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Planning and scalability: How start-up hedge funds’ operational infrastructure is changing

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Despite the changing environment and challenges that Covid-19 has presented to operational and investor due diligence processes, sophisticated allocators still demand a “high level” of compliance and institutional infrastructure, according to Jenny Kim DeSmyter (pictured), Managing Director, Sales Strategy, SS&C Eze.

Speaking on the ‘Evolving Operational Challenges’ panel during this year’s HedgeweekLIVE North America Emerging Managers summit, DeSmyter explained how ensuring data remains protected is vital for both managers and investors in the remote working environment that has prevailed throughout the coronavirus pandemic.

The second session of day one spotlighted how operational due diligence and investor expectations are changing, and discussed budgetary considerations for emerging managers when it comes to picking service providers, and the use of digital solutions in the ODD and IDD process.

Fiona Treble, managing director, global head of membership at the Alternative Investment Management Association, believes that costs for next generation managers starting up hedge funds may be easier in certain areas compared to 15 years ago. She pointed to development of mini-primes and smaller and specialist law firms that “focus on and look after” next generation firms.

In a nod to the way the pandemic has upended the workplace, Treble believes the “jury is still out” on hedge funds’ locations, acknowledging the long-held “myth” that UK hedge funds, for instance, should be based in the well-heeled London district of Mayfair.

“We’re getting to an environment where we can survive on less,” she told the panel. “It’s lovely to be able to have tier 1 everything, but you can’t do that as a smaller manager and you have to prioritise.”

She also noted certain budgets hinge on what strategy a manager runs, with high-frequency quant manages requiring a larger amount of technology than, for instance, a traditional discretionary long/short manager running a concentrated portfolio more focused on research.

DeSmyter said it is crucial for fledgling hedge funds to build processes that will be able to scale up. “It’s important, as you make these decisions early on, you also take a long-term look at where you want the firm to go in terms of growth and scalability, and keep an eye on where you think you’re going to be in 12 months, 24 months, and who are the prospective investors you’re looking to attract.”

Moderating the panel, Cassandra Powell, managing director, The Harbour Trust Co. Ltd, indicated that planning prudently and for longevity remains key for hedge fund start-ups in terms of cost-base and service provider selection and, in turn, being able to effectively communicate those plans to potential investors.

Offering the hedge fund manager perspective, Mark Landis, founding partner and CEO, Wavelength Capital Management, indicated that 50 per cent of the time funds close is not for performance reasons but due to operational issues.

“The things that will hurt you the most are the things you don’t know about,” Landis said. “There may be some niche strategies and niche products that can help you. We are a technology-based quant fixed income fund, and for us it’s all about technology and the utilisation of technology.”

The panel also mulled how managers should consider what their peers’ plans are with regards to service provider spend, and how start-ups should lean on networks forged throughout their time in the industry. Service providers have a “360 degree view” of this industry and “see everything”, according to Treble.

“There are lots of ways that alternative investment managers like to show how they are different – they produce great performance, they look after their investors. But there some benefits to running with the herd, and for smaller managers that is within the realms of regulation and compliance,” she explained.

“No-one wants to draw any unnecessary attention to themselves with a regulator by doing something weird or wonderful or creative. There is no commercial benefit as a next generation manager to being an outlier on compliance. Run with the herd.”

DeSmyter said cybersecurity and data issues are areas that smaller hedge fund firms have a had to focus on during Covid, and suggested the pandemic has highlighted the importance of segregating out roles and responsibilities and showing investors that such policies remain in place during remote working.

She added: “So many COOs these days are wearing five different hats. They’re not just the operations officer, they’re also the chief compliance officer. As you blend all these roles together you really do have to look at your overall institutional infrastructure and processes. The overall infrastructure needs to have an eye toward security, compliance, outsourcing options and vendors, and all your vendors need to be an active part of that BCP process.”

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