Enhancing automation
29 April 2020
Technology is providing the hedge fund administration space with an abundance of opportunities to automate processes,
but what hurdles lie ahead?
Image: jenson/shutterstock.com
Three of the biggest trends in the hedge fund administration space right now include the growth opportunities, continued consolidation of service providers and end investors demanding increased transparency.
Discussing these trends, Peter Sanchez, head of Northern Trust alternative fund and omnium business services, says “Private capital funds are still significantly insourced, with approximately 60 percent lacking a third-party administrator. More broadly, investment managers keep finding new ways to deploy capital, taking a flexible approach to structures they set up for their investors, and these innovations require strong dedicated fund administration support.”
In terms of continued consolidation of service providers, Sanchez says: “Many of the emerging fintechs, for example, are being acquired by fund administrators seeking to buy capabilities to serve a segment or region of the fund industry.”
He adds that end investors are demanding increased transparency, to the extent it can become a differentiating factor for managers. Sanchez suggests: “This is an opportunity for administrators to demonstrate value in the way they build out investor transparency capabilities.”
Since the financial crisis of 2007/2008, regulations have been introduced to the financial services industry to help it work in a more transparent way, and technology is helping to do this.
BNY Mellon’s global head of hedge funds, Mick Murphy, explains that investor requirements for greater transparency, alongside risk and performance analytics, are becoming more frequent and complex, and enhanced technology is enabling that demand.
Murphy says: “Technology has accelerated the automation of processes – such as exception management – and supported client demand for earlier net asset values (NAVs) together with increased automated controls. It has enabled many of our clients to move to daily NAVs for their alternative vehicles.”
Additionally, Murphy notes that technology has brought “greater flexibility and automation for data delivery to clients – via application programming interfaces and portals – while the adoption of machine learning and robotics has improved reconciliations and enhanced insight through analytics”.
In 2019, Northern Trust launched client dashboards with a streamlined interface for enhanced user experience and optimised for mobile devices to provide decision makers with real-time, on-demand access to their portfolio information wherever they might be.
Sanchez suggests that the next step is enhancing the fund investor experience. He explains: “Hedge fund investors want to receive performance information and transact with the fund in a more seamless and automated way, moving away from manual redemptions. They want a portal through which they can access information on sophisticated, multi-asset and multi-strategy portfolios in an intuitive display.”
Generating alpha
Technology is also key to automating critical processes such as data reconciliation, and efficiently managing workflows, which can help clients generate alpha.
Sanchez highlights that administrators can reduce or eliminate “operational drag” that diverts resources away from the research and investment processes that deliver alpha for the fund and its clients.
As a partner to the fund manager, administrators can also provide profit and loss, risk, performance and compliance monitoring to support the investment team. Sanchez explains: “We have presentation tools that help portfolio managers easily identify the drivers behind exceptions and exposures, all of which informs the investment process and strategy going forward.”
He also observes that collateral management and cash optimisation are both high priority operations for hedge funds, crucial to a manager’s ability to be nimble in capturing opportunities and executing their core strategies in dynamic markets.
“We bring deep expertise to these complex processes, so we can provide efficient collateral management based on a variety of criteria, including liquidity of underlying collateral, hard to borrow versus not, or cost base optimisation. On cash management, we offer managers the ability to calculate unencumbered cash, aggregate it across accounts, and invest it,” Sanchez adds.
Hurdles to navigate
Despite the advancement in technology and the opportunities it brings, the hedge fund industry still has hurdles to overcome, some of which stem from high expectations which means fund managers need administrators to do more with less. This is because managers themselves are under pressure from investors demanding more performance while continuing to pressure them on fees and expenses, according to Sanchez.
He comments: “We see a very competitive market for hedge fund administration, with fewer new fund launches. As a result, growth will depend on increases assets under administration with existing clients or taking business from competing firms. The key to success in hedge fund administration is scalable growth through technology innovation.”
According to Sanchez, administrators need to deliver an enhanced investor experience, build out investor transparency capabilities, and deliver on risk, compliance and regulatory reporting as well as front-office data, and provide credit, financing, and other liquidity services.
“It’s a tall order, and in our view, you need a robust, global platform with financial strength that supports continued investment and innovation to succeed,” Sanchez affirms.
Meanwhile, although technology has accelerated, Sanchez explains that higher levels of automation are expected from fund administrators, to meet the higher pace and volume of trades, and clients and end investors also expect a significant increase in the need for data/transparency.
“Those are challenges but also opportunities for administrators that are able to invest in their technology platforms,” Sanchez adds.
BNY Mellon’s Murphy summarises the broader challenges for hedge fund administrators in the current market – many of which are shared across the fund administration sector, in three main points.
“The first is dealing with complexity; both in terms of creating standardised data sets across complex asset classes, fund structures and technology platforms, as well as in handling complex operating models across multiple jurisdictions. Consequently, fund administrators increasingly need to demonstrate both depth of expertise and a strong global footprint,” Murphy stipulates.
“The second challenge is dealing with constant regulatory change, which requires ongoing flexibility and support from administrators.”
“The third is the fee pressure on both managers and administrators. An additional challenge right now is supporting clients through the turbulence of the COVID-19 crisis and its fallout,” Murphy adds.
Looking to the future, over the next five years, Sanchez predicts that we will see continued focus on larger funds and convergence between private capital and hedge funds to capture market opportunities and respond to investor demands.
Additionally, we will continue to focus on building capabilities for our existing clients –especially those that continue to significantly grow and that partner with us strategically, Sanchez says.
He concludes: “Clients are a valuable source of market perspective and feedback, which will guide the next stage of development. As we solve problems for clients, we will then leverage those capabilities further to develop industry solutions.”
Discussing these trends, Peter Sanchez, head of Northern Trust alternative fund and omnium business services, says “Private capital funds are still significantly insourced, with approximately 60 percent lacking a third-party administrator. More broadly, investment managers keep finding new ways to deploy capital, taking a flexible approach to structures they set up for their investors, and these innovations require strong dedicated fund administration support.”
In terms of continued consolidation of service providers, Sanchez says: “Many of the emerging fintechs, for example, are being acquired by fund administrators seeking to buy capabilities to serve a segment or region of the fund industry.”
He adds that end investors are demanding increased transparency, to the extent it can become a differentiating factor for managers. Sanchez suggests: “This is an opportunity for administrators to demonstrate value in the way they build out investor transparency capabilities.”
Since the financial crisis of 2007/2008, regulations have been introduced to the financial services industry to help it work in a more transparent way, and technology is helping to do this.
BNY Mellon’s global head of hedge funds, Mick Murphy, explains that investor requirements for greater transparency, alongside risk and performance analytics, are becoming more frequent and complex, and enhanced technology is enabling that demand.
Murphy says: “Technology has accelerated the automation of processes – such as exception management – and supported client demand for earlier net asset values (NAVs) together with increased automated controls. It has enabled many of our clients to move to daily NAVs for their alternative vehicles.”
Additionally, Murphy notes that technology has brought “greater flexibility and automation for data delivery to clients – via application programming interfaces and portals – while the adoption of machine learning and robotics has improved reconciliations and enhanced insight through analytics”.
In 2019, Northern Trust launched client dashboards with a streamlined interface for enhanced user experience and optimised for mobile devices to provide decision makers with real-time, on-demand access to their portfolio information wherever they might be.
Sanchez suggests that the next step is enhancing the fund investor experience. He explains: “Hedge fund investors want to receive performance information and transact with the fund in a more seamless and automated way, moving away from manual redemptions. They want a portal through which they can access information on sophisticated, multi-asset and multi-strategy portfolios in an intuitive display.”
Generating alpha
Technology is also key to automating critical processes such as data reconciliation, and efficiently managing workflows, which can help clients generate alpha.
Sanchez highlights that administrators can reduce or eliminate “operational drag” that diverts resources away from the research and investment processes that deliver alpha for the fund and its clients.
As a partner to the fund manager, administrators can also provide profit and loss, risk, performance and compliance monitoring to support the investment team. Sanchez explains: “We have presentation tools that help portfolio managers easily identify the drivers behind exceptions and exposures, all of which informs the investment process and strategy going forward.”
He also observes that collateral management and cash optimisation are both high priority operations for hedge funds, crucial to a manager’s ability to be nimble in capturing opportunities and executing their core strategies in dynamic markets.
“We bring deep expertise to these complex processes, so we can provide efficient collateral management based on a variety of criteria, including liquidity of underlying collateral, hard to borrow versus not, or cost base optimisation. On cash management, we offer managers the ability to calculate unencumbered cash, aggregate it across accounts, and invest it,” Sanchez adds.
Hurdles to navigate
Despite the advancement in technology and the opportunities it brings, the hedge fund industry still has hurdles to overcome, some of which stem from high expectations which means fund managers need administrators to do more with less. This is because managers themselves are under pressure from investors demanding more performance while continuing to pressure them on fees and expenses, according to Sanchez.
He comments: “We see a very competitive market for hedge fund administration, with fewer new fund launches. As a result, growth will depend on increases assets under administration with existing clients or taking business from competing firms. The key to success in hedge fund administration is scalable growth through technology innovation.”
According to Sanchez, administrators need to deliver an enhanced investor experience, build out investor transparency capabilities, and deliver on risk, compliance and regulatory reporting as well as front-office data, and provide credit, financing, and other liquidity services.
“It’s a tall order, and in our view, you need a robust, global platform with financial strength that supports continued investment and innovation to succeed,” Sanchez affirms.
Meanwhile, although technology has accelerated, Sanchez explains that higher levels of automation are expected from fund administrators, to meet the higher pace and volume of trades, and clients and end investors also expect a significant increase in the need for data/transparency.
“Those are challenges but also opportunities for administrators that are able to invest in their technology platforms,” Sanchez adds.
BNY Mellon’s Murphy summarises the broader challenges for hedge fund administrators in the current market – many of which are shared across the fund administration sector, in three main points.
“The first is dealing with complexity; both in terms of creating standardised data sets across complex asset classes, fund structures and technology platforms, as well as in handling complex operating models across multiple jurisdictions. Consequently, fund administrators increasingly need to demonstrate both depth of expertise and a strong global footprint,” Murphy stipulates.
“The second challenge is dealing with constant regulatory change, which requires ongoing flexibility and support from administrators.”
“The third is the fee pressure on both managers and administrators. An additional challenge right now is supporting clients through the turbulence of the COVID-19 crisis and its fallout,” Murphy adds.
Looking to the future, over the next five years, Sanchez predicts that we will see continued focus on larger funds and convergence between private capital and hedge funds to capture market opportunities and respond to investor demands.
Additionally, we will continue to focus on building capabilities for our existing clients –especially those that continue to significantly grow and that partner with us strategically, Sanchez says.
He concludes: “Clients are a valuable source of market perspective and feedback, which will guide the next stage of development. As we solve problems for clients, we will then leverage those capabilities further to develop industry solutions.”
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