Comment and Analysis: What challenges are hedge funds facing at the end of 2015?

During the recent market tumult, the asset management industry has no doubt been fully focused on realigning their investment activities to navigate the conditions and protect performance.

Returns have shown huge dispersions across the industry over the last three months, including a decent uptick in October.

In addition to tackling the vagaries of the markets and geopolitical elements, managers are also forced to digest any number of new requirements, events and developments.

In a recent survey by KPMG, more than 75% of managers indicated the greatest threat to the industry is increased regulation. For their part, investors don’t seem to be relying on regulatory compliance to curtail due diligence activities, nor does it seem to satisfy their appetite for transparency.

So, let’s start with the regulatory environment. In her recent speech at the MFA conference in New York, SEC chair Mary Jo White made it clear the regulator intends to expand its oversight role.

Her speech coincided with the release of a 40-page report showing aggregated data drawn from investments advisers’ Form ADV and PF reports.

The data focuses on the size of the alternative investment sector, gearing, liquidity and exposure, all with the objective of monitoring systemic risk. White even hinted at the possibility of stress tests for financially significant hedge funds.

Then comes everyone’s latest “bête noire”, cybersecurity. The SEC issued a Risk Alert in September and just for good measure, followed it up with an enforcement action against a manager.

Cyber-security affects all stakeholders; as an administrator, data protection is paramount to maintaining the integrity of our service offering, and has become the source of significant investment to address all aspects of cyber-security exposure. We are fielding numerous “vendor management” due diligence requests from managers and investors and a group called Alternative Investment Technology Executives Club has even issued an Aima-like standard questionnaire.

The US Department of Treasury’s Financial Crimes Enforcement Network issued a proposal in August to require advisers to establish anti-money laundering programmes.

We think that advisers will be able to delegate this function, given that administrators are already performing it, subject of course to how responsibilities will be apportioned under the rule.

Finally, Mifid II is expected in January 2018; this is where regulatory compliance takes us into the realm of daily transactional reporting and I am sure no-one is fully prepared for that. The operational challenge for the manager is the ability to gather the data to complete the 64 required fields on a timely basis, in particular as it relates to any OTC trading activities, and evaluating whether service providers such as brokers and administrators can support the process. All in the spirit of monitoring the “fair and orderly functioning” of the markets.

On the flipside, M&A season is in full flow; the most eye-catching of a number of recent investments in GPs was the stake taken in Marshall Wace by KKR. Considering these two firms have historically operated at opposite ends of the liquidity spectrum, one can only guess at the asset class convergence opportunities envisaged by both parties in coming together so effectively.

In the administration space, M&A also continues apace, with investment bank-owned administrators continuing to step out, leaving only a few standing; the result being a largely bifurcated fund services sector, comprising independent administrators and large custody banks.

None of this will stop investors from voting with their feet if performance doesn’t meet their expectations, and the recent closure announcements by the likes of Everest & Fortress bear witness to such reality.

Just when you thought this is the time for the industry to show to showcase its strengths, along comes the next wave of developments. Fortunately for us, we operate in an industry that thrives on evolution and views every challenge as a new opportunity.

Published in HFM Week

1st December 2015