Last week, in Part I of our hedge fund operations analysis, we examined the roles of staffing and technology and offered a few tips to help your fund optimize efficiency without sacrificing performance. This week, let’s take a look at two other operational facets: managing counterparties and budgeting.
With the fall of many banks and with prime services divisions being downsized, firms are challenged with increased bank counterparty risk. The newly signed Financial Reform Act puts even greater stress on hedge funds to minimize risks.
Many firms have determined that going multi-prime is the best method for alleviating the risk associated with the most recent banking crisis. The prime broker selection process does pose its challenges as there are many considerations involved, but as banks are aggressively looking for business, the process is manageable. Most banks are trying to make the process as seamless as possible in an effort to attract and win new business.
Transitioning to a multi-prime environment poses many operational and technical challenges, as firms will need to evaluate what changes they will need to make to their operational workflow and technical capabilities. Firms will also need to determine what services and technology the new prime will supply as well as what services are being transitioned or eliminated from the current prime.
Adding additional counterparties will change the way a fund operates and increase the complexity of daily business processes. The major workflow challenges within a firm revolve around aggregation of data, risk management, accounting and reporting. Firms will need to determine if their existing technology/infrastructure and staff can handle the new workload and will have to adjust accordingly.
Key counterparty considerations:
- Adding a new counterparty has a trickledown effect on your operations and how you interact with all counterparties. For example, when going multi-prime, a firm will have to evaluate how to work with its current fund administrator to ensure they can support their new multi-prime operation.
- Evaluate your staff, technology and counterparties to ensure they can support the additional workflow and systems that you will add to your operation.
Budgeting for Hedge Funds
The current economic environment has forced funds to re-evaluate their operating budget and come up with a stricter model that is well-documented and followed. Regulatory bodies, as well as investors, are also pushing for more transparency in order to determine where management fees are headed. (To learn more about the recently enacted Financial Reform Act, visit our Resource Center.)
Funds are taking a more diligent approach to budgeting and are putting forth a strong effort to evaluate their internal operations, payroll and technology responsibilities.
- Determine a baseline operating budget number: The management fee is a good start. A baseline will provide you with parameters to work with when evaluating the various components of your firm. You will also want to break down what items can be paid for via soft dollars (fall under 28e) versus hard dollars.
- Staffing: Determine your staffing needs, including roles and responsibilities. By doing this you will have the ability to determine payroll needs (excluding bonuses), employment taxes, health and benefits cost, office size, etc.
- Building and facilities: Re-visit your current office expenses and lease obligation to determine total cost; there may be an opportunity to renew your lease at a lower cost in a down economy.
- Technology: Complete a technology audit, and determine mission-critical applications. This will provide you with the ability to eliminate unneeded technologies and budget needed upgrades or additional technologies.
- Outsourcing: Determine annual cost for legal fees, audit, consultants and administrator fees
- One time versus recurring: When budgeting, make sure to note what is a one-time fee (a new PC) versus something that is recurring (market data).
- Build an in-source/outsource ROI model. Outsourcing operational, administrative and technical responsibilities to specialists may eliminate costly overhead.
Key budget considerations:
- Budgeting is not an exact science as each firm will have different business needs. If you were to look at your budget from a macro view, the bullets above are a good start. As a firm evaluates its needs at the micro level, the various line items will change accordingly.
- Budget according to current need, and don’t forget to include some room in your budget for unforeseeable expenses (legal fees, consultants).
- Keep ahead of the market. If regulations and compliance requirements change, so will your staffing and technology needs.
Eze Castle Integration has extensive experience with helping hedge funds manage counterparty risk and budgeting. Contact us to learn more.
Next Thursday (7/29), we’ll have a checklist for you with tips for optimizing operations and reducing costs! Subscribe to Hedge IT so you don’t miss it!
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