As the hedge fund market has become more competitive, operational performance has become a critical differentiator for managers. At the same time, the growing complexity of funds, increased regulatory pressure and changing investor expectations have made hedge fund operations extremely challenging. This paper examines some of those challenges and how a strategic partnership, encompassing technology, operational support and fund administration, can help fund managers compete more effectively in this more complex environment.
The hedge fund market is in a fairly buoyant state. According to Hedgeweek’s 2024 Global Outlook, “there is optimism that the new environment facing the industry may be as promising as it has been for a while,” based on interviews with fund managers and limited partners alike. There’s little question, however, that competition in the market has intensified from both a performance and a fundraising perspective. Inflows have lagged outflows in recent years, as investors have diverted allocations to other private market asset classes.
As hedge fund managers strive to distinguish themselves through exceptional performance, they also need to keep an eye on operational performance – potentially a huge differentiator in a more competitive environment. Limited partners certainly expect managers to deliver above-average returns, but they are increasingly rigorous in operational due diligence, scrutinizing such factors as data integrity, risk controls, transparency and reporting consistency. Moreover, in a volatile marketplace, controlling expenses by optimizing efficiency is critical to sustaining profitability. In short, “operational alpha” is almost, if not equally, as important a goal as investment alpha – and just as challenging to achieve.
Operational Challenges for Hedge Funds
Hedge fund middle and back office teams are facing a variety of pressures on time and resources in this fastpaced marketplace. Chief among them:
• Increased fund complexity: Fund strategies are more diverse and fund structures more innovative – which means they are increasingly complex from an operations perspective. Valuing holdings, measuring performance, calculating NAV, accurately allocating profits and losses, and fee calculations have all become extremely challenging.
• Regulatory scrutiny and investor due diligence: As noted earlier, investors are demanding greater transparency and examining their managers’ processes and controls. At the same time, funds face ever-increasing regulatory disclosure and reporting requirements. Your operational backbone needs to be able to deliver on investor expectations and withstand rigorous regulatory scrutiny.
• Data, data, and more data: The volume of data generated and consumed by hedge fund firms is growing at an exponential rate. Data fuels a firm’s technology platforms and drives investment decisions, but only if you can harness it, manage it, ensure its reliability and analyze it effectively. Inefficient data flows, uncertain quality and errors are a drain on time and can have a negative impact on investment strategies.
• Team turnover: The pandemic exacerbated a serious talent shortage in operations, which are still feeling the effects today. Firms have experienced attrition in operational functions and difficulty in recruiting qualified people.
So how do you improve operational performance under these circumstances in order to support your investment decision makers, instill confidence in investors, and protect the bottom line against margin erosion?
It Starts with Technology
A sound technology infrastructure is central to operational performance and a competitive necessity. The precision of accounting, processing speed, and data integrity rely on the quality of a firm's technology platform, the degree of automation, and the seamless integration of various functions. Reliance on spreadsheets, manual processes, workarounds or generic accounting software will quickly prove unsustainable. At its core, a well-oiled technology platform comprises:
• A robust, purpose-built fund accounting system capable of supporting multiple, complex strategies and fund structures, with the flexibility to scale as your firm grows, adapt to changing business needs and incorporate new, often bespoke products.
• An investor accounting and servicing system that enables accurate allocations and timely reporting.
• A global, multi-asset, multi-currency, multi-strategy trade order management system (OMS) that supports the entire trade lifecycle, from investment idea generation through execution and settlement.
• An investment and accounting book of record (IBOR/ABOR) to ensure that everyone, front to back, is working with consistent, current and reliable portfolio and position data.
• All integrated with your services provider’s centralized fund administration platform, one that leverages intelligent technology to automate NAV calculations and incorporates modular, “plug-and-play” solutions to support various middle office operations.
Established firms have often built out their platforms over time, eventually ending up with a patchwork of limitedpurpose legacy systems from different vendors that don’t communicate with each other. Seamless front-to-back integration is the desired goal – and attainable with today’s technology.
More and more hedge fund managers are turning to a managed services and operational outsourcing or co-sourcing model.
Conversely, emerging managers often try to get by with the least technology investment possible, on the assumption they can build out their platforms as they grow. However, technology advances at a rapid clip, and the risk of falling behind is high. It will likely prove more cost-effective in the long run to plan your technology strategy based on where you want the business to be in five or ten years. With some thoughtful research, you can find a solution that can adapt as your business evolves, backed by a provider that has a roadmap that anticipates your future needs.
Exploring Operational and Business Process Outsourcing
Many routine but necessary operational functions can eat up a lot of staff time and divert resources from more productive activity. In the face of mounting operational challenges, it’s not surprising that more and more hedge fund managers are turning to operational outsourcing – with options ranging from co-sourcing of selected operations to full business process outsourcing (BPO) with a specialized provider. By doing so, fund managers stand to gain greater agility and efficiency, while reducing their operational overhead and risks.
By entering into a strategic partnership with an experienced hedge fund operational services provider, you can:
• Optimize operational efficiency: An experienced provider whose core competency is operations will likely be steeped in best practice to accelerate processes, improve accuracy and meet deliverables to investors promptly.
• Augment in-house expertise: Outsourcing operations enables you to leverage the expertise of specialists in hedge fund accounting, tax, and regulatory requirements. A partner that functions as “adjunct staff” can deepen your bench without the pressure to hire up internally.
• Gain competitive agility: Outsourcing your operational platform eliminates internal impediments to growth, giving you the flexibility to diversify products and launch into new markets or asset classes to meet investor demand or changing market conditions.
• Leverage advanced technology: Take advantage of an outsourcing provider’s investment in new and emerging technologies such as AI or intelligent automation, without the pressure to add to your in-house infrastructure.
• Shadow your administrator: Consider outsourcing shadow accounting and administration to validate and reconcile your fund administrator’s NAV, trial balance and fee calculations, without having to invest in internal books-and-records system or expertise.
• Reduce operational and compliance risks: Your operational services should be underpinned by a proven operational infrastructure, designed to strengthen controls, reduce the risk and downstream impacts of errors, and ensure timely and accurate regulatory filings.
• Reinforce investor confidence: An operations provider should be able to demonstrate the ability to meet client demand for transparency, deliver timely, ILPA-compliant reporting and support complex fee calculation methodologies.
• Refocus resources on core business: With experts taking care of your technology platform and everyday operations, your operations team takes on more of a supervisory and approval role. Your firm can devote more people, time and resources to investment decisions, execution and investor relationships.
Signs You May Need a New Fund Administrator
Third-party fund administration has become the norm among hedge funds. Managers who try to self-administer will find that it is not only an operational burden, but rarely looked upon favorably by investors. Even with an outside administrator, however, you may eventually run up against limitations. Among the signs you may need to consider a change:
• Service quality is not keeping up with your growth or changing needs
• The administrator is lagging in technology, unable or unwilling to make the investments necessary to bring you the advantages of innovation
• Geographical constraints; if you’re investing across borders, you’ll want an administrator that is represented in all the jurisdictions where you have investments and knows the local regulatory regime
• Investor servicing risk; if reports or statements are late or inaccurate, you may face investor dissatisfaction and even defections
If you believe a change would benefit your firm and help advance your growth, be clear on roles and responsibilities in the transition. Make sure your new administrator has a proven, disciplined onboarding and migration process to minimize disruption and make the transition as seamless as possible.
What to Look For in a Strategic Partner
A strategic partnership should be built to last. Do the necessary due diligence to build the confidence that the relationship will serve you over the long haul. It starts with a checklist of six key attributes to look for:
1. A track record of strategic partnerships with hedge funds: This one may seem obvious, but it’s more than simply checking references. A true partner should be able to show that it can serve clients of all sizes and at every stage of growth, from start-up and emerging to the largest established funds. Long experience and in-depth knowledge of the hedge fund market are price of entry.
2. Breadth and depth of expertise: Look for teams of experienced specialists in hedge fund accounting, NAV calculation, tax requirements, and regulatory compliance. You want people who can anticipate your needs and act proactively on your behalf. Another consideration: you may want to expand your business at some point. Look for expertise beyond hedge funds, across a full range of asset classes and private market funds.
3. Flexible outsourcing model: It may make sense to maintain certain workflows and processes in-house and delegate others. Look for a provider with the flexibility to shape its operational capabilities to your desired way of working.
4. Global network: If you’re investing internationally or want the option to do so in the future, choose a partner that is represented in all the major investment jurisdictions and fund domiciles, and conversant in local regulatory regimes around the globe.
5. Technological strength: Look for a provider with proven solutions for hedge fund accounting, trading and data management, and a modern technology infrastructure supporting all operational services. Above all, your partner should have the financial resources and commitment to continually invest in new technologies and keep you ahead of the curve. The provider should also be able to demonstrate adherence to the highest standards of data security.
6. Systematic onboarding and migration process: Look for a partner with a documented methodology to get you up and running quicky, proven successful in thousands of hedge fund implementations and migrations. Technology, operations and fund administration are critical factors in your success. You want a true partner who will not simply “take it over,” but actually “do it better.” The right strategic partner can help you optimize operational performance, improve profitability, mitigate risks and keep investors happy –freeing you to focus on investment decisions and results.
About SS&C
SS&C is a leading innovator in technology-powered solutions and operational services for the global investment management industry, with particular expertise in the full range of alternative investments, including hedge funds, private equity, private credit, funds of funds, real estate, real assets and direct investments. We are also the industry’s largest global fund administrator as measured by assets under administration. Our award-winning technology solutions for alternative funds, including the Geneva® portfolio accounting platform and Eze OMS™, are widely considered the “gold standard” in the industry, and are available in a managed services deployment model. Our AI-powered fund administration platform, GoCentral, automates the calculation of accurate NAV and the downstream processes that follow.
SS&C serves a worldwide clientele with a network spanning the major financial and commercial centers of North America, Europe, the Middle East, Asia and Australia. Learn more at ssctech.com