It’s a fair assumption to say that the proliferation of hedge fund regulation has spurred technology providers to produce newer, innovative solutions.
Central to this is the growing complexity surrounding data management. If one were to plot data volume over time over the last five years it would resemble a hockey stick with the introduction of Form PF reporting by the SEC two years ago marking the point at which managers began to deal with ‘Big Data’.
Whether it is Annex IV reporting under AIFMD in Europe, reporting on derivative positions under Dodd-Frank and EMIR, CPO-PQR, FATCA, reporting short selling positions to the Hong Kong Securities & Futures Commission, managing collateral and margining to comply with the demands of CCPs, the point is there is an enormous array of data points that managers need access to. And when it comes to their service providers, they want quick, accurate solutions.
Such is the level of scrutiny that managers now face – especially newly registered managers with the SEC – that even minor infractions are being investigated further under the stewardship of Mary Jo White. Clint Coghill is CEO at Backstop Solutions, a privately owned Software-as-a-service platform provider. He comments:
“If the manager struggles to get the relevant information to the SEC they are more likely to view that as a minor infraction and will then seek to get even more information through a full-blown audit. So we’re helping managers at the level of getting data bound up and shared; to basically speed up the time of the presence exam to hopefully stave off any further investigation.
“We’ve heard requests like ‘Do you have an audit trail of all communications with investors since the inception of the fund?’ If the answer is yes, but they are in email form, where do they sit? Backstop preserves all communications, including meeting notes, emails and calls, all in one place.”
The result is a clear audit trail of communication with the investor in a single file. In April 2014 SEI, a leading US hedge fund administrator, published a white paper that focused on how outsourcing – particularly middle- and back-office functions – could help hedge funds improve operational efficiency. It was entitled ‘Re-inventing Buyside Infrastructure’ and gets to the heart of the issue that many managers face in the data management challenge: how to achieve better efficiencies through choosing the right partners that can deliver the right kind of solutions, that add value, and which ultimately allow them to grow as firms.
“Instead of saying they are going to outsource because it’s not their core competency or to save money, it’s now much more about outsourcing because the manager believes they will be able to get knowledge out of the data, garner more insight about their business, not just collect numbers,” says Ross Ellis, Vice President and Managing Director of the Knowledge Partnership in the Investment Manager Services division at SEI.
“In some respects, which we refer to at the end of the white paper, operational capabilities have become key to hedge fund managers’ competitive advantage. It’s not just about ‘Can I do it cheaper and faster?’ It’s about having more tools with which to make better decisions for the business. By working with the right partners, managers are looking to increase the value they add to processes or reduce their involvement in areas where they add little value.”
Back when regulation started to impinge on managers the collective belief was that they could cope. That it would be straightforward enough to build a proprietary solution and the problem would be solved. This stance has since become untenable. There are now so many reports, so many pressures to deliver customised summaries to institutional investors, that managers would need a number of internal systems to cope. With operating margins getting squeezed enough as it is, this is economically unsustainable for all but the largest multi-billion dollar managers.
“The infrastructure for data management and data governance needs a versatile solution and the only way to achieve that is with technology. Managers increasingly rely on a solution that can take care of both regulatory requests, and those from prospective and current investors, without impacting on the direction of the firm. The last thing they want is to divert the company’s resources to dealing with responding to compliance and regulatory requests,” suggests Ellis.
UMB Fund Services, another US administrator, uses third-party software for portfolio reporting, where most reporting is standard. But where it gets tricky is on the general ledger and the investor servicing side. “That’s where having proprietary software allows for customisation for the fund manager and their investors. We have a team of developers who work on customisations to meet specific requirements,” says Chad Allen, Managing Director in UMB Fund Services’ alternative investment servicing division.
UMB Fund Services administrates both mutual funds and alternative investments. Each fund type uses different software, but as Allen confirms, one big initiative for the firm this year is better integrating the data management function for clients who run both types of funds – a big trend with more managers launching alternative mutual funds and registered hedge funds.
“Since our clients are running both mutual fund and alternative funds, we are working on ways to improve data management to meet both our clients‘ and internal needs across a variety of structures. It’s an important project that we are working on right now,” says Allen.
Pushing for operational efficiency
The SEI white paper found that 83 per cent of operations teams in fund groups regarded operational efficiency as either ‘somewhat challenging’ or ‘very challenging’. With 80 per cent of assets coming from institutions, they are buying the firm not just the fund. Performance remains the number one issue but they need to make sure that it is sustainable and that the right infrastructure is in place.
“If most new assets are coming from those types of investors, the manager has to stop thinking predominantly about how to squeeze an extra 3 or 4 basis points from the bottom line. If they want the business to succeed long term they have to start making longer term institutional decisions,” opines Ellis. The white paper goes on to suggest that by using effective outsourcing partners, firms could reduce their operational expenses by 10 to 20 per cent, freeing up the potential to deploy capital in other parts of the business and gain an edge on their competitors.
“It’s not just about saving money. It may mean only 10 per cent of the team having to focus on the task as opposed to 50 per cent of the team. That gives them more time to come up with product innovation, reach out to a different investor base, or better service existing clients. It frees firms up to be more nimble and competitive and gives investors another reason to invest in them,” suggests Ellis.
Linedata is a leading provider of global solutions to the investment management community. In September 2012 the firm rolled out Linedata Global Hedge, a scalable cloud-based platform that uses a modular approach to supporting the changing needs of managers. All of the firm’s core products – Linedata Global Hedge Portfolio Management (previously Beauchamp), Linedata Global Hedge Trading & Order Management, Linedata Global Hedge Compliance and Linedata Global Hedge Reporting – sit within the platform, which is helping managers address data management challenges with the kind of operational efficiency Ellis refers to above.
“Dealing with one service provider saves the manager time and money. That’s exactly what Linedata Global Hedge is bringing to the table. Investors want transparency which managers need to provide if they want to raise capital. To do that they need a good operational infrastructure to meet due diligence. The typical Asia start-up hedge fund can be as low as USD20mn-50mn; how are managers going to make money with all these demands being put on them?” says Sally Crane, Managing Director, Asia.
“It’s completely modular so a manager can choose to start off by just using our PMS or OMS; most Asian managers prefer to start off with a PMS and move on to use an OMS later on. They do of course need a light OMS which is built into Linedata Global Hedge Portfolio Management but they would typically only move on to use a dedicated OMS once the business grows (and they are trading a bigger book),” she adds.
One leading Asia hedge fund using Linedata Global Hedge Portfolio Management in conjunction with Eze Castle (OMS system) and Imagine Trading System (risk management system) is Hong Kong-based Senrigan Capital.
The firm has a five-year track record and when asked about data management and reporting pressures the firm’s COO, Chris Nash, states emphatically that a fund’s data is its ‘lifeblood. It gives you a whole set of things to dig into and work with.
“The problem is, you don’t really know what you want to do with the data until it’s there to play with. It’s a bit of a chicken and egg situation. One of the problems for managers is that they know they want to look at the data but their administrator (or other service provider) is unable to present it to them in a usable way.”
This raises an interesting point. Many fintech providers talk about the need for front- to back-end integration. Unfortunately, this requires using one provider. Firms like Senrigan, however, are more inclined to use multiple best-of-breed systems. Nash says that it then becomes a judgment call within the firm to decide to what extent in-house technology should be developed to bridge the inevitable data gaps that arise.
“There is no universal panacea. You have to find a way to use these different systems for what they’re good at and decide how to fill the gaps yourself. The reason we use a number of different best-of-breed systems is to get different flavours of information for the various needs we have running the fund.
“What we’ve done is build a data management layer on top of the system to suck in as much data as possible that we can use in a way that suits us. Nobody is going to give you a great reporting tool that can give you everything you need. It’s impossible because they’d need to read your mind,” says Nash.
This wrapper is helping Senrigan address the reporting demands of regulators and investors alike. It helps that Nash has a background in computer science; not all hedge fund COOs can say the same. It certainly places Senrigan in a good position to know exactly how far to go with IT budgets and how much to rely on their service providers.
Different dashboards for different folks
One way that service providers are helping data to become more actionable is by developing different dashboard views for different people across a hedge fund organisation. Ellis notes that the desire among managers to have better data management is in large part a response to investors wanting customised reports, especially those who are moving out of commingled structures into segregated accounts.
“Greater complexity is driving change throughout the industry. Investors are now saying ‘I need to look at my book holistically, not just at your fund, but how it works with all the other vehicles and managed accounts I have in my portfolio’. They don’t always need full transparency down to the position level but they do need certain types of information that helps them analyse their investments,” says Ellis, adding that the exponential rise in customised reporting over the past several years has forced SEI to invest more in and improve its infrastructure.
“What we’ve done is try to build our operational infrastructure and treat it as a platform rather than something product specific. Providing relevant data in an organised, usable fashion saves the manager time and effort, and enables them to better add proprietary value to their investors.”
The amount of data is so vast that different people within hedge funds – the COO, the PM, the CCO etc – need to make sure they see information that is pertinent to them. “Part of what we’re trying to do is say ‘Here are the key pieces of data that are most important and valuable to you so let’s put them front and centre in the dashboard which you can then customise’,” explains Ellis.
At Senrigan, Nash confirms that they’ve built their own dashboard functionality: “We’ve built a set of dashboards to give people an aggregated view of data. It’s not real time but it’s refreshed twice a day.” He adds that the use of dashboards via browsers not only gives mobile access but also brings significant business continuity plan (BCP) benefits.
What this illustrates is just how important a part technology plays for hedge funds as they come to grips with ‘big data’. As Linedata’s Crane says: “That’s why we built the COO dashboard. You can’t just give clients data. You’ve got to give them actionable real-time data.”