Research by Aranca, sponsored by FIS reveals institutional investors looking for risk reduction through hedge fund investing
Institutional investors are motivated by performance, but this is balanced by risk adjusted investing achieved through portfolio diversification. Increasingly, the drive for yield in the era of low interest rates is leading institutional firms into more diverse strategies, therefore investing in hedge funds has become relatively mainstream. Asset selection based on low volatility must also be re-examined frequently, since this property is not a “fundamental” property of a security but is essentially dependent on market sentiment.
The proportion of institutional investors looking for risk reduction through investment in a hedge fund is considerably higher in Europe (73 percent) than in North America (54 percent), or Asia Pacific (14 percent). This seems to be a paradox considering hedge funds are perceived to be risky – hedge funds must constantly monitor their risk reduction, hedging and low-volatility strategies. This trend for risk reduction is forcing greater emphasis on hedge funds risk management.
But when compared with their North American counterparts, European funds marked down the importance of risk management solutions, by ten percentage points, suggesting the pressure to invest in risk technology is less of an issue than in North America. Just 46 percent of European hedge funds plan to increase IT spend in 2016/2017. That makes Europe the only region globally that is expected to see a minority of firms boosting IT investment. Yet with 43 percent of them planning to outsource technology – compared with just 25 percent in North America– it suggests that European managers are seeking to lower costs and channel investment in risk technology through outsourcing.
One respondent noted “We are looking at either outsourcing or investing in technology to be able to simplify processes.”
The issue of keeping up with regulatory change is a further driver forcing a focus on risk. It was named as a top three challenge by European respondents (63 percent). Europe not only has the UCITs wrapper for funds, but is also in the process of implementing the revised Markets in Financial Instruments Directive (MiFID II) and the European Markets Infrastructure Regulation (EMIR).
The Alternative Investment Fund Managers Directive (AIFMD) was named by most participants (73 percent) as having the greatest impact over the next two years, followed by MiFID II (59 percent) and UCITS (57 percent). Keeping track of these developments has been challenging to most of Europe’s financial services firms. The level of reporting is considerably higher than has ever been required before and 22 percent of funds expect investment in reporting to increase most in the next five years. The level of in-house management of investor reporting (91 percent) and middle-office processing (77 percent) is understandable on that basis, particularly since some hedge funds reported that administrators are being slow in generating information, forcing investor reporting in-house.
Regulatory demands compel firms towards streamlined technology and optimized processes, with flexible multi-asset capabilities preferred by most respondents.
The European region clearly offers opportunity to fund managers and investors alike, however the level of commitment needed to stay compliant with regulations is considerable. Trusted partnerships with service and technology providers will help hedge funds meet investor and regulatory demands and in many cases will offer new, efficient ways of working.
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