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Hedge funds’ service provider selection “more important than ever before”

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The selection of service providers – be they prime brokers, administrators or software systems – is more important than ever before following the seismic upheaval faced by hedge fund firms over the past 18 months.

The selection of service providers – be they prime brokers, administrators or software systems – is more important than ever before following the seismic upheaval faced by hedge fund firms over the past 18 months.

2020 and 2021 proved to be “a different world” for hedge funds and the financial services industry more broadly, with firms being forced to evolve through working and trading remotely amid the Covid-19 pandemic, said Billy Murray, head of prime at InterTrader, during the service provider-focused panel at this year’s hedgeweekLIVE European Emerging Manager Summit. 

That, in turn, has thrown the whole business of selecting and managing service provider relationships into ever-sharper focus for start-up hedge funds, which Murray said is “more important than ever before”.

Reflecting on the upheaval brought about over the past 18 months, Murray observed a constriction in the services that many prime brokers are willing to offer, adding that, for emerging managers, it is becoming much more difficult to step up and move on.

Wednesday afternoon’s panel discussion, which took place at the Reform Club in London, probed the questions and considerations that fledgling funds must consider ahead of launch, weighing up relative the advantages of appointing brand-name service providers compared to smaller, more boutique outfits. 

“Quite often, a lot of people make mistakes on day one, and those mistakes stick with them for years and manifest into larger mistakes,” Mark Flanagan, COO, Backbone Capital Partners, told the session.

Flanagan observed that most funds and managers are set up and structured by a CIO, which he said were “possibly the worst people to then select service providers.” He acknowledged that while a CIO is perfectly adept at picking prime brokers – “probably the most important service provider by far” – he added that when it comes to picking other service providers “what you really need is a good COO” to help with that selection. 

A COO ultimately serves as the “face of the fund”, noted Murray. “They’re the person who’s ultimately going to face the investors, rather than the actual investment officer.”

“A start-up manager would probably have asset management experience but not necessarily running a fund – it’s a whole circle of things to take care of,” said Anabel Mifsud, CEO, Bastion Wealth. She suggested that launching a fund now is “completely different” from launching a fund 10 years ago, and pointed to rising regulatory pressures on having correct compliance procedures and policies in place.

“You cannot do that yourself – you have to appoint someone. You have to be very careful who to choose,” she explained, adding that it is vital to find a provider “who is willing to grow with you and are capable of growing with you.”

Meanwhile, Patrick Trew, chief risk and chief compliance officer at Maniyar Capital, discussed his experience of many of the largest service providers in the industry, as well as smaller, boutique providers.

“It’s about having a clear understanding of your ‘day one’ need, your ‘day two’ need, and your aspirational need,” said Trew, who, prior to his time at Maniyar, was partner and chief risk officer at Sir Michael Hintze’s multi-strategy credit hedge fund CQS, where he had been a member of the executive committee and was responsible for risk, compliance and internal audit.

He also conceded that it can be tough as a start-up fund to grab the attention of the biggest service providers, but indicated that leveraging the services of boutique providers can be valuable.  

“There’s an enormous amount of value in preparation – there are no perfect providers out there,” he said. “What you don’t want to do, if you can avoid it, is suddenly go through the institutional pain, and client pain, of suddenly binning your day one providers and putting in a completely new deck with a whole new set of documents and agreements.”

Murray suggested biggest was not always best. “When you are trying to build, you want a partner. Not just a provider – a partner. You need to be able to grow, and the scope to grow with that partner, so that they have a vested interest in you doing well,” he added.

“Anything from what jurisdiction you select, what structure in that jurisdiction, what service providers you need – be it NEDs, AIFMD depositary, administrator, compliance officer, IT firm – I’ve seen people get in very sticky situations,” Flanagan said of the perils of the selection process. “A high price does not mean a high service, and a low price doesn’t mean a low service,” he added.

Panelists also discussed the benefits and risks of outsourcing certain business functions, particularly against a backdrop of huge advances in technology and “an enormous array” of products.

“It can feel like your birthday and Christmas has all come at once,” said Trew, pointing to the assortment of technology delivering particular services around functions like compliance and risk. “But it’s a different form of management challenge to having staff internally. You can end up with a service provider challenge; if you pick niche providers that do great jobs, you then have to bring all that together to actually get the job of managing a fund – or more than one fund – done.”

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