Hedge Fund Risk Management: Outsourced vs. In-House Functions?

Hedge fund risk management is a matter of necessity, as the number of hedge funds shutting down in 2017  was the most since the financial crisis in 2008-2009, and a surprising number of the failures are due to bad operations management.

Whether hedge fund failures are the result of innocent missteps or nefarious actions like a Ponzi scheme, these problems could have been avoided had there been better decision-making, oversight, and risk-mitigating measures in place.

Perhaps your firm needs to improve in some areas, and reducing costs is one of those places. Outsourcing some of your in-house functions might be a way to lower expenses, but the question is does it make sense for your firm? What are your core competencies?

Hedge Fund Risk Management: Outsourcing Options

Back-Office Operations

Outsourcing reconciliation and reporting needs is a growing trend, and over 80% of hedge fund AUM is administered by third-parties in the form of back-office outsourcing.

Cost savings and increased operational efficiency are certainly motivators. The question is how satisfied are you with your in-house back-office operations?

When asking yourself these questions, it might reveal some weaknesses in your back-office operations processes, or it’ll confirm that everything is running just fine.

If you believe everything is fine, what is your reference point?

How you answer these questions will determine if exploring the possibility of hedge fund outsourcing is a good idea.

Compliance

One of the biggest challenges for hedge fund managers when starting their company is focusing on the non-investments aspect of the business.

Running a hedge fund company is not as simple as doing the research, creating the strategy, and executing the trades. Research, strategy, and execution are undoubtedly important, and they are often what you first think about when a hedge fund comes to mind, but a hedge fund requires a solid operations and proper oversight via compliance.

The fund managers, often founders and/or managing executives as well, would rather focus on their passion, which is investing. Putting the time and resources into compliance is a matter of necessity, but it’s not the reason managers get into the profession.

Considering these factors, how is your compliance?

In light of the lack of passion or expertise in compliance on part of the fund managers, there are hedge fund companies that are happy with their compliance department because they have hired the right people to do the job.

But increasing regulatory demands make it harder to do business, and rising compliance costs not only eat into your profits, but they also could threaten your firm’s existence.

Whether you’re unhappy with your current compliance and/or worried about increased expenditures, outsourced compliance functions are an alternative.

According to a Deloitte survey, more than 57% of firms that use compliance outsourcing saw cost savings of 10% or more.

Here are some of the functions you could outsource:

Whether you choose to outsource compliance or not, and whether or not you feel the pinch from rising costs, your outsourcing options are not just limited to middle- and back-office operations.

Considering Solutions for Hedge Fund Risk Management

Hedge funds face many risks to their business. Whether it’s from rising operational and compliance costs, increased regulatory demands and a failure to comply, or downright ineffectiveness and incompetence, an honest assessment of your firm’s practices are needed.

Comparing the performance of your in-house functions with those of previous managers at your firm or at rival firms is a good thing, as is seeing how back-office operations and compliance outsourcing compares.

Whatever choices you make, the most important thing is you are open-minded and well-informed in your decisions.