2018 has been in the books, but the events of last quarter cannot be dismissed as “old news”.
What’s happened in Q4 affects the present and future, and some of the trends from then will continue into 2019.
- The challenges hedge funds faced last year performance-wise look to persist.
- New regulations will put pressure on bottom lines and demand:
- increased operational due diligence.
- innovative, cost-cutting solutions.
Investment Industry Market News
The global hedge fund industry ended 2018 down -4.86% for the year, following a -2.15% slump in aggregate performance in December, according to the latest eVestment data. The industry’s aggregate annual performance was similar to 2011, which was the industry’s second worst year on record.
The 2018 performance figures contrast with the +8.93% achieved in 2017, which saw almost universally positive performance among hedge fund markets, strategies and geographies.
While some funds performed well in 2018, others – including some major industry names – faltered. The mixed fortunes, and prospect of heightened volatility going forward, will further incentivize investors to undertake thorough research and due diligence in their selection process. A strong investment track record, along with a robust operating environment to help minimize risks and costs, and support the development and implementation of profitable investment ideas, will be key to attracting allocations going forward.
IDW Group chief executive Ilana Weinstein predicted the shakeout in the hedge fund industry is still unfolding, with “many more” closures coming.
According to Eurekahedge data, fund shutdowns in 2018 outnumbered openings 580 to 552 as of Dec. 3.
In a December Bloomberg Television interview, Weinstein noted that hedge fund managers will need to distinguish themselves in a highly competitive market.
The onus inevitably will be on achieving superior long-term investment returns. However, funds’ fees, costs and risks are also facing increasing investor scrutiny, forcing firms to rethink how they operate to optimize efficiencies and performance.
Buy-Side Operating Trends
Investors’ operational due diligence demands and vetting processes are becoming ever more stringent.
While the extra hoops investment managers must jump through may seem onerous, meeting and exceeding ODD requirements can be a valuable differentiator – helping alternative managers progress onto more investor shortlists, and ultimately leading to more allocations (as well as helping attract and retain the best recruits, who will be drawn to the firm’s reputation for quality).
The key, according to this article, is a documented, well-planned risk management strategy covering IT and other business areas.
Innovation within the capital markets sector is key to ensuring its continued resilience and future growth. However, with many back offices still running on legacy technologies, asset management firms are struggling to adapt to change.
In this article, the Realization Group sets out some of the practical steps all capital market firms should take to successfully implement innovation within their organizations … including focusing resources on the transformations needed in the middle and back office, ensuring technology innovation is an ongoing process, and driving change through board-level and CEO intervention.
A well-defined target operating model is an increasingly important differentiator for buy-side firms.
Facing pressures ranging from heightened regulatory demands to compressed margins, small- and mid-sized buy-side firms will need to be nimble, niche, and willing to expand into new markets if they are to remain competitive.
But to adapt to the changing market landscape, many firms will need to re-evaluate and modify their operating models.
In this article, Bloomberg Professional Services notes that firms generally seek to adopt one of four operating models: specialization, expansion, front-to-middle consolidation and firm-wide alignment.
Yet while creating a well-defined target operating model is crucial to firms’ future success, making the shift is a complex process that requires three essential steps:
- Aligning key stakeholders across the organization.
- Leveraging internal capabilities.
- Deepening partnerships with third-party technology providers.
Economic and competitor demands, increases in data complexity and volumes, continued speed of regulatory change, and enhanced scrutiny from external audits all demand more effective and efficient back-office functions.
Many organizations remain reliant on labor-intensive manual processes and spreadsheets to meet their financial and regulatory obligations, but regulators and auditors are becoming less tolerant of them.
The return on investment on an automation project is much quicker these days. COOs are therefore starting to act. By embracing technology in areas such as data management, reconciliations and financial controls, employees can be redeployed to more valuable work, and more efficient and effective work practices introduced.
The result: performance growth, reduced operating costs and improved regulatory compliance.
Regulation and Compliance
New initial margin requirements are coming. And unless you’re compliant in time, you won’t be able to trade bilaterally.
In this three-part series, Cassini Systems explores what the Uncleared Margin Rules (UMRs) mean for the buy side, and outlines some factors to consider as firms start planning for implementation of UMRs and ISDA’s Standard Initial Margin Model (SIMM). Cassini also investigates the steps needed to ensure firms remain compliant, and how they can minimize the impact of the additional collateral requirements on their liquidity and trading.
Meanwhile, the DTCC notes that the next phase of derivatives reform will spark a significant increase in margin calls, and a corresponding liquidity crunch. This will require market participants to place an increased emphasis on capital efficiencies and liquidity management, since these areas drive investment performance for clients and investors.
The DTCC sets out three key ways for the buy side to optimize collateral, with the focus on:
- Maximizing the value of data.
- Globalizing assets so firms can quickly and easily move collateral to enhance the financing or settlement process.
- Facilitating collateral movement and recognizing settlement to better manage risks.
US and European regulators recently introduced separate initiatives intended to enhance reporting in the repo market. However, they’ve taken significantly different approaches.
This TABB Group article breaks down the two reporting initiatives to help market participants begin to prepare for the new repo regime.
A recent survey of executives across the asset management, corporate, capital markets and private wealth sectors found the overwhelming majority (85%) predict demand for RegTech solutions will continue to grow until at least 2020, driven by ongoing changes to tax and regulatory regimes and the release of new rules.
Some 40 per cent of survey respondents said their company struggled with a skill shortage in RegTech and compliance. Given this deficit in RegTech expertise and resource, many institutions are turning to external organizations for assistance.
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