Rising operational costs, as well as the increasing complexity of funds and the demands of managing capital flows and reporting requirements, mean that many hedge funds are now looking to outsource non-core operations. That trend is likely to continue, with hedge funds anticipating a further significant rise in costs in 2025.
As in other industries, rising costs have taken a toll on hedge fund profitability in recent years. Around 43% of hedge fund respondents to the survey conducted for IG Prime’s 2024 State of the Hedge Fund Industry report cited investment compliance and other regulatory requirements as a key pressure, while 42% named technology. But costs appear to be rising across the board, with salaries and wages, back-office and administrative costs, and marketing and service-supplier costs cited by significant proportions of respondents. Moreover around 45% of respondents expected costs to rise by more than 6% over the next year, while 42% anticipated a still inflation-busting increase of 3% to 6%.
What are the main cost pressures facing your business?
Source: IG Prime, December 2024
The regulatory burden on hedge funds has increased dramatically in recent years. Between 2014 and 2023, for example, nearly 2000 new data fields were created, according to Robert Botha, Head of Data Operations at FE Fundinfo. Inevitably, this has led to a corresponding increase in compliance costs, as firms seek to recruit staff and adapt solutions to proactively manage disclosure obligations every month.1
BNP Paribas reported in September 2024 that regulatory compliance costs ‘are further heightened for firms that shift into more regulated offerings such as UCITS funds’. The bank added that ‘expanding into different structures or entering new asset class[es]/geographic markets similarly raise[s] the operational and technology infrastructure ante’. ESG trends are another consideration, bringing additional regulatory and investor transparency expectations.
BNP says one way to address rising costs is to outsource non-core activities across the front, middle and back offices, adding that managers ‘can then concentrate on their secret sauce: generating alpha and nurturing investor relationships’.2
The emergence of new technology, such as generative artificial intelligence (AI), comes with a considerable upfront price tag, but hedge funds are looking to technology to boost productivity and cut costs in the long term. AI could potentially eliminate many laborious and costly processes, help deliver more cost-effective marketing, and make a huge contribution to portfolio management. For example, generative AI is already starting to deliver cost savings of up to 25% at leading companies, according to the management consultants Bain & Company.3
Moreover, technology can enhance risk management and eliminate human error, thus reducing the threat from events that can cause considerable reputational cost. It is also increasingly important as a way of maintaining competitiveness, allowing companies to enhance the client experience by offering hyper-personalised services.
The scramble for talent is driving up salaries, which are already very high. efinancialcareers.com says that Millennium’s London partners received an average of £8.9 million in 2023, for example, while the average employee earned £776,000. Citadel, meanwhile, paid its London partners $23 million each in 2023, while the average employee earned $1.5 million.
These are just the average figures. efinancialcareers.com reports ‘unconfirmed talk’ that in 2023 Millennium paid £50 million to hire one individual from Citadel, albeit over a multi-year period. It adds that the business development professionals who source talent for major hedge funds ‘stand accused of offering sign-on packages as high as $120 million for people they especially like’.4
efinancialcareers.com cites two main reasons behind these high salaries:
• Non-compete contracts mean that portfolio managers and other key employees must spend up to two years out of the market when they jump ship to a rival. The consequence is that ‘at any one time some of the industry’s best talent is out of action; available talent must therefore be paid more’.
• A ‘pass-through’ approach to costs, usually including compensation, is deployed by most large multi-strategy funds. These pass-through arrangements mean that if a fund wants to pay a portfolio manager $120 million, it can charge that amount directly to the fund’s investors.5
A number of factors lie behind the rise in back-office and administrative costs. They include a long-standing lack of investment as hedge fund managers focused on raising capital and investing. The rising complexity of the products being offered by hedge funds, such as private markets and digital assets, and expansion into new geographic markets have exposed this underinvestment. Hefty investment in staff and systems has been required to rectify the situation.
Managers are increasingly seeking to outsource operations and focus on core activities to reduce cost pressures. Around 86% of respondents expect third-party support for risk management, for example, to grow in the next five years, with 26% predicting a dramatic increase, according to research by the fintech firm Beacon Platform Inc.6
Outsourcing can reduce the need for large in-house teams and hefty investment in new technologies. It can also boost efficiency by enabling hedge funds to focus on managing investments and generating alpha for their investors. Outsourcing allows hedge funds to scale up quickly without making large investments in new staff and IT systems, for example. That is particularly appealing for smaller managers seeking to expand their investment strategies or enter new markets.
In conclusion, cost pressures on hedge funds are likely to continue mounting, reflecting the need to stay competitive by investing in new technologies and attracting the best staff. However, new technologies also offer the potential to boost efficiency and, by offering a better service to clients, grow revenues.
IG Prime commissioned a survey into the attitudes of hedge funds and institutional investors to key issues facing the industry in 2024 and looking forward to 2025. To see the full results, please click here.
As part of our aim to be at the forefront of the hedge fund industry, IG Prime commissioned a survey into the attitudes of hedge funds and institutional investors to key issues facing the industry in 2024 and 2025. The results help inform our State of the Hedge Fund Industry 2025 report. The first of a forward-looking annual series, this year’s report seeks to explain why the industry may have reached a turning point, with returns and asset growth set to improve – possibly markedly – in the coming years. Click here to download the full report now.
Sources
1 https://www.fefundinfo.com/insights/the-hidden-costs-of-regulatory-compliance-what-every-asset-manager-should-know
2 https://securities.cib.bnpparibas/how-alternatives-managers-can-combat-their-3-key-challenges/
3 https://www.bain.com/insights/zero-based-redesign-the-key-to-realizing-gen-ai-cost-savings-potential
4 https://www.efinancialcareers.com/news/hedge-fund-pass-throughs
5 https://www.efinancialcareers.com/news/hedge-fund-pass-throughs
6 https://www.fundsglobalmena.com/hedge-funds-turning-to-third-parties-for-risk-management-study-shows/
Date de publication:
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