5 ways for hedge funds to remain competitive right now

This blog post was originally published on September 4, 2020. It was updated May 19, 2022.

When looking at the future of operations in the alternative investment space, there are only so many ways for fund managers to maintain a competitive advantage, especially with costs and interest rates on the rise. Economic shocks and volatile markets present both unique challenges and opportunities for private equity and hedge fund managers – and there are steps managers can take right now to help their funds stay ahead of the competition.

Over the last decade, more money has been poured into private equity than just about any other form of alternative investment. Additionally, private equity has historically experienced lower pullbacks and quicker recoveries than public equities in times of uncertainty. Many investors view this form of investment as an opportunity for higher returns than they would anticipate from other markets. The number of private equity funds has been growing, ramping up competition for deals and, to a lesser extent, for investors. While private equity investors are generally committed to having their money invested for years, a more volatile economy may make some nervous about having their money locked up for so long and make them more concerned about the fund’s performance.

Meanwhile, hedge fund returns continue to be affected by today’s stock market and overall economic volatility. Increasing regulation, higher costs and tightening returns have made this a more challenging industry. Most hedge funds are open-ended though, which gives investors some comfort as to the liquidity of their investment. As hedge funds have been experiencing more hardships, managers need to focus now more than ever on preserving equity.

During this uncertain time, fueled by inflation and interest rate concerns, the war in Ukraine and continued pandemic-related supply chain disruptions among other issues, private equity and hedge fund managers should consider the following five ways to stay competitive and position their funds for success.

1. Increase communication with your investors and, for private equity funds, with target companies

During these volatile times, strong communication is more important than ever. This is crucial to building relationships, landing investments, and keeping investors happy. Better communication can help funds to better establish their brand and build credibility. It is one way fund managers can remain competitive and differentiate themselves through sharing information about their fund’s strategy and mitigating risks, while highlighting their credentials and track record of success.

Communications should aim to reassure investors and potential investors of a fund’s solid underlying fundamentals and operations. Share the entity’s culture and what it does uniquely compared to others. Reminding investors about the fund’s investment strategy and asset classes, while explaining the underlying investments can help you maintain investor confidence.

Acknowledging areas of operational risk and sharing how you are mitigating those risks, such as leveraging outside resources, can also help to build trust with investors. For instance, if a fund is audited by an external auditor, remind investors and potential investors of that additional level of assurance. If you outsource fund administration, show you have engaged reputable providers, and share information about the level of service and attention the fund receives. Have you had a cybersecurity risk assessment? Let your investors know. If you have SOC (System and Organization Controls) reports on any of your key vendors, make this known to investors.

Share financial results with investors as soon as they are known and provide an outlook on future expectations. Your investors will want regular updates about the performance of the fund and where the fund is headed. Your internal or external financial team should be providing timely, complete, and easy-to-understand reports for investors. If this is not happening or if there is room for improvement, consider outsourcing that operation, or if you are already outsourcing, consider whether you have the right fund administration provider.

For private equity firms, communication is also important to landing opportunities with target companies. Deals often materialize through word of mouth. Use communications channels to nurture relationships with current and future target companies and your broader network so you can stay informed about opportunities.

The SEC’s Modernized Marketing Rule opens new branding and advertising channels for registered investment advisers (RIAs). This is a great time to consider expanding your communication and marketing to leverage more digital platforms. A growing number of investment managers are using social media to attract new investors. Email and websites are also important marketing channels for communicating with investors and potential investors.

However, with new regulation comes new compliance obligations and risks. A risk advisory consultant with specialized investment industry experience can help your firm stay in compliance by reviewing your current marketing and communications strategy, looking at existing processes and assessing your supervisory framework against disclosure obligations and other requirements. Kaufman Rossin offers turn-key solutions to help RIAs address the new SEC marketing rule and other regulations.

2. Reassess your office model and the role of remote or hybrid work

After two years of employees working from home due to pandemic office closures, now is the ideal time for investment managers to assess how remote work has affected their firms and whether remote or hybrid operations are a viable option for the future. As you consider your office space needs and operations plans going forward, consider factors such as potential impact on overhead costs, productivity, recruiting, collaboration, and relationship building.

Private equity fund investors and investment managers continue to insist on a certain amount of face-to-face interaction. Investors usually want to meet the investment manager of the private equity fund prior to investing large sums or money in the fund, and investment managers in turn seek to meet those involved in operations of their private equity targets. This face-to-face interaction allows each party involved to establish an additional level of trust.

If you decide to continue remote operations or move to a permanent hybrid model, remember the importance of having regular communication and setting clear expectations with employees. Also consider whether you have the right technology and connectivity in place to keep all aspects of your business operating smoothly.

Technology such as video apps and project management software can greatly facilitate collaboration, information sharing and even help a firm maintain team culture and connection. Fully online human resources, accounting, financial and reporting platforms also play an important role in successful remote work. Finally, do not forget to review your cybersecurity and data privacy strategies – they may need to evolve as your operating model changes.

3. Gain a competitive edge with outsourced research and alternative data

Many hedge funds in today’s markets use alternative data or outsourced research to gain a competitive advantage.

Alternative data is not the conventional financial or economic information that investors can obtain by applying analytics. Alternative data can draw out information from multiple sources such as mobile app store analytics and satellite images, combine them, and deliver data sets that provide insight into new ways of investing. The extensive amount of information that is processed requires specialized software, which is why many investment managers outsource this service.

You might use this data to compare variables such as spending patterns and market trends. This, in turn, improves risk management and assists managers in weighting the positions in their funds’ portfolios.

4. Streamline operations and cut costs with RPA and AI tools

Robotic process automation (RPA) uses software “bots” to mimic the computer activities traditionally performed by a human being. When properly designed, bots can increase accuracy by reducing human errors, improve efficiency by increasing the speed at which tasks are performed and improve productivity by working continuously.

For example, Kaufman Rossin has created bots that help clients automate due diligence procedures by performing a search and documenting evidence for compliance record-keeping. The bots can screen names against the online sanctions list database maintained by the Office of Foreign Assets Control (OFAC), search for corporate records in online databases maintained by secretaries of state and screen against custom sanctions lists.

Investment managers looking for cost savings should consider whether automating certain processes would be beneficial.

5. Maximize value from third-party providers

After more than two years of pandemic-driven changes to the work environment, economic changes, and market volatility, now is also a great time for investment managers to review their third-party service providers.

Is your firm getting the attention and quality of service desired relative to the size and complexity of your operations? Some service providers have grown so large that they no longer provide personalized attention to each client. If that has been your experience, consider switching to a boutique provider who has both deep industry expertise and a focus on providing high-quality service.

Also assess whether your current providers are meeting your service offering needs. For example, if one firm is doing your fund administration work and another is doing your tax and audit work, finding one firm with the capability to provide all services may create efficiencies. There are major benefits to choosing service providers that have the inter-departmental synergies to assist private equity and hedge fund managers with many different issues. Consider choosing service providers that have the ability to assist with many different needs, from tax and audit to fund administration to regulatory compliance, and that have the technology, industry expertise and experience to continue serving you as your business grows.

You should also look for service providers that go beyond the numbers to guide clients in this rapidly changing economic and regulatory environment.

The Kaufman Rossin Group includes tax, audit and compliance professionals at Kaufman Rossin CPAs and Advisors as well as fund administration professionals at Kaufman Rossin Alternative Investment Services. The Group’s investment industry-focused professionals help private equity funds and hedge funds plan strategically to minimize their investors’ tax burdens, comply with regulations, meet their financial goals, and stay competitive in today’s dynamic environment. Contact us to learn more about how we can help your fund.