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Second wind

Has the hedge fund outsourcing trend peaked? As a host of forces in 2023 increase the pressure on managers to do more with less, our research suggests that, if anything, it’s accelerating.

This article first appeared in the May 2023 Outsourcing Insights Report

Has the hedge fund outsourcing trend peaked? As a host of forces in 2023 increase the pressure on managers to do more with less, our research suggests that, if anything, it’s accelerating. 

In the tightly controlled world of hedge fund operations, where high standards and accountability are all-important watchwords, outsourcing has had to earn the sector’s trust over the years. And if the pace and scale of uptake is any measure, that trust has been earned.

Once a niche activity – primarily used by launches and the smallest firms to control overheads in a cost-effective manner – outsourcing is now very much part of the hedge fund mainstream.

According to a new Hedgeweek survey, around 70% of hedge fund management firms outsource a meaningful proportion of their middle office (defined here as at least ‘a minority’ functions) and around 80% do the same for their back office. Over a third outsource a meaningful proportion of their front office.

Indeed, such has been the rate of outsourcing within the hedge fund industry over the past ten years that – until recently – there had been some quiet suggestions the trend may have peaked. Our research says otherwise. Anecdotal evidence may suggest the trend slowed in 2022, but there are strong signs that key forces in 2023 have put outsourcing back on many managers’ radars and bumped it up others’ priority lists.

Within Hedgeweek’s survey pool, 34% of hedge fund managers – across multiple locations and types – plan to outsource more or are considering it. Furthermore, managers with more than $1 billion in AUM are similarly likely to be driving current and future demand for outsourcing as are managers with less than $250 million, if not more so.

“Larger firms are under increasing pressure to innovate and remain relevant by diversifying into new strategies and asset classes to stay competitive,” explains Ken Hope, COO of Aspect Capital, the $10 billion quant manager headquartered in London. “This is a key driver behind the demand for outsourcing, as this can present a quicker, more flexible and more efficient route to being able to implement new approaches on behalf of clients.”

US COOs canvassed in person at a New York industry event in May showed similar openness to outsourcing more of their operations – so long as allocators were comfortable with arrangements.

“We are growing assets towards $1 billion but remain a single strategy firm and are definitely open to outsourcing more. Given costs in the industry I think it would take significant asset growth before we started bringing more functions in-house rather than go the other way,” said one COO. He spoke anonymously as he didn’t want staff to think their jobs were at risk from greater outsourcing – “I don’t think that’s the case, the two can work hand-in-hand.”

Rising costs

Unsurprisingly, increasing costs were highlighted as a key driver by those survey respondents planning more outsourcing – ranked top, followed by the improving quality of outsourced providers generally and a growing confidence in the outsourced providers respondents are currently using.

But as Aspect’s Hope says, the rising cost of running a hedge fund business in 2023 is “not necessarily the only or even the main driver for the demand” for outsourcing.

“In a world of increasing complexity for many hedge funds, it is driven by a realisation that better scale, speed to market and efficiency can be achieved by relying on experts, rather than having to invest on an ongoing basis to achieve these outcomes.

“In turn, this enables hedge fund firms to focus on where they can really add value for clients through their own expertise. The impact of rising costs are, in my view, simply adding momentum to an already well established trend.”

Outsourcing providers, themselves, echo this sentiment.

As costs increase, hedge fund firms are feeling more pressure to find new revenue streams. Benny LoCascio, Managing Director of Global Operations at SS&C Technologies’ fund administrator SS&C GlobeOp, says this pressure is driving many hedge funds to explore new markets – notably, private equity and credit – and to consider more outsourcing as a means of supporting the expansion.

“With outsourcing, you don’t have to build out additional infrastructure to trade new products,” he says. “There are other ways to access the latest technology and expertise – by outsourcing”.

LoCascio highlights one SS&C hedge fund client who wanted to move into statistical arbitrage: “If they had to do that on their own, the lead time would have been at least a year, despite having a portfolio manager ready to go. They came to us, and we set them up within days.”

Quants under pressure 

Appetite to increase the use of third-party providers in executing key business functions was strongest among systematic managers, with 41% either planning or considering more outsourcing.

That beat the 30% figure for discretionary strategies (overall, 34% of the industry is exploring it, split between the 16% with active plans to outsource more and 18% considering it).

“As a single strategy systematic hedge fund manager, it can be a huge expense and unrealistic to get the talent and continuity of service and depth of bench in key functions,” says Russell Hart, COO at Alcova Asset Management, a systematic firm.

“We can get better service in, for example, compliance, regulatory reporting as well as technology/cloud infrastructure through outsourcing. There is benefit in terms of efficiency, quality of service and experience of people we can achieve through outsourcing.”

Interestingly, Aspect’s Hope does not have a strong view on whether outsourcing is better suited to quant or discretionary firms.

“Intuitively the focus and efficiency benefits of outsourcing should be just as evident for discretionary managers as they are for quant firms like Aspect,” he says. “There is the potential that the technology led focus of quant firms may help to ensure the onboarding and integration with outsourced providers is easier and more efficient than discretionary managers.”

Andrew Wall, COO at Greenvale Capital, a London-based long/short equity firm, sees the value of outsourcing for discretionary managers, too.

“The skillset we get from a specialised outsourced IT firm can be way above what we could do internally, and the same goes for industry compliance.

“It will be different for larger managers, but the quality of outsourced service in these functions is perfect for a firm of our size. Things have moved on lightyears in the past 25 years and often outsourcing is the best way to access that evolving expertise.”

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