Hedge fund managers are struggling to identify the optimal operating model for their organization and their technology. Some believe that outsourcing is the only viable approach while others seem determined to build their capabilities ‘in house’. As fund managers start to evolve their perception of technology, many are recognizing that there is no single path to technology enablement in the hedge fund sector.
On face value, our data would suggest that hedge fund managers are trying a variety of approaches to access technology. Twenty-seven percent say their preference is to develop technologies internally, 26 percent indicate that they prefer to outsource to third party providers and 25 percent say they will likely purchase an existing platform or service.
Dig a little deeper, however, and it becomes clear that the approach to technology acquisition largely depends on the size of the fund. Smaller funds (those with AUMs of US$5 million or less) report a much higher preference for outsourcing their technology. “For smaller firms and funds, outsourcing isn’t just about reducing complexity, it’s also about staying current with the latest technologies in an environment that is constantly changing,” added Jeff Kollin, Partner, KPMG in the US.
That being said, our data suggests that large funds (those with AUMs of US$5 billion or more) demonstrate a much stronger preference for developing technology internally. And mid-sized firms report a slight preference for purchasing existing platforms and services.
Yet this could also yield significant advantages for smaller firms. As one US-based fund CEO noted, “The smaller guys don’t have the same legacy investment costs for technology which gives them an absolute advantage because they can simply build from scratch. They can become best in class quite quickly and create a significant competitive advantage.”
Approaches for sourcing technology also vary depending on the function. In the front office, most fund managers say they prefer to build their own technology and systems. In the back office, they indicate a strong preference for outsourcing their technology requirements. And in the middle office, respondents were evenly split between building, buying and outsourcing.
“The front office is where you make the ‘secret sauce’ and few managers feel comfortable placing that in the hands of a third party provider,” noted Rob Mirsky, KPMG Global Head of Hedge Funds, “But when you get into the more commoditized areas of the middle and back office – particularly accounting systems and data management systems – outsourcing becomes a no-brainer.”
Ultimately, fund managers will want to consider outsourcing any capital expenditures (CapEx) that do not directly influence their ability to generate alpha.
Interestingly, while only 18 percent say that their top preference is to partner with customers, suppliers and peers to develop new technology, our data suggests that many are exploring the potential of these partnerships. In fact, almost half (47 percent) of our respondents report they have partnered with a third party in the past 5 years to develop technologies.
While in other financial services sectors, partnering is often viewed as a way for smaller organizations to build scale with their investments, our data shows that – in the hedge fund sector – it is the larger fund managers that are most active in exploring partnerships. In fact, large managers are almost three times as likely as their smaller competitors to say they had entered into partnerships recently (73 percent versus 28 percent). At the same time, our interviews suggest that some of the larger fund managers may have larger ambitions for their technology investments.
A look at the challenges and opportunities that technology and innovation are creating in the hedge fund sector.