Hedge Fund cost survey

Transcription

1 FINANCIAL ADVISORY SERVICES Hedge Fund cost survey September 2008 ADVISORY

2 1 Hedge Fund cost survey Background The Hedge Fund industry is going through a period of significant change, with three main factors helping to shape the future: Challenging financial markets following the credit crunch. Total hedge fund industry returns were negative in quarter one 2008, for the first time since 2004 and several large hedge funds closed down or defaulted in 2007 and 2008 Self-regulatory best practice and governance standards proposed by various bodies, including the HFWG and AIMA in the UK and the PWG in the US, in an attempt to head-off direct regulatory intervention Increased interest in outsourcing and the expanding suite of products offered by Service Providers, Prime Brokers and Administrators This survey explores the structure of the cost base for small to mediumsized Hedge Fund managers in the current market, looks at managers appetite for outsourcing and also where costs are expected to change in future. Survey approach The participants are London based and have USD13 billion in total assets under management, with a significant proportion under USD1billion. 20 Hedge Fund managers took part in the survey, which included hour long interviews and completion of a questionnaire. Costs are often categorised in different manners, which poses challenges in obtaining a meaningful comparison of costs. Therefore an interview approach was adopted to conduct this survey, supported by a structured questionnaire. This allowed to probe behind the figures, ensure like for like comparisons were obtained and explore emerging trends. This survey is sponsored by PCE Investors Limited (PCE), who provide a range of business support services to Hedge Funds of varying size. PCE can perform operations, risk management, marketing, compliance and an IT infrastructure, as well as providing physical amenities if necessary. They can also provide independent FSA fund vehicles under the PCE regulatory umbrella. PCE currently have clients with c. USD1.5 billion under management. firms affiliated with International, a Swiss cooperative.

3 Hedge Fund cost survey 2 Executive summary Managing costs are as crucial as managing the portfolio. PCE Investors Increasingly managers are looking to move to a more variable cost model, geared to activity or performance. The services and technology offered by service providers have expanded from monthly NAV calculations to full office support including daily valuations, compliance, risk management, front-to-back office processing, premises and IT. Managers are able to outsource more of their operations, providing flexibility and leaving them free to focus on performance. The high fixed cost elements of operations, particularly for small to medium sized firms usually make a clear business case for outsourcing in financial terms alone. The findings indicate that: Costs* are on average 45% of management fees One out of ten managers are not currently covering costs by their management fees, plunging some into net losses Operations are the greatest cost, comprising 19% of revenue or 35% of management fees Investors exert increasing influence on costs in particular their desire for improved governance standards and compliance. Where over 70% of a manager's clients are institutional investors, the proportion spent on corporate control increases significantly. Eight out of ten of those polled consider that investors are placing more emphasis on the back and middle office. Half of managers are taking steps to reduce costs either in premises, staff or front office systems. The degree of outsourcing is high and appetite for and extent of outsourcing is increasing 30% of managers are looking to outsource additional services. Segregation of duties continues to be a challenge within small and medium sized funds Only 6% of respondents performed risk management by someone independent of the front office. * Costs excludes front office salaries and bonuses firms affiliated with International, a Swiss cooperative.

4 3 Hedge Fund cost survey Costs as a proportion of management fees and revenue For one out of ten managers surveyed, costs are currently greater than management fees and the generation of performance fees is needed in order to cover costs. 20% of managers did not generate performance fees in the last year. The average cost base is 45% of management fees, or 25% of revenue (management and performance fees). Operations are the greatest cost, comprising 19% of revenue or 35% of management fees. Most managers state they are carefully monitoring and controlling costs. In this report costs excludes front office salaries and bonuses since these contain a high discretionary element which otherwise would not allow a meaningful comparison between firms. Cost as % of management fees and revenue Units 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Management fees Total revenue (i ncluding perform ance fees) Operations Marketing and PR Front Office Costs need to be at least covered by management fees for a sustainable business model. Where this is not the case, management should take urgent action to resolve this. firms affiliated with International, a Swiss cooperative.

5 Hedge Fund cost survey 4 Current cost breakdown Respondents provided cost information in the following categories: Front Office Operations: Business Support Corporate Control Facilities Infrastructure IT Marketing and PR Other Front Office 12% of costs Front office costs include dealing and market data systems, but excludes salaries and bonuses since these contain a high discretionary element which otherwise would not allow a meaningful comparison between firms. Front office costs as a proportion of total costs for managers under two years old are more than double that of established managers. Cost breakdown Marketing and PR 17% Other 6% Front Office 12% The landscape of managing a hedge fund business has become more complex. Investors are now driving the need for pertinent risk controls, efficient operational systems and studious compliance in a way Business Support 21% Facilities, Infrastructure and IT 26% Corporate Control 18% that has not been witnessed before. PCE Investors firms affiliated with International, a Swiss cooperative.

6 5 Hedge Fund cost survey Operations: Business Support and Corporate Control Operations including payroll comprise 19% of revenue. Most managers outsource more than one service, and 30% of respondents are looking to outsource additional services, including: IT, risk, compliance, fund accounting, trail fee administration and disaster recovery. Only 6% use financing options although some expressed frustration at the lack of availability of this service from their administrators 12.5% use back and middle office services and similar numbers use company secretarial services COO would hire (a Risk Man ager ), but overruled. Survey participant Business support 21% of costs Business support comprises operations, fund accounting and administration and office administration: 94% of respondents outsource fund administration. Services include NAV Calculation and Shareholder Services. Generally respondents are satisfied with fund administrators, although feel they could do more. 20% cited staff factors within the administrators such as high staff turnover and poor training as areas of concern Corporate Control 18% of costs Corporate Control comprises amounts spent on compliance, legal, finance, risk, company secretarial, audit and professional fees: Only 6% of respondents had risk management that was independent of the Front Office Half of firms outsource some or all of their compliance function. In 38% of cases a manager spends 15% or more of their time overseeing this function Administrators are reactive rather than proactive. We expect more ideas for growing the Segregation of duties can be a challenge in small to medium sized firms, reflected in the low incidence of independent risk management given in the results. business including regulatory expertise. Survey partic ipant firms affiliated with International, a Swiss cooperative.

7 Hedge Fund cost survey 6 Operations: Facilities, Infrastructure and IT Generally managers consider that prestigious offices are important to attract clients, although we found no evidence of correlation between premises costs and either AUM or performance! Facilities, Infrastructure and IT 26% of costs This is the largest cost area surveyed, comprising rent and rates, utilities, maintenance, software licences, IT development, IT support and other items including travel expenses. Just over half of these costs are Premises related, with the remainder primarily related to IT. The average premises cost per employee is 15,000 in the sample with a wide range from 3,000 to 42,000. The high per capita costs related to prestigious and underutilised offices, often taken up when the market outlook was more positive. 25% of respondents were concerned by the amount spent on rent. Facilities, infrastructure and IT breakdown The average IT cost per employee is 6,000 pa, ranging from under 1,000 for a firm that is outsourced up to our eyeballs to 30,000 where software licence fees are high related to staff numbers. 56% outsource IT support with half of the remainder considering outsourcing this function. Other 6% of costs Other costs include travel, expenses and insurance. Maintenance 4% Other 10% Rent and rates 32% There is an increasing trend to increase the extent of services outsourced from traditional fund administration and IT into the middle, back office and business support functions, including compliance and legal. This may result in more pure Hedge Fund management, extending the role of an incubator service from start-ups to mainstream, where the manager concentrates on ideas within a cocoon of third party business support services. Support / helpdesk 18% Development 14% Software licences 16% Utilities, maintenance 6% firms affiliated with International, a Swiss cooperative.

8 7 Hedge Fund cost survey Manager maturity impact on cost distribution Cost distribution by maturity of manager New HF (from 2007) Established HF Front Office Business Support Corporate Control Facilities, Infrastructure and IT Marketing and PR Other 0% 20% 40% 60% 80% 100% Managers less than two years old tend to spend a higher proportion of cost on Front Office, excluding salaries, largely due to the relatively high fixed cost of dealer software and market data systems. After the initial seed investors are found, capital is drawn down as opportunities are available, reducing the need for further marketing and PR until a track record has been established. Marketing and PR 17% of costs Only two out of ten managers have a dedicated in-house marketing team, despite high incentive fees being charged by external agents: 44% of respondents use third party marketing and 71% of these rated the relationship very satisfactory with remainder dissatisfied. The main reason given for dissatisfaction was that marketers did not appear sufficiently dedicated to the manager Only 12.5% of respondents used professional PR services The highest use of third party marketing is in mid-sized firms, with little in new Hedge Funds or where there is a high proportion (over 75%) of institutional investors in the funds. Managers established within the last two years show negligible Marketing and PR spend, and significantly greater Front Office and Facilities and IT spend. firms affiliated with International, a Swiss cooperative.

9 Hedge Fund cost survey 8 Cost by fund size Facilities, infrastructure and IT is the greatest cost area for newly established funds under USD150m. Marketing and PR costs are greatest in the USD150 to USD300 million range. Between USD300 to USD500 million size, business support is the dominant cost. Once AUM is over 500 million facilities, infrastructure and IT become the dominant costs again. Cost by fund size 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0-150m m m 500m+ Front Office Business Support Corporate Control Facilities, Infrastructure and IT Marketing and PR Other Newly established Hedge Fund managers spend less on Marketing and PR until they have established credible performance. Once in the USD150m to USD300m range there appears a push to increase AUM, indicated by the increased Marketing and PR costs shown. Thereafter, managers spend on Operational areas again dominates. Sustained investment in infrastructure and IT through the USD150m to USD500m range could improve scalability and result in a more robust operating platform. firms affiliated with International, a Swiss cooperative.

10 9 Hedge Fund cost survey Investor impact on costs Investors are increasingly placing more importance on robust corporate control and governance at Hedge Fund managers. The proportion of cost spent on corporate control increases from an average 18% to 27% of total costs for managers where over 70% of their clients are institutional investors. Eight out of ten of those polled consider that investors are placing more emphasis on the back and middle office. Investors are conducting extra due diligence on internal controls, risk management, and relations with fund administrators. Institutional investors, which are becoming a larger proportion of managers investor makeup, put a great deal of weight on operational due diligence. The effect on cost distribution appears more pronounced when a large proportion of a manager s client base are institutional investors. In-house admin puts investors off. Cost distribution where most clients are institutional investors Survey participan t > 70% inst Front Office Business Support Corporate Control Facilities, Infrastructure and IT Entire sample Marketing and PR Other 0% 20% 40% 60% 80% 100% The survey The Hedge Fund Best Practice Standards: The investor perspective published in April 2008 confirmed that Institutional investors are actively driving compliance with the standard. This could increase compliance costs and supports the above finding, which shows correlation between the proportions of institutional investors in a manager and spend on compliance, risk and governance controls. firms affiliated with International, a Swiss cooperative.

11 Hedge Fund cost survey 10 Employee breakdown Operations, even with large outsourced components, engage 52% of staff, with 35% in the Front Office and 13% in marketing and PR. Although Operations have large outsourced components, staff are needed to manage the service providers. However, the relatively high proportion of operational staff found in the survey suggests there could be potential for further services to be outsourced. Often in smaller to medium sized Hedge Fund managers, the COO performs a hybrid role, spending a significant portion of his time in each of the operational areas, together with Marketing and PR and front office roles. Rarely did the time apportionment received from COO s in the sample add up to 100% or less! Employee breakdown Facilities, Infrastructure and IT 16% Marketing and PR 13% Corporate Control 12% Business Support 24% Front Office 35% Respondents view of future costs Effective management of costs, including looking at more variable cost models, is particularly important when costs are expected to increase. Managers consider that costs are increasing greatly in the following areas: compliance, salaries and rent. Managers are seeing: Salary increases from 5 to 10% Increases in rent of up to 40 or 50% for those with rent reviews Half of respondents consider that their compliance burden is increasing: Some funds are seeing increases of 25% to 30% in compliance costs Extra work includes MiFID and the short selling declarations from the FSA 60% of respondents are considering increasing headcount in order to grow AUM or to increase profitability. 40% of respondents will keep headcount stable or reduce due to tough market conditions. firms affiliated with International, a Swiss cooperative.

12 kpmg.co.uk For further information about this report or s award-winning Hedge Funds practice, please contact: Andrew North Principal Advisor, Investment Management anorth@kpmg.co.uk Tim Fundell Manager, Alternative Investments Group tim.fundell@kpmg.co.uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation LLP, a UK limited liability partnership, is a subsidiary of Europe LLP and a member firm of the network of independent member firms affiliated with International, a Swiss cooperative. All rights reserved. Printed in the United Kingdom. and the logo are registered trademarks of International, a Swiss cooperative. Designed and produced by LLP (U.K.) s Design Services Event name: Hedge Fund Cost Survey 2008 Publication number: RRD Publication date: October 2008