Hedge fund launches are at 18-year lows and emerging managers are facing an uphill battle for capital when compared to their larger, more established peers.
According to the FT, “the composition of the hedge fund industry’s investor base has also changed over time. Allocations are now dominated by large institutional clients that have a bias towards larger managers. Competition to win seed capital is also intense so it is increasingly difficult for new managers.”
In addition to industry headwinds emerging managers are often constrained by low headcount and limited bandwidth which impedes their ability to add new capabilities. Despite these challenges some managers choose to invest heavily in technology as a way to differentiate themselves. For managers with limited resources however early investment in enterprise technology can create more problems than solutions.
Emerging managers can be every bit as attractive as larger managers when it comes to performance. Aside from aggressive fee structures and more innovative marketing there is another area of opportunity available to many managers. That is to demonstrate an institutional quality infrastructure that is built on systematic processes and the same level of technology employed by larger firms. “Performance can be strong but also volatile. Investing in emerging managers requires a greater appetite for risk as well as more due diligence expertise,” as Ken Heinz, HFR president, told the FT.
In particular emerging managers should be looking to integrate advanced risk analytics into all aspects of the business as early in their evolution as possible. Not only can the right analytics be an asset to a robust portfolio management process, but they are also extremely important in the eyes of institutional investors. An ability to systematically manage risk with enterprise grade technology is an area where emerging managers can and should be on equal footing with their larger competitors. While conventional wisdom is that such capabilities are out of reach for smaller firms the maturity of software as service (SaaS) offerings has in fact put them in in play for firms of all sizes.
The right approach for leveling the playing field when it comes to risk analytics is to start with a solution that is simple to implement, easy to change and that does not require a large up-front investment (in either time or dollars). Onboarding time should be measured in hours, not days or weeks, and the ability to change how the system is used should be something that can be done easily without running up a big bill for professional services. Cloud based SaaS offerings will be a manager’s best option for finding solutions that don’t require an intensive setup and that can be provisioned on pay as you go terms which significantly reduce the risk of implementing new technology.
Another consideration should be selecting a risk engine that is mature enough to satisfy the internal needs of portfolio managers while providing a robust set of reporting for potential investors. At a minimum, managers should have access to position level, portfolio level and multi-portfolio level models. In addition, they should be able to run multi-model Value at Risk (VaR) as well as multi-scenario stress testing. Options analytics are yet another tool that emerging managers should have at their disposal.
Traditionally, the decision on when to implement risk analytics has been difficult. SaaS based offerings have made it much easier. With low or no up-front costs, fast onboarding times and ready access to advanced capabilities there are few, if any, downsides. The upside is that enabling risk analytics earlier in a fund’s lifecycle is creating less risk for investors, it’s a small step towards leveling the playing field when it comes to capital raising.