Managing change in the Hedge Fund industry

Date: Tuesday, June 26, 2012
Author: Shane Brett, HedgeTracker

"It must be considered that there is nothing more difficult to carry out nor more doubtful of success nor more dangerous to handle than to initiate a new order of things."

Niccolò Machiavelli (1446-1507), Italian statesman and philosopher, in "The Prince"

Machiavelli got it right. Trying to successfully manage the implementation of widespread change is one of the most difficult tasks an organisation in our industry can undertake.

Over the last 10 years the Hedge Fund has experienced change on an enormous scale. The first years of the new century were marked by huge growth across the industry. Hedge Fund Managers and their service providers struggled to absorb massive asset growth, a high volume of fund launches and an ever increasing number of investors.

Then came the Post-Lehman/Madoff carnage where funds instead had to manage a more negative period of change, primarily driven by funds reorganising, gates being imposed, irate investors trying to redeem and difficult to price illiquid securities.

All of this has made the last decade in the Hedge Fund industry one of great change. The evidence suggests this change has largely been managed in an organic fashion (i.e. uncontrolled and haphazard).

Whereas change ten years ago was primarily driven by positive factors – AUM’s rising, subscriptions into Hedge Funds increasing and positive stock market returns – change in recent years has been the result by more negative trends – increased competition, an unstable economic environment, a wave of new global regulation and far more demanding investors.

Current status

Up to this point companies in the industry have been either growing very quickly or trying to deal with the consequences of the economic meltdown. This meant few have had the chance to put firm controls in place around the process of change management. Change which is constant and on-going and needs to be project managed effectively. Particularly as the Hedge Fund industry had moved from adolescent into adulthood and is now becoming a mature industry in its own right.

The result of the industry moving from adulthood to full maturity can be seen all around us. More regulation, more demanding client requirements and more competition for existing Hedge Fund.

For this White Paper, firstly we’ll look at the current main drivers of change in Hedge Fund industry, before looking at some of the techniques we can use to manage this change more effectively.

Regulatory Change – This is currently the largest driver of change in our industry.

Specifically the Hedge Fund industry is in the early adoption stage of a huge wall of legal and regulatory requirements, which will likely change the way the industry operates in the future.

The Dodd Frank Act in particular contains onerous regulatory reporting requirements (by previous industry standards) and even sometimes contradictory requirements (as pointed out by The Economist newspaper recently). There is confusion across the industry and yet the deadline for Hedge Funds to register is now upon us.

Similarly from July next year the European AIFM directive will come into force across the EU. This legislation is still in the process of been finalised. What Hedge Fund Managers will have to do in respect of issues like domiciliation or reporting is still unclear and will make the process of applying these required changes internally very difficult, given a relatively short timescale.

Finally in the US the IRS has issued requirements around foreign tax compliance (FATCA) and this has meant a wave of registration and documentation for many Hedge Fund entities worldwide. Again the details regarding compliance and operational requirements are still being clarified.

Even if the changes projects proposed in your organisation are not regulatory driven in nature, Hedge Funds need to ensure that internally operational or outsourcing projects are organised is such a way that their output will easily satisfy both existing and future likely legislative requirements like Dodd Frank and the AIFMD.

Investor appetite – The launch of new funds, new fund structures (e.g. Managed Accounts) and the provision of new operational requirements (e.g. enhanced, flexible and far more granular investor reporting) is been largely driven by the rise of Institutional Investors among many Hedge Fund’s shareholder base.

High Net Worth Investors will continue to be an important source of many Hedge Fund’s subscriptions, however the future will see large institutional investors coming to dominate the shareholder register and with that a demand for increased liquidity and transparency

Industry Growth - 2012 is expected to be the most promising year for the Alternative Investment industry in 5 years. Growth in net inflows is expected from Institutional Investors and particularly Pension Funds. Hedge Funds are now an established part of the investment landscape and many Institutional Managers are increasing their allocation. This means proposed changes to the operation and structure of your organisation must be scalable and able to accommodate growth.

Financial, Operational, Investment, Counterparty & Liquidity Risk - Post- Lehman Investors, Regulators, Hedge Funds and the wider world have all become far more risk aware. Risk management seems to be at the centre of everyone’s strategy and this is likely to continue in the near future. All proposed changes to operations and strategy need to ensure they at least maintain, if not tighter your risk controls and processes.

Due Diligence – Post-Madoff Operational Due Diligence had increased massively in importance for most Investors, Hedge Funds and particularly for the Fund of Hedge Fund community. Investors do not want to be told about your processes - they want to see them. They expect durable and transparent operational controls and the process for ensuring these are in place is an important driver of many upscale projects across the industry.

All of these crucial regulatory changes, as well as the demand from Institutional Investors for greater fee flexibility and enhanced reporting, has added the pressure on Hedge Fund Managers, their Administrators and Software Vendors to meet this challenge.

The importance of all the drivers of change identified above illustrates how change in the industry must be managed in an ordered and controlled manner. Global Perspectives has managed change programmes for some of the largest Hedge Fund Managers, Administrators and Software Vendors in the world. This exposure to many projects of different scale and size has enabled us to identify the key steps to managing change successfully in the industry.

Key Steps to Managing Change

Document the Business Need

As soon as the change need has been defined the Project Manager must sit down with the Project Sponsor and clearly document the business need. Perhaps it is a new fund launch or adopting regulatory change. This will give the project a clear reason for being and positions the change required more clearly in everyone’s mind. Subsequently project buy-in is increased across the board, as everyone understands why they are doing what they are doing. It’s also critically to emphasise to those affected by forthcoming change that what they are doing is better than the alternative.

Project Planning

Most projects fail because they have not been planned properly. It’s that simple.

A Hedge Fund Manager may want to get a new product to market or a Hedge Fund software vendor may be keen to rush the latest release of their shadow fund accounting software to market, but if the project has not been planned extensively the project will be a failure.

Without a proper period of analysis, in order to consider the best way to organise, proceed and manage the proposed change project and associated risk the likelihood is the project will not succeed.

This is a particular problem in our industry if an investor is ready to write a cheque and the Hedge Fund Manager is keen to get a new fund launch in place. The urgently can mean planning is overlooked and the project execution will be sloppy and haphazard. Similarly if you are a Hedge Fund Administrator there is no point in quickly onboarding a large new hedge fund client if it is not planned extensively. This will lead service to your existing clients demonstrably suffering and damaging your industry reputation.

Part of the planning process should include a definition of how the project’s success will be measured. For example, success could be defined as successfully outsourcing all operational reporting to a specialist provider by a specific date, in a specific budget. This needs to be documented and widely circulated. Make it clear for both the Project Manager and team involved what will constitute a clear success. Too often projects muddle along without anyone having defining exactly what is required and by when, be it on boarding a new manager or launching a new Hedge fund.

The planning phase must include an extensive period of requirements gathering from all relevant areas. Make it clear to everyone affected why the new situation will be an improvement and how these business requirements will help achieve it. It is important that change should be driven by satisfying your customer’s needs. If you are a Hedge Fund unhappy with a particular software vendor, the project must be focused on identifying the missing functionality required from a replacement vendor that will increase your customer satisfaction.

Also, over time it is advisable to build up a series of change templates that work for different types of change projects. These can include Investor Onboarding, Fund launches and Fund reorganisations. They can come in particularly useful on the sort of change project that only occurs in an organisation every couple of years (e.g. upgrading existing software, launching a new Fund umbrella). The optimum steps required can be easily forgotten by the time a similar project next comes around.

All of this sounds like basic common sense but it is amazing, especially in the alternative investment industry, how often ambitious change is embarked upon without it ever been planned properly. This point needs to be emphasized. The old adage “Fail to plan, Plan to fail” is as accurate as it ever was.

Project Execution

Once the change projects requirements are defined the project moves to the execution phase. This should be completed using clear and agreed goals, assigned work-packages for each area of the project and use brief, frequent check-ins by all members of the Project team to keep everyone updated (Software development methodologies like Agile use regular brief updates and small ongoing deliverables to great effect) .

Unclear priorities, a lack of accountability and bad communication are all some of the most common reasons projects are not executed successfully. The team should focus on accomplishments and keep the morale sapping “blame-game” to a minimum. However it also must to be clear that everyone involved in the project will be held accountable for their piece. Failure to meet a deadline is not acceptable.

Fostering teamwork to ensure successful project execution is easier said than done. Often in our industry the guys working in Operations might have previously little time to spend getting to know the Portfolio Managers or Risk team. If the project covers multiple departments the Project Manager needs to schedule some time to allow everyone to get to know each other, preferably socially as well as professionally. The Project Manager has an important role to play here and carefully articulating and repeating the common goal of the project, as well as everyone’s assigned role, can help a team develop into a coherent whole

On large projects strategic alliances with suppliers, functional groups and relevant stakeholders can make the process of delivering change far smoother. If you are executing change with a third party (e.g. Service provider like an Administrator, Consultancy or Software Vendor) consider using a partnership approach. This means adopting an open communication process where either party can freely raise issues or concerns.

A partnership process moves beyond the traditional Client – Supplier relationship where instead each party is ready to help the other In order to meet the projects requirements. This win-win process tends to reinforce the success of the project as both partners want the other to succeed. It also means there is a far less chance of encountering unexpected surprises throughout the project’s execution, as each party should be keeping the other fully briefed at all times.

Project Management

On a large transformational project, with multiple streams across a Hedge Fund company, the organisation needs to appoint a dedicated Project / Programme Manager.

This is not meant as a reflection on the often very talent Senior Managers in the company. The simple truth is that managing a large multi work stream project takes a specific set of skills and experience, and this is often best done by someone external to the organisation.

As well as their obvious previous project management knowledge an external project manager come to the table immune from existing internal politics and historical animosities. Their temporary duration also ensures they do not get as easily bogged down by internal disagreements.

Often at Global Perspectives we have been retained to manage a project after the client has tried to progress it on their own. In that process they have encountered internal resistance - exhausted staff trying to juggle their daily work with projects requirements and a sinking sense of morale as the project runs into trouble.

An external Project Manager ensures a fresh set of eyes is brought to the organisation, with an independent perspective, and most importantly, someone whose attention is focused solely on the success of the project and who will not be distracted by the daily operational activity.

It is the Project Manager’s job to ensure the team is sold on the project from Day 1 and that communication is clear, regular and concise. It is easy to confuse a new team with mixed messages and unclear resource assignment. The process of allocating tasks should be as transparent as possible.

Project Managers should be able to organise the chaos and install organisation administration on the project, ensuring each element of the change process is managed, assigned and timetabled for delivery. Similarly they must every goal oriented and adaptive to the project requirements as this may be required during project execution, when requirements can be amended or updated. If a change deadline is particularly aggressive, they must flag this to the Project Sponsor and carefully balanced the business need against burning the team out, and ultimately sapping morale.

A really effective Project Manager leads from behind the scenes, allowing the achievements of the team members to be recorded and recognised. They must be open and approachable and be fully familiar with the main formal change management methodologies, as well as having a deep knowledge of the Hedge Fund industry itself.

Lessons Learned

Finally, ensure your organisation documents the lessons learned while they are still fresh in everyone’s mind. Often when a project is completed, when everyone is under pressure and the project participants are exhausted, people just want to get the project finalised and move onto to the hundred other things waiting their attention. This is a mistake.

Once of the most valuable things you can do to help your future hedge funds projects be a success is to spent some time documenting the lessons that have been learned. Particularly while they are still fresh in everyone’s mind. What worked, what didn’t? What do the project team wish they had of had more of – more time, a larger budget, a better test plan, more responsive service providers?

Spending a brief session brainstorming and documenting everyone’s thoughts can be invaluable to the organisation when a year or two later you have to upgrade to that new software or launch that new Fund umbrella and the experiences of the previous project are long forgotten and everyone’s memories is hazy. This is not a time for recrimination but is actually an investment in the organisations future success.

In conclusion, it is clear our industry is in the process of adopting its next huge wave of change. The pain of managing these changes can be greatly alleviated by successfully planning and executing the process using an experience Project Manager.

We will return to the Project Management theme in a future Global Perspectives white paper.