COOs deliver a message to portfolio managers
If SunGard commissions the Aite Group to survey hedge fund managers, we can be confident that the technology and outsourcing vendor will be delighted if the respondents say they are going to increase their technology expenditure and outsource more of their technology needs. So the results of the recently published report on Hedge Fund Trends and Challenges: Achieving Institutional Credibility will have made disappointing reading for SunGard sales executives.
A clear majority (69 per cent) of respondents told Aite their spending on technology will stay the same for next three years, and a minority (5 per cent) even think it will go down. Of the firms that are planning to spend more on technology, not one plans to increase budgets by more than 10 per cent per annum in the next three years. A whopping 85 per cent of the respondents had built their own systems, either wholly or partly in-house and partly by using vendor components, and are not planning to change.
As to outsourcing, half (49 per cent) of respondents thought it unlikely, and another quarter (28 per cent) were unsure. Another quarter (23 per cent) think it is unlikely they will outsource platforms in the next three years, because the risk of loss of control and lack of customisation outweighs any cost savings they might achieve. Asked if they liked the idea of handing their technology needs to a single vendor - such as SunGard - nearly half the respondents did not answer the question and, among those that did, there was little confidence it would save money or increase efficiency.
But there is another way of reading the survey results, and it offers fascinating insights into the tensions that persist between hedge fund operations chiefs and portfolio managers. The survey was not a large one, with just 40 respondents, of which no less than 60 per cent were COOs, controllers or operations managers. A mere 8 per cent were portfolio managers, with the balance made up of managing partners, directors or vice presidents, many of which will have had an operational role within their firm. In other words, the survey had a strong operational bias.
So when two of out three respondents say the greatest obstacle to alpha generation is the lack of ability or skill or style of the firm in choosing investment strategies and asset classes and allocations, and the same proportion claim alpha generation is either easy or not that difficult even in current market conditions, it is hard to avoid the conclusion that this is the voice of the COO rather than the CIO. The fact that the second most important obstacle to alpha generation is lack of operational investment and resources only reinforces this impression. That the security and reliability of data enjoys equal ranking, with regulatory challenges and funding, clinches it. These are, of course, all ultimately the responsibility of the COO.
The impression that operational chiefs are asserting themselves is reinforced by other findings of the survey. The study identifies considerable frustration among respondents at the quality of their technology, and the limited integration of their systems and operations. Just one respondent in six (15 per cent) reported a fully integrated front to back office system. Needless to say, respondents think that this under-investment in technology is hampering investment performance by denying portfolio managers the data they need to understand the value of the instruments they are buying and selling and the risks they are running.
In fact, two out of three respondents also told Aite that better technology would improve, considerably improve or transform investment decision-making by the portfolio managers. That claim is a fairly transparent pitch by operational managers to portfolio managers to recognise that investment in operations and technology can make money as well as cost money. The same belief in the centrality of operations and technology to success in fund management lies behind the belief among all but a twentieth of the respondents that investors will avoid fund management houses whose operational infrastructure falls short of "institutional" quality. Indeed, the study suggests that credibility with institutional investors is where respondents believe most strongly that technology and operations can make a real difference.
There are also discernible signs in the survey that operations chiefs believe they being asked to do too much with too little. 43 per cent of respondents to the study regard operational efficiency in general as either "very" or "extremely" challenging. They explain that this is partly a consequence of regulatory uncertainty, which makes it impossible to put people and processes in place - half the respondents named regulation as deeply problematic - but add that it also reflects the lack of resources needed to automate existing processes and keep up with innovation in the business.
The specific regulatory concerns that are responsible for what the authors call "efficiency purgatory" are as predictable a list of current operational concerns as it is possible to conceive. It consists of FATCA (named by 74 per cent), Form PF (60 per cent), AIFMD (47 per cent), OPERA (37 per cent), EMIR (35 per cent), Dodd Frank (34 per cent) and UCITS (21 per cent). Significantly, a new regulatory change that is approaching rapidly - namely, the transition of swap trading to SEFs - prompts scarcely any concern, with less than one in five (16 per cent) respondents seeing it as material. That may be because it is seen as largely an external or front office issue - at least at this stage. (Look out for the COOConnect webinar on SEFs, which takes place on Monday 7 October 2013.)
Of course, front office trading and investment decisions always have an operational impact. A careful reading of the survey does pick up some dissatisfaction about the growing propensity of portfolio managers to seek exposure to emerging and exotic markets, without taking the operational difficulties fully into account. Buying, selling and safekeeping securities in obscure markets is expensive and operationally challenging, and entails heavy dependence on external broker-dealers, custodian banks and market infrastructures in jurisdictions whose legal and fiscal regimes are not always welcoming to foreign investment.
In short, the survey Aite Group conducted for SunGard can be read as an assertion by the operational leaders at the firms surveyed of the importance of infrastructural efficiency and technological excellence to the ability of a fund manager to attract and retain investors and achieve high investment returns. If there is limited confidence among respondents that operational spending is poised to increase, there is an equally noticeable lack of enthusiasm for further cost-cutting. This is not just because COOs have to cope with a torrent of regulation. In fact, if COOs are asking for one thing in the survey it is people and money to better integrate their systems, so they can access and report the data investors and regulators want to see - and help their colleagues in portfolio management make better investment decisions.