By Henry Phillips
Investor interest in seeding and emerging hedge fund managers is set to rise this year. Rather than focus exclusively on short-term goals, emerging hedge fund managers should define a long-term vision and strategy designed to attract and retain capital and talented resources.
This particularly rings true in the crowded Connecticut market, which was ranked by CityUK as the third-largest owner of hedge fund assets in 2011 after New York City and London.
Managers should ask themselves the following questions:
Ӣ Will the strategies and products we trade tomorrow be the same as today?
Ӣ How do we evaluate and select the right service providers?
Ӣ Should we consider using multiple prime brokers? If so, how will we consolidate data?
Ӣ What are the options and implications of outsourcing?
”¢ To what extent should we “shadow” our administrator to ascertain that net asset value and other calculations are correct?
Ӣ Do we have the right technology platform to deal with future growth in size and complexity?
Ӣ Is our team structured correctly with the appropriate skill sets?
Ӣ Are our compensation structures able to incent and retain our people?
Increased regulation in the hedge fund industry, coupled with growing investor demands for full compliance, has the industry at a crossroads and is creating significant pressure for hedge funds to reevaluate their current compliance programs.
For example, tax issues do not often take center stage in the hedge fund industry, but a confluence of factors has made tax issues particularly relevant. This is a trend that is likely to continue. Months of congressional debates over deficit reduction have kept alive the possibility of tax increases. Other tax-compliance issues facing the industry are the impact of the Affordable Care Act and the Foreign Account Tax Compliance Act.
Also, changes in regulatory reporting requirements may prove a challenge for the hedge fund industry, whether it is the Securities and Exchange Commission”™s Form PF or the Commodity Futures Trading Commission”™s change in filing exemptions. New managers should understand the regulation impacting the industry and see if their organization has appropriate resources to build a comprehensive compliance framework.
Many hedge funds are beginning to understand the importance of establishing their own risk management framework and how it can contribute to enhanced success. The evaluation should consider, at a minimum, market, liquidity, leverage, counterparty and operational risks. New managers should think about what their appropriate risk appetite is.
Five years ago, the presence of a CFO or chief operating officer (COO) at a hedge fund might have been considered optional, but now it can be viewed as a business necessity. Investors and regulators are constantly demanding information and evidence of internal controls. Regulators and institutional investors expect emerging funds to be able to operate and provide the same level of control and transparency as mature funds, while also being nimble and adaptable to change.
Startup funds should consider hiring a COO or CFO from the beginning. This role should be filled by an experienced financial and operations manager who can work closely with the portfolio manager. New managers need to focus on making smart trades, not working on issues where they are not experts. Conversely, the CFO or COO should ensure that the business is scaled to support the asset size and trading portfolio that is envisioned by the manager.
The hedge fund industry is large and growing, exceeding $2 trillion globally in 2011, and the number of funds continues to grow. Success should come to those industry players willing to raise their game and who are able to thrive under pressure ”“ with the right people and infrastructure in place and attention to regulatory requirements and risk management.
Henry Phillips is Deloitte”™s Northeast regional managing partner and lives in Ridgefield. He can be reached at officeofthermpnortheast@deloitte.com.
