A recent survey of investment management firms by The Glass Hammer and Stone House Consulting Group, LLC, a strategic, operational and IT consulting firm for investment managers and hedge funds, found that investors, together with the investment consulting firms that advise those clients, are requiring more due diligence on investment managers than ever before, and that operational risk could rise at investment management firms because of staff cutbacks.
The survey, which included responses from more than 75 investment managers with nearly $7 trillion in assets under management, was conducted in conjunction with a recent event for senior women executives working in the buy-side investment community. The event was hosted by The Glass Hammer and sponsored by Omgeo, the global standard for post-trade efficiency, and Linedata Services, the global leader for investment management and credit technology.
The survey found that after sharp market declines, the fall of Lehman Brothers, and the discovery of fraudulent activities such as those of Bernie Madoff, Alan Stanford and others, 88% of respondents agreed that investors are spending more time and attention than ever before on due diligence, and were nearly unanimous that the importance of operations due diligence has risen.
"In the post-crisis world, where firms are rethinking fundamental issues such as risk, transparency, liquidity and regulation, investment managers need to be increasingly aware of the operational risk profile of their firm," said Marianne Brown, CEO of Omgeo. "In this environment, investors are becoming more aware that an issue like counterparty risk can significantly impact their investments, and they're taking a deeper look into key middle- and back-office issues, like reconciliation and collateral management, which can help reduce many of the unknown factors that currently exist in derivatives contracts."
The survey also showed that more than half of the respondents think that hedge funds will move to lower base management fees while traditional investment managers may begin to introduce performance-based fees.
"The findings indicate that operational risk may be on the rise, despite all the increased attention. Not only have staff cutbacks increased operational risk within many buy-side firms, but increased staff turnover as the employment market improves will cause operational risk profiles to deteriorate furrther," said Holly Miller, Partner at Stone House Consulting.
"Gone are the days when funds could get through due diligence meetings with fancy spreadsheets. Potential investors now want to see proof that funds have prioritized the right infrastructure to track positions and value them properly," said Annie Morris, Managing Director, Linedata Services. "Fund infrastructure has moved out of the shadows, and mission-critical systems provided by stable vendors are now having a real impact on those conversations."
Other findings from the survey include 64% of respondents feel barriers of entry in the investment management business have increased in the last two years. Nonetheless, 87% think it is still possible to launch new firms and products.
The survey results ultimately found that successful firm leaders must be familiar with all aspects of their organization, from the investment decision-making process through the middle- and back-office, technology, compliance, client service and distribution. Managers are faced with margin pressures on two fronts:
• Increasingly costly infrastructures driven by compliance and risk management requirements;
• Downward pressure on fees and changing fee structures.
The winners will be those organizations who learn to navigate these conflicting tides most effectively.