Technology Considerations For Emerging Hedge Fund Managers
Launching and growing a hedge fund has never been more onerous. Emerging hedge fund managers face ever more intensive regulatory and investor scrutiny, but the practical side of launching and running a hedge fund successfully is often underestimated, from selecting a prime broker to making sure your NAV is accurate. AlphaWeek’s Greg Winterton spoke to Dave Shastri of portfolio management operations technology provider Truss Edge to learn more about some of the questions new hedge fund managers should be asking themselves when it comes to their technology infrastructure plans.
GW: Dave, the results of a recent survey by Truss Edge suggested that hedge funds are not allocating enough money to technology budgets. Explain what ‘budgeting the J-Curve’ means and why it’s important that it’s not overlooked in the lead up to launch.
DS: Building a hedge fund is no different than building any new business; the firm will be focused on its costs and the investment required to establish the business. These investments will include building the quality of infrastructure demanded by the business processes themselves and the investors. The hedge fund firm will need to give itself enough runway to succeed - that runway being the period of time to reach sustainability, whilst delivering the critical attributes that support its success with investors. Ultimately the J-curve, which is the period over which the firm is in a negative cashflow position, requires an amount of investment that needs to be reserved.
There are several ways to do this. The most obvious is to set aside capital for this, and that can include the manager's own capital invested alongside other investors in the fund. A number of firms will leverage the infrastructure of an existing regulatory umbrella and this is usually offset against future revenues, and this can also give advantages in time to market. Other firms may cut out some of the infrastructure investors require and this may have long term effects in impeding the growth and success of the fund and possibly prolonging the J-curve. Either way, firms should make active decisions about budgeting in their business – it’s a feature of good management.
GW: Funds have to respond with technology to regulations and investor due diligence. Walk us through the main considerations here.
DS: Regulatory requirements are foundational in the investment business as we operate in a regulated environment as guardians of investor monies. However, the demands of regulation can put a strain on resources as we see increasing compliance and reporting requirements that can be difficult to address. Depending on the markets and strategies that are employed by a fund, this can include cross-border regulations, overlapping jurisdictions and quite complex matters in trading. Therefore, defining your regulatory framework is often addressed by obtaining expert assistance, often on an ongoing basis to define your framework. At its core, the manager needs to have complete and accurate records and in today's world that means technology in the areas of trading, portfolio exposure and risk and compliance oversight. The breadth of regulatory compliance cannot be met with manual solutions without sacrificing timelines and accuracy. Firms should be able to exploit technology to leverage solutions that have already addressed these issues and by definition there can be efficiencies in not re-inventing the wheel.
Investors also have requirements and of course responding to these can be franchise decisions. It’s not likely that funds can succeed on track record alone; astute investors have learned to identify key requirements about firm governance, staffing, infrastructure and service providers. These same investors will interrogate a prospective manager concerning the quality of their technology as part of that infrastructure. They will look to ensure that the firm uses best practices, that there are not obvious single points of failure and that the manager can produce quality records to allow oversight of the prime broker’s and administrator’s records. But the investor expects this to be performed intelligently - with efficient technology that streamlines the manager's business, not burdening it. Ultimately the seasoned investor is looking to see if the manager runs a good business from every perspective and so firms should expect to have to be transparent about all of these features.
GW: With regards to outsourcing, from a technology perspective, what advice would you give a new manager?
DS: Of course, it is rare that a firm will build its own software to run its business, that's extremely costly, risky and frankly unnecessary given the availability of software at this point. Most importantly, for most firms it's also outside of their skill set and it’s not why they attract investors in any case. It is quite clear that firms will use technology that someone has already developed and used. The question then is not whether there is outsourcing but rather how much outsourcing is used? There are a number of points I would make:
• If your firm does not have technology experts, use a consultant that can help plan for your needs. This should be really at your level - if you are a small firm you don't need to hire the most expensive consultant. But also try to maintain independence because some will guide you to their own solutions or have other conflicts with the services they offer.
• Some technology today is purely utilitarian and can easily be implemented at low cost. This includes office automation for phones and other communication, email, PCs and their software, secure cloud hosting, cyber-security and maintenance of office machines. There are many companies supporting this process and speaking to a few will allow you to get the lay of the land and the help you need.
• For core technology used in the company, ensure that it’s flexible, handles at least 80% of what you do, and that the supplier has the level of service you will require.
• As with any supplier, technology suppliers need to be aligned with your business - look for vendors that you can grow with.
• Keep it as simple as possible. If you are a small firm, you don't need so many vendors that you cannot manage the relationships. And be realistic - you will need to manage all your vendor relationships throughout the business and technology suppliers are no different.
GW: What other advice would you give to new managers that we’ve not covered off here?
DS: Ask yourself, would I invest in this business? That's ultimately what you are asking the investors that are critical to your success. Assess your infrastructure in detail, expect that it is all transparent to the outside world, and then ask: is that the quality of platform that survives such a high level of scrutiny? At the same time ensure your infrastructure needs to be flexible and cost effective. Make sure you have vendors that are responsive to you - not just at the start but into the future.
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