COO Connect Editorial: Interview with Sandy Kaul, US head of business advisory services at Citi Prime Finance
With the growing institutionalisation of hedge funds, operational infrastructure has come to the fore. However, as many managers have quickly discovered, these overhead costs build up and increasingly squeeze upon alpha generation. This is one of the reasons why Citi Prime Finance has unveiled its Hedge Fund 3.0 Model. The model facilitates hedge funds outsourcing and helps managers identify service providers who can cater to their requirements in middle office, collateral management, cash and treasury, reference data management functions, technology data and infrastructure management, human resources and employee benefits. COO Connect Editorial speaks to Sandy Kaul, US head of business advisory services at Citi Prime Finance in New York.
COO: How does Hedge Fund 3.0 help managers?
Kaul: We introduce hedge funds to middle office, infrastructure, data management and other outsourcing providers so the hedge fund does not need to build systems and infrastructures or hire people to run these systems. Instead, the hedge fund uses us as an intermediary to make contact with a provider. We introduce managers to accredited providers who will give investors peace of mind. We have several different partners with diverse skill-sets and we match up hedge funds with them.
COO: Why should hedge funds go through Citi and why shouldn’t they just go straight to the service provider, and is there a risk managers are outsourcing too much risk and responsibility?
Kaul: We are basically trying to help our hedge funds find opportunities in the market and this is a value add service. We have also carefully screened the providers we introduce and are able to speak to other hedge funds who have used these providers about their experience. Once we make the introduction, the discussions are exclusively between the manager and the service provider. Regarding outsourcing responsibility, it is essential hedge funds maintain control and oversight of their operations.
COO: What type of managers are going to use Hedge Fund 3.0?
Kaul: The model applies to all sizes. We have seen start-ups or spin-offs from investment bank proprietary trading desks express an interest. Conversely, we have seen managers at the other end of the spectrum – the largest managers are looking at it because they have a cost base that is inflated and the ratio for support staff to investment personnel has become skewed. These firms, especially in these volatile markets, are looking to cut costs and want to outsource big chunks of their operational infrastructure. The service providers we pair hedge funds up with are experienced in a variety of areas. They can handle the complexities of a global macro strategy or a multi-strategy portfolio. The ability to handle complexity is really the secret sauce that these expert outsourcing firms offer. A lot of larger managers might need to make systems upgrades. To save money and instead of rebuilding their data centre, we can introduce them to a service provider who can cater to their needs.
COO: How does Hedge Fund 3.0 differ from Hedge Fund 1.0 and Hedge Fund 2.0?
Kaul: There has been a major evolution in the hedge fund industry over the last decade. When we launched Hedge Fund 1.0, the industry was niche and young, and almost all strategies were equity long/short. There was only one prime broker working with the fund and they tended to provide middle and back office support. There was no need for managers to build up their infrastructure or hire people to oversee portfolios. They relied heavily on their prime broker. This was the typical hedge fund model up until 2001 and 2002. When the tech bubble burst in 2001 and 2002, returns predictably declined and therefore hedge fund managers started to become more diversified. The strategies became more complex and we started seeing more funds focused on fixed income, listed and over-the-counter (OTC) derivatives. Furthermore, because of counterparty risk, the managers started multi-priming. These operational complexities forced hedge funds to build their own technologies. Hedge Fund 2.0 and Hedge Fund 3.0 were therefore designed to help managers as the industry evolved. As the barrier to entry became higher, it was essential for hedge funds to outsource more and more of their workload to trim costs.
COO: Are regulators and investors driving Hedge Fund 3.0 demand?
Kaul: Investors will refuse to put money into a hedge fund where there are no controls or systems in place. Investors need to feel confident that the people managing their assets are professionals, both in terms of investing and business operations. However, investors have a desire to bring down infrastructure costs. Regulation does not come cheap and it is important to note that managers with $150 million in assets under management (AuM) need to have the same reporting systems in place as a billion dollar shop. This will not come cheap for managers and outsourcing is going to play a part in trimming the expenditure.