All this may seem somewhat daunting to the smaller or medium-sized fund manager. We have seen that bigger firms, especially those linked to larger long only businesses with strong internal resources are well able to meet these challenges. For those still considering their first UCITS fund launch, however, it is worth looking at how technology can be used more effectively to meet the enhanced reporting requirements of both regulators and investors.
One of the reasons for the success of the UCITS brand has been the sins of the past, and the wake up call for investors in 2008 as the barriers to redemption were suddenly raised. It has created a climate, if not of suspicion, then certainly of caution. This has been mirrored at the regulatory level with the AIFM Directive and the Dodd-Frank Act.
UCITS address investor concerns
The use of a UCITS structure helps to address many investor concerns, providing a high degree of liquidity coupled with enhanced transparency. More regulatory emphasis on proper disclosure means fund managers will need to focus on their ability to report, and report frequently and accurately. With funds that are priced on a weekly or daily basis – and the vast majority are at the moment – this requires investment to ensure that the infrastructure is in place to communicate prices clearly, succinctly, and on a regular basis.
Communication is becoming a much more important tool in the fund manager’s toolbox than it was previously. Good investor communication can make the difference between maintaining an investor relationship and seeing that dreaded redemption notice arrive in your mailbox. It is a fine line at the best of times, but the investor who feels he is being kept informed, particularly during times of enhanced market volatility, is less likely to pick up the phone to the fund manager or indeed, to consider selling that fund.
What is transparency?
Although it is a term often bandied around, it is worth closely considering what transparency really means to the hedge fund investor. Investors are not investing in a fund’s actual underlying positions, or its people, or even a legal structure: they invest in a product which marries together all of these. At recent industry conferences this has emerged as a key theme, with investors speaking about the need to ensure the ‘product’ met their requirements.
The quest for transparency, then, is the quest for the visibility of the product. Fund managers have historically worked under the assumption that this meant oversight of the fund’s positions, and it can still mean this, if investors ask for position level transparency. Other investors may not be interested in this level of detail, or may recognise that position level transparency does not of itself translate into a proper insight into the fund’s strategy. There are, however, a growing number of investors seeking more transparency of strategy.
Position level transparency is akin to a recipe in a cook book. What really counts is the talent of the chef. Only he can determine the success of the dish that is finally offered up to the diner. For hedge funds, the skill, talent, market views and ingenuity of the manager are the true differentiating factor. Most investors appreciate this, and this is why the question of transparency has moved on from one of pure position oversight.
The behaviour of a few managers over the last few years has tarnished the reputation of the many professional organisations in this sector, and has caused some investors to quite naturally seek a higher degree of control over the funds they invest in. Seed investors have been able to ask to become partners or shareholders in the fund management businesses they back, while managed accounts have become a more popular route into hedge funds for some, offering as they do the comfort of separation of assets, position transparency and ready access to capital. However, they are time-consuming to establish, maintain and operate.
Has regulation helped? It has certainly become a hot topic in the alternative investments realm, with both legislative regulation being imposed from above, and the industry adopting some initiatives of its own (like the Hedge Fund Standards Board). Those seeking improvement have zeroed in on guidelines, rules, and codes of conduct, and certainly regulation can only help to keep unqualified organisations out of the business and reduce the scope for irresponsible practices.
But regulation and other codes only impose a minimum set of operating requirements. The UCITS brand and the HFSB guidelines set a benchmark, but these are really only a set of standards to be met. They provide a level of comfort and reassurance to the investor, but they won’t prevent a blow-up, they don’t absolve responsibility for good due diligence and they certainly leave the decision to invest in a fund with the investor.
Building and maintaining confidence
The delivery of transparency is all about not only establishing confidence, but maintaining it as well. Working with both managers and investors, we have been able to distil some of the key issues surrounding transparency.
Transparency can stretch to include a range of items in the fund manager/investor relationship, including:
• the product as an entire entity
• legal documentation, terms and conditions
• who the decision makers and risk takers are (personnel level transparency)
• business operations
Establishing investor confidence stretches beyond regulation and controls. These factors do not adequately address confidence. They help to establish a minimum starting point for today’s investor, but the relationship goes far beyond this. Fundamentally, the investor is trusting the manager with his money, and regulation and control are not in themselves trust-based measures.
Investors are not the only beneficiaries of transparency. It can pay dividends for managers as well. For example, transparency of operations can help to win trust, but can also benefit the manager, especially those who have sought to provide more internal efficiency and transparency across their business. Such achievements can also in turn help to enhance the investor relationship, as it gives the manager the tools to provide a much higher and more professional degree of reporting.
This can include a range of operational items, from prime broker reports to fund administration, compliance to performance-based compensation. To be prepared to disclose some items to the investor, and to do so in a process-based environment, demonstrates that the manager is ready and able to work on improving the fragile climate of trust that exists between him and his investors. To go beyond the minimum standards of disclosure, to offer more, will help get the manager noticed and remembered, for the right reasons.
The deployment of superior reporting technology and the dramatic savings it can bring to the fund management operation, coupled with the proper management of information internally, is increasingly being described as ‘smart transparency’. It leads to streamlined operations and the dramatic reduction in cost versus operational savings. The reporting requirements of UCITS are already starting to focus minds in this direction, and while manpower constraints are always a consideration, technology can help to deliver substantial benefits to fund managers seeking to earn the trust of their investors.
Smart transparency
The wider use of managed accounts by fund managers who feel comfortable providing their clients with full transparency is part of the growing trend towards better ongoing reporting. Managed account and segregated account providers have been reporting growth in their business over the past 18 months, particularly from institutional investors. The same is true of the UCITS hedge fund industry, where both new and old investors are insisting that managers who are serious about their mandates look at UCITS as an option.
The use of ‘implied’ transparency, by offering UCITS or UCITS-like structures and attributes, is also appealing to both the manager and the fund buyer. But ‘smart transparency’, offering the investor more access to the fund operation beyond simply an overview of positions within the portfolio, takes the whole transparency dynamic much further down the road towards good customer relations. This means being more up front about the product itself, the legal structure used, service providers, operations, and indeed providing more access to decision makers, or at least letting investors hear from them more frequently, and in greater depth than a monthly letter. It means volunteering more, and doing it in a way that the manager still feels comfortable about disclosing the information.
This may seem like a grind to those who want to focus on their market activities, but it is the shape of things to come if assets are to be successfully gathered and retained. Ironically, we hear far fewer complaints from managers today about in-depth operational due diligence from investors.
This all sounds like a lot of work, and indeed the prospect can be intimidating for all but the largest fund managers. There are the costs and man-hours to consider. There is the need for more internal technological oversight, perhaps the hiring of a Chief Technology Officer (a ‘must have’ these days for the multi-billion dollar club).
Luckily, this demand for more transparency comes as the cost of technology continues to come down, allowing the smaller manager to get his hands on exceptionally advanced systems that even a few years ago would have been unaffordable to all but the biggest firms. It creates choices and opportunities that simply weren’t there before.
Invariably, any investment in advanced reporting processes will be looked on kindly by clients. Managers have focused in the past on the speedy flow of information within their firms, but now they need to include their investors in that loop. They almost need to think of their investor as having a virtual desk in the corner of the office.
Technology as a facilitator
Technology won’t provide all the answers, but it can be a good facilitator. It can help to define how the culture of transparency evolves between the manager and his investors. It can also help to ensure the manager meets his responsibilities in the investor due diligence process and make it as seamless as possible. But here’s a revolutionary thought: what if a technology package was sufficiently seamless to be able to sit on both the manager’s and the investor’s desk? In effect, it would not be noticeable where the information seam lay between manager and investor. The manager could control his information outflow but in a manner and an environment that could be configured for the purposes of his client.
This is where reporting technology is heading in the hedge funds sector. There is now a requirement for very advanced reporting capabilities, particularly for those using UCITS structures and their brethren, and a seamless and dynamic communications infrastructure that is flexible enough to be defined by the manager, and which can really make a difference for the small and medium-sized firm.
What used to require substantial outlay in terms of time and capital investment, namely an institutional-grade reporting system, is now much more accessible for those on a more constrained budget. Institutional investors, which comprise more than 60% of global hedge fund assets these days, are no longer interested in the cookie cutter approach to reporting. They want something more bespoke. They are getting this from the larger $2 billion plus managers, but there is no reason why they can’t receive the same levels of service from smaller managers, too.
Grant Fuller is the co-founder and CEO of Axicorda, a provider of specialist information management solutions for the financial services industry. Axicorda delivers both independently hosted and internally hosted systems, and works with a range of institutions, including banks, fund managers, investors and service providers.
