Hedge fund managers embracing innovation amid industry challenges and increased competition

Singapore, 16 November 2017

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  • More than half of hedge fund managers are innovating to improve their operational efficiency
  • A third of investors want to see hedge funds innovate more in front office/investing
  • Nearly half of managers plan to incorporate non-traditional data in their investment process
  • Managers are seeking talent with technology and data analytics skills, as this become increasingly important to investors

A majority of hedge fund managers (57%) are innovating to improve their operational efficiency in response to market disruptions and to avoid falling behind the industry, according to the EY 2017 Global Hedge Fund and Investor Survey: How will you embrace innovation to illuminate competitive advantages?

The 11th annual survey found that hedge fund managers are actively seeking innovative ways to improve operational efficiency and grow their asset base, as pressure on margins remain. Meanwhile, investors also said they recognize the need for managers to innovate, with 30% noting they want managers to do so in the front office.

EY Asia-Pacific Wealth and Asset Management Leader, Elliott Shadforth said: “The pace at which the hedge fund industry is being disrupted continues to accelerate. Advances in technology are creating new threats, but also new opportunities. In this environment, hedge fund managers need to be more proactive in identifying novel solutions if they want to keep pace with investors’ appetite for innovative new product offerings, stand out and remain competitive in a crowded sector and, ultimately, drive sustainable growth.”

Evolving investor demands and competition from alternative asset classes

Consistent with last year’s findings, fewer investors plan to increase their allocations to hedge funds. Of those surveyed, 15% of investors note they are more likely to decrease allocations in the next three years versus 11% of investors who indicate they plan to increase allocations. However, the vast majority (74%) of investors still expect to keep their hedge fund allocations flat.

Alternative investments are also continuing to spur competition, with 40% of investors now saying they plan to shift hedge fund assets to alternative asset classes and 20% saying they will begin using non-traditional hedge fund products for the first time. In particular, private equity is experiencing a dramatic shift in demand, as three-quarters (76%) of investors currently allocate or plan to allocate funds to this alternative asset class in the next two years.

To attract and retain investors, the survey reveals, more than half of managers now offer separately managed accounts (56%) and funds with customized fees and liquidity terms (52%), and two-thirds of managers have adopted or are considering non-traditional fee structures for growth (66%). The largest hedge fund managers have been able to keep momentum, making the largest investments in non-traditional product development.

Mr. Shadforth said investors are turning to customized products for a number of compelling reasons. “Managers of all sizes must engage in dialogue with their investors and align product offerings that are responsive to shifting investor needs.”

Investors looking for front office innovation

Given the excitement around FinTech and the advancements in data set analytics, it’s no surprise almost one-third (30%) of investors said they would like to see hedge funds become more innovative within their front office operations. While investors say only 24% of the hedge funds they currently allocate to use non-traditional or next generational data and tools, they expect that number to rise to 38% in three years.

The landscape is quickly changing in response to investors’ demands, as managers are implementing innovative approaches to improve operational efficiency (57%), attract capital (36%), attract/retain talent (28%) and the front office (25%). The goal is to invest in cutting-edge technology to improve the speed and quality of data reporting. While, in 2016, only half of managers used or expected to use non-traditional data or tools in their investment processes, this year, more than three quarters indicate they currently use this technology (46%) or have future plans to do so (32%).

Alleviating margin pressures through technology investment and operating model innovation

Until now, most managers have responded to added complexity, increased product offerings and reporting requirements by increasing headcount, which in turn drives margin pressure. Simultaneously, investors continue to place management fees under scrutiny, forcing managers to lower operating expense ratios. The average operating expense ratio is currently 1.75%, down from 1.95% in 2015.

However, hedge funds are realizing the need to break the cycle and invest in operational efficiency. Fifty-seven percent of managers say their organization is investing, or will invest, in initiatives to improve their operating models. Half of managers surveyed plan to tackle margin pressures by investing in technology. Forty percent said they plan to invest in automating manual processes, and more than a quarter of managers (27%) have or will be making investments in artificial intelligence and robotics to strengthen their middle and back office.

“Recent advances in technology provide creative solutions for hedge fund managers in supporting operating models that add to the bottom line, rather than reduce it,” Mr. Shadforth said.

Shifting talent management priorities

As the industry embraces innovation, the roles and responsibilities of traditional talent are shifting to account for technological and qualitative skills. The ability to compete for the right talent is a strategic imperative for hedge fund managers, particularly in the front office where more than half of those surveyed say they struggle to attract and retain executive investment professionals and more than a third express difficulty in attracting non-executive investment professionals.  

Managers are also feeling pressure to provide competitive compensation and workplace culture. Nearly half of managers (45%) have taken steps such as formally surveying or employing consultants to understand what employees are looking for in the workplace. As a result, they have found that collaboration, compensation and work-life balance are key.

“Competition for talent is fierce, as hedge funds compete with others in the space as well as in the growing FinTech community. Hedge fund managers must be attuned to the wants and needs of newer generations of talent in order to attract the right people and foster an unmatched work environment,” Mr. Shadforth said.

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About the survey

The purpose of this study is to record the views and opinions of hedge fund managers and institutional investors globally. Managers and investors were asked to comment on innovation and its impact on changing strategic priorities, the use of big data as a differentiator in the front-office, capital raising, expenses and non-traditional fee structures, disruptive technologies, evolving operating models, the changing face of talent management and the future landscape of the hedge fund industry.

From July to September 2017, Greenwich Associates conducted 106 telephone interviews with hedge funds representing nearly $1.3 trillion in assets under management. Research also conducted 55 telephone interviews with institutional investors (fund of funds, pension funds, endowments and foundations) representing over $1.6 trillion in assets under management, with roughly $260 billion allocated to hedge funds. The complete survey is available at ey.com/hedgefundsurvey.