EY survey: Hedge fund managers embrace innovation amid challenges

Technology is becoming an important factor for hedge fund managers who are actively seeking to innovate to improve operational efficiency and attract capital.

More than half of all managers (57 percent) are implementing new approaches in their operations to avoid falling behind in the industry, the latest EY hedge fund and investor survey found.

Managers also invest in cutting-edge technology that improves the speed and quality of data reporting to attract capital (36 percent), to attract and retain talent (28 percent) and to inform their front office (25 percent).

Whereas, in 2016, only half of all 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 percent) or have future plans to do so (32 percent). They are particularly interested in leveraging social media data, private company data and credit card data, the EY survey found.

Investors also see the need for funds to use new technology, with nearly a third emphasizing that managers should focus these efforts on the front office.

Investor sentiment reflects the general excitement around FinTech and advancements in data set analytics. While investors say only 24 percent of the hedge funds to which they currently allocate use non-traditional or next generational data and tools, they expect that number to rise to 38 percent in three years.

Managers recognize that the effective use of data can offer key advantages with nearly half confirming that they are using non-traditional data to support the investment process. This includes for example software to extract data from multiple earnings calls to evaluate information more quickly.

Michael Serota, EY Global Hedge Fund Services Leader, says the pace at which the hedge fund industry is being disrupted continues to accelerate, as advances in technology bring new threats, but also opportunities.

“The evolving landscape forces managers to not only be reactive but also proactive in identifying novel solutions that allow them to deliver alpha and remain competitive. Managers of all sizes are embracing innovation to stand out in a crowded hedge fund universe and to achieve a common strategic objective: growth,” Mr. Serota said.

Fewer allocations to hedge funds

Consistent with last year’s EY survey findings, fewer investors plan to increase their allocations to hedge funds.

Only 11 percent of the investors surveyed indicated they are more likely to increase allocations to hedge funds in the next three years compared with 11 percent stating they plan to lower their allocations. The remainder and majority expect to maintain the same level of hedge fund investments.

Hedge funds face competition from alternative asset classes and non-traditional hedge fund products. Especially, private equity continues to attract capital and leads to a shift away from hedge funds, the survey found.

To attract and retain investors, the results show, more than half of managers now offer separately managed accounts (56 percent) and funds with customized fees and liquidity terms (52 percent), and two-thirds of managers have adopted or are considering non-traditional fee structures for growth (66 percent).

“Investors are turning to customized products for a number of compelling reasons,” said Natalie Deak Jaros, Americas Co-Leader, Hedge Fund Services, Ernst & Young LLP. “Managers of all sizes must engage in dialogue with their investors and align product offerings that are responsive to shifting investor needs.”

Margin pressure

The pressure on fees has forced managers to lower their operating expense ratios from 1.95 percent in 1.75 percent. However, EY noted that hedge funds are realizing the need to break the cycle and invest in operational efficiency.

By investing in technology half of the managers surveyed are hoping to counter continued margin pressures from the added complexity, increased product offerings and more extensive reporting requirements.

Forty percent say they plan to invest in automating manual processes and more than a quarter of managers (27 percent) have or will be making investments in artificial intelligence and robotics to strengthen their middle and back office.

“Managers with growing businesses will often need to add to their headcount to support the business, but modern advances in technology provide helpful solutions in supporting operating models that add to the bottom line, rather than reduce it,” said Zeynep Meric-Smith, EMEIA Leader, Hedge Fund Services at EY.

Tech recruitment

The impact of technology is also visible in the funds’ recruitment strategies, which has shifted the staff profile sought by managers to talent that has experience in using technology to improve an organization.

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 find it difficult to bring in non-executive investment professionals.

Elliott Shadforth, EY’s Asia-Pacific Leader, Wealth & Asset Management, says: “Competition for talent is fierce, as hedge funds compete with others in the space as well as Silicon Valley and the FinTech community. Hedge fund managers must be attuned to the wants and needs of newer generations of talent to attract the right people and foster an unmatched work environment.”

Nearly half of managers say they have taken steps such as formally surveying or employing consultants to understand what employees are looking for in the workplace and found that collaboration, compensation and work-life balance are key.