March 12, 2012
post contributed by Megan Flynn
Sandy Kaul, the U.S. Head of Business Advisory Services at Citi Prime Finance, hosted the Roundtable’s first meeting of 2012 in January. She explained the evolution of hedge funds’ internal structure, giving members an in depth analysis of the past as well as painting a picture of what might be to come.
Hedge Funds were initially built to maintain the intellectual investment process only, for all other necessary responsibilities early hedge funds relied on Prime Brokers. Since then, funds’ investment diversity has expanded to more of a multi-asset platform which prompted a shift to a multi-prime service model. This shift created pressure on the hedge fund itself to manage various new functions associated with taking on a variety of asset classes, which then demanded extensive teams and platforms internally. The pioneers of this point in the evolution built out very sophisticated IT products which then changed the whole cost structure, Kaul said.
Some of these robust internal systems and processes have recently started being lifted out and sold to service providers (One big example being the deal between Bridgewater and BONY Mellon), which then allows them to switch to a more variable cost structure rather than keeping expensive fixed costs that come along with running your own operations and technology, etc. This also moves the expenses to the fund level instead of the management company, Kaul said.
Hedge Funds are now starting to consider other options for shifting their cost structure including making strategic outsourcing decisions. Outsourcing responsibilities like middle office, cash management, benefits, and administration has started to allow funds to move back towards the entrepreneurial focus they had previously as a small organization yet still preserve operational controls they have created and become accustomed to, Kaul explained.
Sandy’s presentation piqued a lot of interest in members as the Q&A session for this Roundtable was particularly active. Ideas and concerns were presented about the next step in the structural evolution of hedge funds, concerns about the risk required in adapting new operations and procedures and the costly ramifications of an unavoidable risk in duplication of efforts. The sincere interest shared by everyone in the room that night was a testament to quality of the hedge fund industry’s quality of institutional infrastructure.