and so did the number of bodies.”
Route
Such fundamental shifts in the business landscape have meant ops heads’ skillsets are constantly evolving. That, in turn, is upending the previously well-established career path of the hedge fund COO. Industry observers note how COOs and CFOs traditionally specialised in so-called “block-and-tackle” defensive processes, but tended to be less well-versed in portfolio risk or strategy details. “In the past, the COO did their thing, and the CFO did their thing, and
compliance did their thing – and everyone was in their own little realm,” Chris Scarlata, COO and CFO, New Holland Capital, notes.
“Now, though, COOs understand enough about what’s happening in accounting and finance, and they understand what’s happening in compliance, and they also understand IT, which has been a big shift compared to the past. They tend to be people who are becoming much more familiar with the trading itself. So they are coming in and are, almost by survival, having to really be the central point for execution, for everything that’s going to let that firm grow.”
“Every COO has a different route to becoming a COO,” adds Phillip Chapple. “When I first came into the industry, most of them were accountants. It was considered similar to a CFO; people had maybe been at an administrator, or at a bank, or an accountant, and then moved into ops. Now, though, I’d say most of the people are coming in from a pure operational background, though talking to a lot of COOs, there are some lawyers too. There is no right or wrong route.”
He continues: “It’s about having certain core skills: looking at risk management is core, having a good idea of regulation is core, as well as legal and accounting. There are so many different facets. So I don’t think it changes the route in, but it perhaps broadens it, so that it isn’t just purely accountants, or people with legal backgrounds – there are now people with more operational, mechanical, engineering approaches, in terms of figuring out how things all fit together.”
Value
As a result of this broadened remit, and expansion of the role, ensuring operations specialists maintain that the right mindset and approach to this increasingly challenging role is almost as important as core skillsets. “For a hedge fund COO, trying to design an infrastructure that is controlled, and gets the firm to where it needs to be, can vary depending on the type of strategy, and personnel. It’s tough, and COOs must be able to think technically in terms of what they are good at and they you need help on,” Chapple adds.
“It can be really tough being honest with yourself and admitting you don’t 100% know something, and so figuring out how to learn something, or pick the right service provider or adviser to plug a hole, is important.” Underlining this point, he believes it is ultimately “impossible” for a COO to cover off everything, adding that “no-one’s an expert in everything.”
Chapple says: “The most dangerous thing about the COO role is if you just presume that you know enough, when you don’t. In those cases, the control points on yourself are not going to be caught, and that can become a big problem.” “It’s often down to finding the right individual,” says Chris Scarlata. “The expectations on that person are that they will be able to come in and work with all these different teams and be the central figure that the founder of the fund can trust and know that everything is going to be looked after.”
There is now a growing acknowledgement of the importance of the COO role on the part of hedge fund CIOs and owners of firms. “It’s definitely not just about clearing trades and moving cash anymore. It’s a much wider remit now,” says Scarlata. “Having someone who is really rock-solid that can look after essentially all of the business other than the investment function is more acknowledged today than it has been in the past,” adds Scott Radke. “The consequence of that is you’re seeing, in general, the hiring of more capable individuals who are being compensated really well when things go well. Not quite at the level of the key investment professionals, but it is definitely not the afterthought that it might have been 10-plus years ago.”
“The value that gets added to the system by allowing the CIO to just focus on investments, that is enabled by a really good COO, is worth a lot of money.”
