Forecasting For The Year Ahead: What Are The Challenges Fund Managers Face?
The hedge fund industry faced some unique challenges during the pandemic; whilst the nature of the sector enabled a seamless transition to remote-working, and market volatility produced record levels of performance for some funds, the sector has not escaped unscathed. For smaller and emerging managers in particular, it has been a difficult year: how to raise capital without the ability to travel? If you are able to secure an interested investor, how to navigate the challenges of the operational due diligence process in a virtual world? These are issues that remain ongoing and, despite the easing of travel restrictions and hopes of brighter times on the horizon, look set to be key considerations in the months ahead.
For the majority, fundraising in 2020 was tough. In Q2 and Q3, the investor operational due diligence (ODD) process slowed, in the hopes of a prompt return to normality. After an initial period of adjustment to the new paradigm and associated technology, there came an acceptance that some activity, albeit in a virtual space and on a reduced basis, would resume and so the industry adapted. Of course, where an emerging manager already has a strong network of institutional investors, fundraising may be less of an issue; indeed, some managers have been able to progress to launch very quickly where they are in this fortunate position, despite the challenges of the current climate. A key challenge of the lack of in-person activity is the absence of roadshows for newer managers, in part offset by the ability to increase touch points through the time saved in a virtual working environment. Irrespective of the various drawbacks, allocators have identified some clear advantages to moving the process online, notably the ease of connectivity across time zones and increased meeting loads due to reduced travel. Anecdotally, capital flows and pipelines are strong, but the process is, inevitably, slower than pre-pandemic.
With calmer market conditions and an industry now more comfortable with the virtual ODD process, managers should be seeking to capitalise on new opportunities and make up for lost time; it is therefore particularly important that managers position themselves favourably against their peers. Critical to this will be financial preparedness. Detailed budgets and forecasts that stand up to scrutiny by investors and regulators are a given.
Careful consideration should be given to the likely financial implications of new working practices. There is ’no one size fits all’ solution but, whilst the office maintains a key function for purposeful, collaborative work, now is not the time to be investing in an expensive long-term lease on office premises. However, do consider the robustness of your technology solutions given the current direction of travel. Though the need for a weighty T&E budget in present times is minimal, once the world reopens there will likely be appetite for a return to previous levels of travel and entertainment, and therefore these costs should not be underestimated.
Plan prudently and for longevity, both in terms of your cost base and service provider selection: stress testing should consider the impact of delayed inflows, redemptions, and a buffer in the cost base, and your outsourcing and service provider solutions must be scalable. For newer managers, in the absence of profits, regulatory capital will be eroded so consider the ability of the founders to provide appropriate financial support to sustain the business through the start-up phase. All UK-based FCA regulated managers must be mindful of the potential impact on capital of the new prudential regime, due to come into effect in January 2022. Emerging managers will also find that combining well-considered forecasting with an independently verified track record can help a fund stand out against the competition in a tough fundraising environment.
Cultural considerations will come to the fore as we prepare for a return to the workplace later this year. Established firms have an embedded culture, and have therefore found it easier to adapt operationally. For newer managers, there is a high premium on collaboration and learning by osmosis, particularly for more junior members of the team; now is an opportune moment to put your desired approach into action. Technology has enabled trading to be performed from anywhere, and both emerging and established managers will undoubtedly use this to their advantage to extract the benefits from a hybrid approach to working.
With the advent of the end of the first quarter, latest data from Hedge Fund Research was suggesting a positive picture for the hedge funds industry. Late 2020 saw the strongest performance gains since 2000, and combined with a good start to 2021, this will provide encouragement to investors, with healthy net asset flows across hedge fund strategies in early 2021. There were 175 launches in Q4 2020, the highest number since 2018, outpacing closures for the second quarter running. Whether this will continue into Q2 and beyond remains to be seen, but there are clearly grounds for optimism.
Melanie Pittas is Partner and Co-Head of Financial Services at haysmacintyre
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