GAIM Ops: Emerging managers warned on challenges
Managers need Assets under Management (AuM) of between $100 million and $150 million if they are to break-even amid growing regulatory scrutiny and pressure from investors to institutionalise their businesses.
This is far lower than the $300 million put out by Citi Prime Finance in its 2013 Business Expense Benchmark study. The Citi study said firms with less than $300 million will struggle to pay through the 2% management fee for items such as third party expenses, salaries and compensation without additional capital or incentive fee pay-outs. In Citi’s 2012 survey, it estimated hedge fund managers running under $250 million spent approximately 198 basis points of their 2% management fee on operations and third party service providers alone.
“I would say an AuM of $100 million is a good break even point. We adopt an institutional approach to managing money in terms of systems and compliance but we are frugal towards other costs such as marketing and travelling” said Adam Chud, assistant portfolio manager at Capstone Equities Capital, speaking at the GAIM Ops Conference in Dublin.
Others put that cost at slightly higher. “We would put it at $100 million to $150 million. How long is a piece of string? It depends on fee conversations so it can be difficult to run a business when individuals put significant pressure on fees. We have seen an end of an era for mega launches though. Furthermore, fund managers must be institutional and while firms can control costs on some aspects of the business like marketing and travel, they cannot be complacent on compliance, tax advice or legal advice, and corporate governance just to save costs,” said Matthew Johnson, chief operating officer (COO) at Makuria Investment Management.
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 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. “Regulation and regulatory reporting takes so much time. Each regulator wants different data and it has certainly raised the bar for the industry. We have got massive resources dedicated to regulatory reporting,” said Rowan Levy, COO at Salt Rock Capital.
A 2013 study by Deutsche Bank Markets Prime Finance found regulatory compliance to be the biggest contributor to chief operating officers’ (COOs) workloads. The survey, which polled 44 COOs at hedge funds with collective AuM of $325 billion in the US and Europe, said almost a quarter of US-based COOs and 13% of European COOs were devoting 75% more time to dealing with regulatory issues. On average, the global COO is spending 50% more time handling compliance, legal and regulatory matters. Predictably, this has prompted a surge in recruitment of non-investment professionals to handle these challenges with 40% of hedge funds acknowledging they had made such hires.
“The regulatory acronyms are coming through thick and fast. AIFMD, the European Market Infrastructure Regulation (EMIR), the Foreign Account Tax Compliance Act (FATCA), the Markets in Financial Instruments Directive II (MiFID II), in addition to the likes of Dodd-Frank and Solvency II, are all going to impact hedge fund managers. It will be harder for start-ups but I am confident that those money managers which are well-run organisations and equipped with effective COOs will survive and thrive,” said Joshua Barlow, vice president of operational due diligence at Pacific Alternative Asset Management Company (PAAMCO) in Irvine, California.