Alternative Investment Industry Weighs in on Merits and Potential Risks of Operational Alpha

November, 2016 – From the costs of complying with heightened regulations, to the lingering low interest rate environment, hedge funds and private equity funds have found it increasingly difficult to generate strong returns for investors. As a result, the alternative investment community has turned its attention to operational alpha –the use of an integrated front-to-back-end cloud based infrastructure that enables fund managers to both generate better data and to reallocate capital previously used for infrastructure maintenance and upgrades back to the front-office.

With operational alpha becoming increasingly important to the alternative investment community, the New York Hedge Fund Roundtable recently surveyed its membership about the topic. Operational Alpha and How it Can Lead to Emerging Fund Manager Success was the topic of the Roundtable’s most recent event in late October, where featured panelists Marc Schneider, CIO of Twelve Lions Capital; Eric Benda, CEO of Soundshore Technology Group; Nick Castoria, CEO of Agile Fund Solutions; and Bruce Frumerman, CEO of Frumerman & Nemeth weighed in on the topic.

“Small and emerging hedge fund managers, as a group, consistently outperform other managers… However, as the physicists like to remind us from time to time, there are no free lunches,” said Robert Akeson, COO of Daewoo Securities, who moderated the event. “These managers are also known for their operational risk and many studies reflect that when these funds fail or disappoint it has a lot to do with operational risk,” he said, adding that operational alpha gives small and emerging managers the necessary tools to reign in operational risk in a way that doesn’t impact the qualities that enable these managers to outperform.

Roundtable members believe that operational alpha is equally important for small and large firms alike, yet they are also concerned that relying on a cloud-based infrastructure could create unforeseen security risks. New York Hedge Fund Roundtable members had the opportunity to weigh in on this topic both at the most recent Roundtable event in late October, as well as through an online electronic poll.

*Of the respondents to this survey, 36% were fund managers; 16% were allocators; 7% were risk management or trading; 34% were service providers; and 7% were other industry participants.

Following are some of the other key findings of that survey:

  • Asked whether they believe that operational alpha is more important for small firms just starting out or for larger firms, 77% of respondents said they believe it is equally important for both, while 23% believe it is more important for small firms.
  • When asked what the biggest potential benefit of operational alpha is for fund managers, 52% of respondents said it is the ability to reign in overhead costs; 23% said it is the ability to market an additional level of compliance to investors; 19% said it is pre-trade risk controls; and 6% said it is post-trade risk controls.
  • 42% of respondents believe that the biggest potential benefit of operational alpha for institutional investors is the ability to be made aware of investment specific risks in real time; 39% think it is greater comfort knowing that funds are complying with multiple regulations; and 19% think it is the ability to have greater oversight of separately managed funds.
  • When asked to identify the biggest risks with regard to operational alpha, 90% of respondents believe that a cloud-based system could create unknown security risks, while 10% are afraid that it would make it easier for federal regulators to more easily hack into a firm’s trading activity without their knowledge.
  • Asked what impact Basel III will have on the relationship between hedge fund firms and prime brokers, 47% of respondents said that the liquidity coverage ratio will force prime brokers to be more selective about the hedge funds they work with and to reduce the number of relationships they maintain; 30% think that hedge funds will find it more difficult to find prime brokers willing to work with them; and 23% think that prime brokers will ultimately be forced to rely on longer term funding sources and will have to pass on their higher operating costs to hedge funds.

October’s “bonus” question: Following Bob Dylan’s selection as the winner of the Nobel Prize in Literature, Roundtable members were asked if they think that songwriting rises to the level of great literature. 67% of respondents said they believe it does and that Dylan’s songs are essentially poems set to music, while 33% believe that there are countless more traditional authors who were more deserving of the honor.

About The New York Hedge Fund Roundtable:

The New York Hedge Fund Roundtable is a non-profit organization focused on promoting ethics and best practices within the alternative investment industry. The membership consists of investors, fund managers and other industry professionals who regularly meet to discuss current issues within the industry and connect with peers. Monthly events center around thought-provoking speakers and panels designed to keep members apprised of timely and important issues within the alternative investment industry. The Roundtable’s goal is to provide a forum for thought leadership, where industry professional have the opportunity to enhance their knowledge and skills and to network with other individuals committed to advancing the industry with the highest ethical standards. For additional information about the Roundtable, visit: http://www.nyhfr.org

 

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