Institutional investors increasingly launching operational platforms for hedge funds

14 Nov, 2014

An increasing number of institutional investors are building internal operational platforms or umbrella platforms for emerging portfolio managers to leverage upon.

This comes as a growing number of emerging managers are struggling to cope with rising regulatory costs and demands from investors for institutional standard infrastructure. Citi Prime Finance’s 2013 Business Expense Benchmark study estimates hedge funds with less than $300 million in Assets under Management (AuM) will struggle to pay for third party expenses and regulatory compliance through the 2 per-cent management fee.

By launching these platforms, investors enable managers to circumvent some of the operational challenges inherent during the early stages of a fund management business, while also saving costs. “Investors are in a dilemma. They recognise there is more alpha available from emerging managers, and this has been demonstrated in numerous studies. But simultaneously, these same managers often suffer from operational shortcomings. A handful of investors are simply launching their own platforms with institutional operational infrastructure, and asking managers they like to run their strategies on their platform,” said Marianne Scordel, founder of Bougeville Consulting. 

Kevin LoPrimo, managing director and global head of hedge fund services and equity finance at Global Prime Partners in London, agreed. “Investors are building these platforms and the manager is almost like an outsourced trader for these investors.  The platforms provide the operational support and compliance infrastructure and lets the manager do what they do best, and manage money,” he said. 

Blackstone Alternative Asset Management, the $58 billion fund of hedge funds, launched such a platform in the summer, whereby fund managers will utilise its operational infrastructure.  It is also a strategy employed by Millennium in New York. 

Some have warned such platforms risk contagion should a manager default. “The impact of a manager default would depend on the platform’s structure. If the platform has segregated cell structures, there will be no contagion. If there are no cell structures, and the platform is co-mingled, then there is a risk. Investors launching such products have to continually monitor their managers in real-time, and should there be problem, they need to shut down that manager,” said LoPrimo. 

Interest in emerging hedge fund managers appears to be static. Internal market research conducted by Bougeville Consulting and GPP found that while 70 per-cent of investors said they will look at emerging managers “in theory” , only 25 per-cent had actually allocated. Nonetheless, those investors that do allocate tend to be sticky, according to the research.  “We are getting more family offices calling in for introductions to good emerging managers as they are having problems finding them on their own,” said LoPrimo.

The challenges facing emerging managers are well-documented. Costs are rapidly rising at hedge funds. This increased expenditure is mainly attributable to the onslaught of global regulations on both sides of the Atlantic. Hedge fund managers must supply the Securities and Exchange Commission (SEC) with the highly-forensic Form PF document, and the National Futures Association (NFA) with a Form CPO-PQR. Meanwhile, in the EU, managers with more than €100 million are facing the Alternative Investment Fund Managers Directive (AIFMD), a regulatory initiative which BNY Mellon calculates could cost the average hedge fund manager anywhere between $300,000 and $1 million.

Total compliance spend by firms with $100 million in AuM was 18 basis points, half of which covered internal compensation for compliance personnel while the other half was spent on third party outsourcing and software charges, said the Citi study. It added firms managing between $500 million and $10 billion spent between three to four basis points on compliance.

A study conducted by AIMA, the Managed Funds Association (MFA) and KPMG of 200 managers running more than $910 billion in AuM estimated the total spend by hedge funds worldwide on regulatory compliance was $3 billion.  The study –The Cost of Compliance - found the average spend on compliance at small fund managers was approximately $700,000; $6 million at mid-sized funds, and $14 million at large hedge funds.


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