It’s a given that hedge fund managers consume data — and lots of it — to ensure the most lucrative trading strategies and efficient post-trade processes.
They need to know just how the global market is moving at every fraction of a second every business day and just which transactions must be cleared and settled each business day and how.
But that breadth of understanding is no longer enough to guarantee success. With savvy institutional investors and wary regulators wanting more information about just what hedge funds are investing in, what risks they are taking, and how they will ensure operational soundness, hedge fund managers must be a lot smarter about how they handle data.
New internal pressures are also ratcheting up: with competition so stiff for investor monies, hedge fund managers are under new stress to achieve a higher alpha. For that, they need to fine tune their fundamentals — analyzing market risk, performance and portfolios.
“It comes down to endogenous and exogenous demands,” says John Eley, the newly appointed chief executive for enterprisewide data management firm GoldenSource in New York.
Managing the Flow
If it sounds like managing volcanic eruptions it is. Fund managers just need to be careful of the lava flow. Getting burned isn’t an option, but harnessing that energy — in the form of more and better information and analysis — is always on their minds. “Funds themselves are looking at ways to tackle the increasing amount of information available to them,” says Eley.
Suppliers of enterprise data management technology, such as GoldenSource and competitor Asset Control, as well as providers of regulatory reporting services, are playing to the pressure from regulators and customers for greater transparency. Their systems, which are ultimately designed to centralize, cleanse and provide adequate controls over critical data, are one logical approach to making data more dependable and accessible.
Relying on Excel spreadsheets to store the data or at best keep it unreconciled in multiple departments with disparate data models and formats is the opposite of efficiency when it comes down to analysis and report. Data can be difficult to merge because of non-compatible formats, or turn out to be inconsistent, leading to mistakes in investor reports, regulatory reports and risk metrics. At a time when honesty is heavily monitored, neither investors nor regulators will be forgiving.
“Hedge fund managers who once were concerned about accurate investor and financial reporting must now address regulatory reporting, not only on their transactions and holdings, but their counterparty and asset exposures as well as leverage,” explains Paul Soltis, North American market director at Confluence, a Pittsburgh-headquartered software firm specializing in regulatory reporting.
In addition to traditional investment funds, the firm already had a handful of hedge funds under its belt. Its 2013 acquisition of reporting software specialist Data Agent gave it additional clout in the alternative investment manager market.
The three critical new reporting requirements causing hedge fund managers the most grief, says Soltis, are Form PF for the US Securities and Exchange Commission; reports for European regulators in countries which have transposed the Alternative Investment Fund Manager Directive (AIFMD), and the CPO-PQR reports for the US Commodity Futures Trading Commission.
Although the data formats and specific questions might differ there are enough similarities among reports to make it worthwhile for hedge fund managers to converge the efforts to track down the necessary data. That’s a far smarter way to handle the multitude of reports than having multiple data, operations and reporting teams reinventing the wheel for every new reporting requirement.
“There is a lot of overlap in the underlying data required for holdings, positions, transactions, counterparty exposure, and asset concentration,” explains Soltis. “The key differences are in the methodologies used for calculations which in some cases are subject to the interpretation of the fund manager.”
Just how to alleviate the reporting headache is a multimillion dollar question. The search for an answer leads to more than one alternative for untangling the data management morass.
“Some fund managers will opt to handle the entire data management process in-house while others will outsource the process to fund administrators so they can also do the regulatory reporting. Yet others will take a hybrid approach,” explains Marshall Saffer, chief operating officer of MIK Fund Solutions, a New York based data management firm specializing in hedge fund managers.
The intermediate approach, some hedge fund managers tell FinOps Report, involves allowing fund administrators to handle regulatory reporting, while maintaining control of the overall data cleansing and oversight process in-house.
The two most important deciding factors : the size of the hedge fund operation and its competitive concerns. “Smaller single-strategy hedge fund managers might outsource reporting a lot more readily than larger ones,” says Eley. “Size correlates with more complex strategies and the larger fund managers ensure they have the expertise and IT resources to handle their data management needs related to reporting on their own.
Hedge fund managers can also be pretty cautious creatures. “They don’t want anyone knowing just their specific trading strategies and individual security allocations. So they might be hesitant in allowing an external party access to that kind of data,” says Gil Leon, a consultant specializing in hedge fund managers for Asset Control in New York.
Fund administrators doing reporting work would de facto have access to positional information that shows the hedge fund manager’s strategy, explains Leon. The value-added service that administrators might offer hedge fund managers might encompass not only fund accounting and investor reporting, but also include managing their operations. Such a scenario includes taking on the sourcing of security master and reference data needed for trade settlement and regulatory reporting.
One more rationale for doing the data management work in-house: the chief compliance officer might demand it. “It could end up being a philosophical discussion,” says Soltis. “Some fund manager compliance experts don’t want the process outsourced, because the asset manager still retains legal liability.”
While Confluence and MIK Fund Solutions are well-entrenched in the hedge fund manager community, GoldenSource and Asset Control are gaining steam in diversifying from their traditional stronghold among large banks. Neither firm will disclose what percentage of their revenues or client base comes from hedge fund managers, but both claim it’s a growing figure.
In fact, Eley says that GoldenSource has expanded its business delivery from a strictly software-licensing model to include a hosted one as well, to accommodate hedge fund managers who don’t wish to handle applications management in-house.
At the core of Confluence and MIK Fund Solutions’ platform is the collection of data from multiple internal applications, ensuring its accuracy, and storing it in a physical data warehouse. That data includes basic financial instrument data, counterparty data, corporate actions data and pricing data, when can then be accessed by the hedge fund manager’s risk metrics application. The platforms then take all of the data and calculations to populate and file the regulatory reports.
Enterprisewide data scrubbing and integration engines such as those offered by GoldenSource and Asset Control ultimately do help hedge fund managers fulfill their reporting requirements, but neither firm markets itself as a regulatory reporting service provider. Regulatory reporting is a by-product, albeit a critical one, in what they offer.
In allowing hedge fund managers to create their own rules of engagement, GoldenSource and Asset Control say they ensure that the same core data will show up about the same financial instrument, transaction, or counterparty in multiple applications such as risk, compliance, pricing, valuations, accounting and trading. Easier access and viewing of whatever data sets are need is an advantage touted by all enterprise data management strategies. They also claim that new products can be far more quickly integrated into a hedge fund manager’s operations than relying on an external provider.
Tiered security can control which data points can appear to specific departments. Likewise, they ensure just who can add data and how much falls under some strict guidelines. Any changes to the data, and who made the change and when is recorded.
What might start off as an exercise in ensuring accurate and consistent data can easily turn into a full-blown data governance project. As a first step, data experts from multiple business lines sit at the same table to work out exactly what data points need to be included in the project, how to build consistency in identifying them, and just who will be responsible for what and when.
Such initiatives have become popular at some of the world’s largest banks, which have gone so far as to designate a data management guru: the chief data officer. They have good reason. In the wake of the financial crisis where so many errors were made in measuring investment and counterparty risk, someone has to be held accountable for ensuring the data is accurate and correctly applied.
Hedge fund managers may have a long way to go before the CDO title becomes commonplace. But with new internal, investor and regulatory demands closing in on them, they are beginning to realize the merits of relying on dedicated data management staff. “Data management is no longer the sole purview of a back-office geek,” explains Asset Control’s Leon, who previously ran a hedge fund manager’s data team. “The buck stops with the chief financial officer, who will hold the chief operations officer accountable for any data errors.” The chief operations officer will likely turn to a centralized group of data specialists for data cleansing, normalization, distribution and access.
With data management becoming such an integral part of hedge fund operations, it stands to reason that far fewer reporting errors will be made or tolerated. It also stands to reason that investors and regulators will get far better reporting of the return versus the risk taken by each hedge fund manager.
Hedge fund managers may gripe about all the extra work, but ultimately know that it holds a silver lining. “We’ve often been made the scapegoats of the financial crisis or any economic downturn when all we tried to do was outsmart the market,” quips one New York hedge fund manager to FinOps. “Investors often don’t understand how we work and neither do regulators. What they don’t understand, they are only too quick to unfairly demonize.”
With more comprehensive and efficient handling of data, hedge fund managers may be able to provide more answers without, of course, giving away their valuable secrets.