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Increase in redemption requests threatens viability of hedge funds

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An increase in client redemption requests is threatening the viability of even the most well-managed hedge funds, according to a white paper published by Pershing, a BNY Mellon company, and Aite Group.

The paper, Fueling Growth: Outsourcing Solutions for Hedge Funds, says many fund managers are taking action by reassessing their overall investment strategies and evaluating their relationships with key service providers, such as those with prime brokers, fund administrators and information technology companies.

It says hedge funds must consider a multitude of factors to help make an informed decision on establishing an outsourced vendor relationship, including cost, evaluating disparate information, balancing internal resources, prioritizing short- and long-term business goals and establishing appropriate relationship metrics.

According to the paper, a majority of hedge funds have favoured the approach of implementing a hybrid outsourcing model because it provides them with operational flexibility to meet short-term goals using third-party service providers for some key functions, while allowing the firm to develop internal capabilities for long-term expansion.

The hedge fund market is dominated by small- and mid-size funds, many of whom lack expertise in specific functions and have limited resources. These funds often opt to outsource a significant portion of their functions to third-party solution providers and to their prime broker. Smaller hedge funds should also consider outsourcing essential business functions including legal, accounting, administrative and back-office-related tasks, such as clearing and trade reconciliations;

Most leading prime brokers have seasoned internal consulting teams who have relationships with a broad array of service providers – such as law firms, real estate agencies, recruiting firms and software vendors – and can facilitate introductions with various vendors who can potentially meet the needs of the hedge fund. The paper says hedge funds should consider seeking out their prime broker’s counsel before establishing a new relationship with a third-party firm.

Pershing says the stability of a third-party solution provider should be an important consideration for hedge funds as it relates to their disaster and recovery planning. As hedge funds rely more heavily on outsourced services, they should execute proper due diligence on a vendor’s financial viability, technology capabilities, contingency around business continuity and disaster recovery, management and customer service.

To help hedge fund managers better understand business continuity and disaster recovery planning processes and principles, Pershing Prime Services, in collaboration with Eze Castle Integration and its colleagues across BNY Mellon, has developed a guidebook entitled, Establishing Business Continuity and Disaster Recovery Plans: A Hedge Fund Manager’s Guide. The guidebook provides fund managers with insights into creating thorough plans that may help minimise financial loss and the negative effects of downtime on their firm’s strategic plans and operations.

Craig Messinger, managing director of Pershing Prime Services, says: "It is important for hedge funds to develop a thoughtful, long-term outsourcing strategy to ensure that its needs for support during various stages of the fund’s lifecycle are closely aligned with its goals and objectives to serve investors well. Employing this type of approach will enable hedge fund managers to focus on generating profitable returns for their clients and help them grow their businesses in a more productive manner."

Sang Lee, managing partner at Aite Group, adds: "Substantial benefits exist for hedge funds that develop strong outsourcing relationships across their businesses. However, selecting the right vendor relationship is a complex process. It is critical that fund managers develop a thorough process to understand their own needs as well as evaluate vendor relationships for cultural fit and long-term continuity."

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