How can hedge funds work more effectively with wealth firms as assets soar?

14 January 2022 - The wealth management industry has seen assets surge over the last decade as markets have recovered from the great financial crisis, presenting new opportunities – and challenges – for hedge funds trying to raise assets.

Assets under management at US wealth managers soared by 64% from 2010-2018 to total $30.5trn1, and this pattern is mimicked globally. Boston Global Consulting (BGC) said global financial wealth hit $250trn in 20202.

This pool of money – which is spread across wealth managers, private banks and other providers of investment services to high net worth individuals – is not only unlikely to dissipate anytime soon, but is also one that is increasingly looking to alternatives.

In recent years many wealth management clients embraced alternative investments in their quest for higher returns, shifting away from low-yield debt securities amid the ongoing quantitative easing programs which have been instigated by governments. As part of this trend, BGC said real assets - led primarily by real estate ownership - reached an all-time high of $235 trillion by the end of last year. 

Hedge funds are very much part of this trend. Our own data shows that flows from wealth managers to our own hedge fund clients have doubled on average over the last three years.

Hedge funds themselves concur. BTG Pactual, the $70bn asset manager with offices across North and South America, said: “We expect to see additional inflows and growth through our own wealth management channel, as well as external wealth managers.”

What is driving this trend is a reflection of the wider market; record low interest rates and stretched equity markets touching (or breaking through) record highs are among the reasons why investors are looking elsewhere for returns which are uncorrelated to traditional assets.

For hedge funds, the benefits of tapping into wealth managers are significant. If a hedge fund manager can get their fund offered to investors via the wealth manager’s platform, they can gain access to a large investment pool of high-net-worth individuals, who might otherwise not have considered their fund. These investors place a high degree of trust in these professionals, so having a fund offered via their platform serves as another layer of product approval.

Hedge funds also get to diversify their own investor base and build a relationship with wealth managers which can provide future opportunities, and also inform their own product roadmap if they launch further solutions.

However, benefitting from this is not straight-forward. The issue for hedge funds is not that this trend is happening, but whether they can maximise its potential.

ENGAGING WITH WEALTH MANAGERS – KEY CONSIDERATIONS

Hedge funds face a number of challenges when it comes to engaging with wealth managers.

Firstly, simply getting their product onto the wealth managers’ own platforms is not a light undertaking for hedge fund managers. If they manage to do so, it also then takes a significant effort to remain relevant on the platforms, with the fund managers required to allocate a significant amount of time to marketing their product offerings – after all, there is plenty of competition on the platforms for investments.

Many wealth managers are also inundated with product offerings and will not actively market a manager’s product. In many cases, the wealth manager will provide the hedge fund with access to the investors, but it is still up to the hedge fund itself to market the product and make the sales.

The way the wealth managers and the hedge fund talk to each other on everything - from valuations and holdings, to inflows and outflows - can also differ. Having systems that can interact effectively with wealth managers’ own systems is crucial if hedge funds are to tackle this space effectively.

ADMINISTRATION KEY TO UNLOCKING PLATFORM POTENTIAL

For those hedge funds approaching wealth managers, there are some clear administration challenges.

Firstly, there are KYC challenges with using a wealth manager, and carve outs may be required, to make sure these conditions are met.

Hedge funds may also be required to use consolidated bulk transaction files for orders and cash, and from a wealth manager’s perspective, if it has bulk investments into the same funds each trading cycle, it’s justifiable to look for the most efficient way to submit those instructions. It’s not unusual to see a lot of the processing effort pushed back onto the administrator’s operations teams, or the same administration staff at the hedge fund itself if it does not employ an external partner.

Share classes are another area to consider. There is a tilt towards distribution classes for many end clients of wealth managers, but regardless of whether clients want to receive regular income or not, it still requires bulk automated transactions.

Finally, the way hedge funds report to clients who come via wealth managers needs to be thought out, as there may be a requirement for bespoke or customised reports.

Therefore, in order to make this product distribution channel work as well as possible, hedge funds need to collaborate closely with fund administrators. With the right administration partner there should really be very little, if any, differences between direct and wealth manager-driven flows.

This is good news for hedge funds as it should allow them to maintain their own standard transaction processing workflow regardless of where the investment is coming from.

There might be a requirement for minor adjustments in the fund offering documents, but in general, any significant changes to transaction processing can be absorbed by the administrator.

Rather than having to engage directly with the wealth manager on the administration side, this in turn means the manager can keep their overheads low by using their fund administrator to digest and report to them in the format they are used to.

Mackay Shields, the New York-based asset manager with $164bn of assets, says this area should not be overlooked. “Accurate and timely exchange of information between the administrator and wealth manager is vital, and it is very important that the administrator maintains a positive and efficient relationship with them,” the fund said.

This scenario may change in the future; the industry as a whole would benefit from having a best practice that investors can leverage across wealth managers, funds and administrators.

But for now, for hedge funds wanting to capture the opportunity that wealth managers represent, being adaptable and utilising administrators remains the best option for those trying to control their own costs and focus on running the money.  

KEY DIFFERENCES BETWEEN STANDARD DIRECT INVESTMENT AND WEALTH MANAGER INVESTMENT:
  • KYC Challenges - carve outs may be required for wealth managers

  • Consolidated bulk transaction files on orders and cash

  • Potential preference for distribution classes from wealth managers which require bulk automated transactions

  • Wealth managers may require bespoke reporting

 

By Brian Casey, Product Manager, Investor Services and Reporting, Citco Fund Services (Ireland) Limited 

  


1According to McKinsey & Company’s “On the cusp of change” report published in January 2020 (pg4)
2According to Boston Global Consulting report – Global Wealth 2021 https://www.bcg.com/en-ch/press/10june2021-despite-covid-19-global-financial-wealth-soared-record-high-250-trillion-2020