The Future of Funds – Part 2

By
Paul Milnes

future-of-funds-london-hedgethink

In the first part of our The Future of Funds – Part 1 we gave an overview of the issues that are affecting the present state of the fund industry and its future, including the impact of new trading technologies and the challenges facing the hedge fund industry in a post-financial crisis world. Today, we’ll be doing the same for the topics under discussion in the second half, namely fund administration and the opportunities presented by technology and social media for hedge fund professionals. In this second part will develop our thoughts about other key trends and topics.

How technology and social media are disrupting and opening new opportunities for hedge funds

When social media first came along, it was strongly resisted by the financial services industry, and particularly the traditionally ultra-secretive world of hedge funds. The ideals of transparency and open sharing of information that it promoted seemed to be anathema to the behind-closed-doors world of alternative investments.

As it grew bigger, and infiltrated into more and more facets of everyday life, it got to the stage where social media could no longer be ignored by the world of finance. Even without being used by the finance industry, social media was nonetheless starting to wield a profound influence over the markets, to the extent where traders just couldn’t afford to ignore it any more.

  • 2013 – the year finance woke up to social media

For many traders, the ‘Damascus moment’ with social media came with the so-called ‘hack crash’ of April 2013, when a hoax tweet coming from the Associated Press Twitter account claimed that there had been an explosion at the White House. Almost instantly, markets went into a tailspin, with billions of dollars being wiped off the Dow Jones index, only for the markets to recover only a few minutes later when the tweet was revealed as a hoax, perpetrated by hackers. Nonetheless, the damage was done, and traders realised that they could no longer afford to ignore social media.

This was not the only watershed moment for social media in finance that year, however. The previous July, Netflix CEO Reed Hastings announced via Facebook that his company had exceeded one billion hours of live streaming, a landmark event that sent its shares through the roof. Naturally, this attracted the SEC’s attention, as it was not permitted at the time to make company announcements of importance to shareholders via social media. However, the regulator later softened its stance, and in April 2013, it announced new rules regarding the use of social media to make company announcements.

It was surely no coincidence that, shortly after these events, Bloomberg incorporated a customised Twitter feed into its industry-standard Bloomberg Terminals. Although most finance professionals are still barred from Tweeting at work, traders are now actively encouraged to monitor social media for potentially market-moving news and rumours.

  • Social media and big data in the financial markets

Many traders had, however, been using social media for this purpose for a while. In fact, studies had shown that as well as being a valid source of financial news, the Twitter firehose could actually be leveraged as a surprisingly accurate indicator of market sentiment when analysed using advanced big data analytical tools.

In 2012, a hedge fund was set up – Derwent Capital Markets – using this as its only strategy, and to many people’s surprise, it worked, returning over 1% in its first month of trading. There was no second month, however, as an almost total lack of investor interest killed it off before it had a chance to prove its worth over the long term. However, it did have a lasting impact, and many multi-strategy funds now incorporate data mining and predictive analytics into their decision-making process when deciding what to invest in.

Why is fund administration necessary?

Although many of the larger hedge funds perform most or all of their back-office administrative tasks in-house, there are several factors driving an overall trend towards outsourcing these tasks to a third party fund administrator.

  • Playing to your strengths

Many smaller hedge funds are operations involving just one or two traders and/or analysts, and this can often prove to be a highly effective model. After all, if you are a successful trader in your own right, why would you want to dilute that success by employing more people just for the sake of scale? However, keeping things small generally means multi-tasking, and this might mean that the trader(s) in question also have to perform marketing duties and take care of the back-office administration – all of which can weigh heavily on their time.

The upshot of this is that they have less time to devote to their primary skill – trading – and can easily get distracted by the other concerns of a hedge fund, without which it cannot function. This means that the performance of the trader will be impaired, as they would be much better positioned to spot and take advantage of profit opportunities if they were able to concentrate on this alone.

Also, being good at analysing and trading the markets does not necessarily mean you will be good at performing the other functions of a hedge fund, and in many cases the kind of person who is adept at trading the markets may be ill-suited to the demands of the other duties involved in running a hedge fund. Therefore, in most cases, it can pay to get other people to do this for you.

While there is a case to made for doing this in-house, finding and recruiting dedicated staff for this purpose is a task in itself, and again requires a skill set that may not be innate to an otherwise successful trader. Also, in the case of smaller hedge funds, it could be that these tasks do not require a dedicated staff, and that a team servicing the needs of several different hedge funds could do the task much more efficiently and cost-effectively.

  • Regulatory concerns

In many cases there are regulatory reasons why hedge funds choose to use a third party fund administrator, rather than doing it all in-house. It could be that the activities that they are engaged in demand that administration is carried out by an independent party, so as to ensure full compliance with the rules for that jurisdiction.

And with new regulations coming thick and fast into the industry, it makes more and more sense for firms – especially smaller ones – to err on the side of caution in terms of compliance, and this is something that third party firms can guarantee as part of their terms of service.

Also, the influx of institutional money into hedge funds – a topic covered in the previous part of this series – brings with it a much greater obligation in terms of transparency and oversight, and again this is something that third party administrators are in a much stronger position to do. As a result, most institutional investors demand third-party administration as a condition of their investing in a fund, placing funds that do their own administration at a distinct disadvantage in terms of attracting investment.

This article is associated with the Event The Future of Funds. This Thursday 5th June 2014, Saxo Capital Markets and JP Funds Group will be holding an event entitled “The Future of Funds – Technology and Innovation” at the London Capital Club. It kicks off at 5pm with a drinks reception, followed by an introduction from Saxo Capital Markets CEO Torben Kaaber, and ends at 7pm – registration instructions are at the base of this article.

The event will feature talks from prominent thought leaders from within the investment industry, including Torben Kaaber and Richard Elston from Saxo Capital Markets, Janet Thomas from Infinity Capital Partners, Dinis Guarda founder / CEO of Ztudium – HedgeThink.com – Intelligenthq.com, and Julian Stockley-Smith from JP Funds Group.

If you’re interested in attending the event, please confirm your attendance with Uriel Alvarado ual@saxomarkets.com.

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