special report how to start a hedge fund in the eu 2016 · 2016. 8. 22. · 6 hfmweek.com how to...

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TECHNOLOGY Protecting your fund on a limited budget

CHANGE Coping with economic and financial instability

PARTNERSHIPS Working with the correct people to grow your fund

HOW TO START A HEDGE FUND IN THE EU 2016

H F M W E E K . CO M 3

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his year’s edition of HFMWeek’s How to Start a Hedge Fund in the EU follows the UK’s vote to leave the European Union which, although unlikely to create any seismic shifts in hedge fund activity, could lead funds to think more carefully about certain pre-launch decisions.

Technology, and in particular cyber-security, is once again a key point of discussion.

Technological advancement has created many possible advantages in terms of streamlining operations but a number of risks must also be understood.

Choosing the right service provider partners, and knowing where and when to outsource, is also crucial when looking to launch a new fund.

In this HFMWeek Special Report, we aim to provide a vital source of information, while supplying interesting opinions from a range of industry experts.

Tom SimpsonReport editor

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REPORT EDITOR Tom Simpson T: +44 (0)207 832 6535 [email protected] HFMWEEK HEAD OF CONTENT Paul McMillan T: +1 646 891 2118 [email protected] HEAD OF PRODUCTION Claudia Honerjager SUB-EDITORS Luke Tuchscherer, Alice Burton, Charlotte Romeyer ASSOCIATE PUBLISHER Lucy Churchill T: +44 (0)20 7832 6615 [email protected] PUBLISHING ACCOUNT MANAGERS Alex Roper T: +44 (0)207 832 6594 [email protected]; David Butroid +44 (0)207 832 6613 [email protected]; Alexandra Bethanis T +44 (0) 20 7832 6618 [email protected]; Andrew Durbidge +44 (0)207 832 6637 [email protected], THE MEMBERSHIP TEAM +44 (0)20 7832 6511 [email protected] CIRCULATION MANAGER Fay Oborne T: +44 (0)20 7832 6524 [email protected] CEO Charlie Kerr

HFMWeek is published weekly by Pageant Media Ltd ISSN 1748-5894 Printed by The Manson Group © 2016 all rights reserved. No part of this publication may be reproduced or used without the prior permission from the publisher

I N T R O D U C T I O NH O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 6

4 H F M W E E K . CO M

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 6 C O N T E N T S

FUND SERVICES

BREXIT – A DOOR CLOSED FOR START-UP MANAGERS?Andrew Frost of Lawson Conner details the multiple outcomes which Brexit may have on the hedge fund industry in Europe

FUND SERVICES

COUPLING RISK AND PERFORMANCE MEASUREMENT TO ATTRACT INVESTORSDamian Handzy of Statpro examines the latest developments in the industry

FUND DOMICILE

MALTA: WE HAVE IT ALLJoseph Camilleri of Valletta Fund Services examines the sheer versatility offered by the array of fund structures available in Malta

FUND SERVICES

SURVIVING CHANGEJerry Lees of Linear Investments investigates the ever-shifting hedge fund environment

TECHNOLOGY

KNOW EUROPE HFMWeek hears from a range of industry experts on topics such as cyber-security and the key considerations of launching a fund in Europe

FUND SERVICES

UTILISING YOUR PRIME BROKERLawrence Obertelli of Global Prime Partners investigates the importance of working together with your prime broker in an effective way

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H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 6

On Thursday 23 June, 2016, a world of uncertainty opened up as the UK voted to leave the European Union. Understandably this has made many question the future of the hedge fund industry within the region. Added to the compliance and regulatory

complexities of launching and running a fund, Brexit is a further deterrent for start-up managers. However, despite the uncertainty, the implications of Brexit may not be as impactful as first feared.

CURRENT LEGISLATION AIFMD sets a clear framework under which an AIFM operates and markets its AIF and when passed into law, created a scenario where, should managers/sponsors establish an AIFM as well as an AIF within any EEA member state, they would have unrestricted distribution access to professional investor capital within these states. Ucits, while being much more cumbersome from a distri-bution perspective, follows a similar framework for retail investors as it is an EEA-wide directive. Furthermore, other directives relating to the trading operations of fund managers (specifically Mifid and Emir) are all applicable throughout the entire EEA.

THE REMOVAL OF PASSPORTING RIGHTS – ACCESS TO EUROPE REMOVED?There are a number of potential outcomes as a result of Brexit. The best case scenario is for the UK to remain in the EEA, despite leaving the EU, meaning that it will maintain its access to the single market. However, the UK will have limited ability to influence any policy decisions made within the EU and therefore any updates to the passporting framework.

On the opposite end of the scale, a ‘clean break’ could occur, resulting in the UK losing access to the single market and the ability to benefit from EU passporting and third country rights. This would be very damaging to the industry. However, the most likely outcome will be somewhere in between the two, with the UK maintain-ing its third country rights but losing its access to the single market and with that, passporting rights under AIFMD. Therefore, if no new agreements are implement-ed, for UK managers, the world will revert back to the same distribution landscape of pre-AIFMD days and the individual national private placement regimes will apply.

However, if the UK opts, and is accepted, to remain as a member of the EEA, then it is likely that there would be minimal disruption from a regulatory perspective.

The question of whether the AIF passport is actually required depends on your investors and where they are domiciled. Pre-AIFMD, national private placement was the only method for alternative funds accessing European capital; whether it was possible was down to whether a bilateral agreement existed between the country of domi-cile, of the fund management company, and the legisla-tion governing private placement of the chosen target market. Post-AIFMD, private placement has remained as a secondary option for those distributing funds in the EEA and will remain open as a route to market until at least June 2018.

Although private placement may appear as a simple fix, in some jurisdictions, such as France, Italy and other Southern European countries, private placement mecha-nisms are underdeveloped and in some cases, do not exist at all. As a result, an EU passport would be the only way to access this capital unless a reverse solicitation approach was received but this is very difficult to prove in practice. Contrary to this, if the intended investor audience is domiciled in the UK, the Netherlands and some of the Nordic countries, the private placement mechanisms are well developed and it is possible to distribute in these jurisdictions and have your fund be domiciled in more flexible, tax-efficient offshore jurisdictions.

It is therefore of critical importance, when consider-ing how to structure a fund in a post-Brexit scenario, to complete a heat map of potential investors and their geo-graphic locations as private placement may be the most effective method of accessing your chosen market.

A pre-structured solution, such as a Cayman Islands fund platform, is an attractive solution which makes use of the private placement regime. A fund platform is a plug and play solution that provides immediate access to a suite of market leading firms and is compliant with European and offshore regulations. It allows you to launch your own dedicated and protected sub fund which is fully compliant with fund regulation, helping to mitigate any potential complications associated with compliance and regulation.

ALTERNATIVE MODELS TO PASSPORTINGIf your potential investor base requires access to the AIF

As Lawson Conner’s director of Investment Management, Andrew Frost’s efforts are focused on the ongoing growth of the fund incubation, wealth management and launch activities of the Lawson Conner Group. He works very closely with the alternative investment community on prospective fund launches (hedge, private equity and venture capital) and with a diverse range of entrepreneurs looking to establish their businesses under the FCA regulatory framework .

BREXIT – A DOOR CLOSED FOR START-UP MANAGERS?

ANDREW FROST OF LAWSON CONNER DETAILS THE MULTIPLE OUTCOMES WHICH BREXIT MAY HAVE ON THE HEDGE FUND INDUSTRY IN EUROPE

F U N D S E R V I C E S


passport, then alternative models which allow a fund to be managed from London, while maintain-ing access to the passport, are available.

Historically, using a third-party provider has allowed start-ups to remove the burden of act-ing as the AIFM to an AIF as it can provide the entire regulatory and compliance infrastructure, risk management, governance functions and even operational capability, allowing new managers to set up a fund and conduct regulated activities as outlined within AIFMD. In some EEA countries (notably Luxembourg, Ireland and Malta) the host AIFM infrastructure is as well developed as it is in the UK with the ability to launch an AIF quickly by appointing a third-party AIFM as one manage-ment company to the fund. In this scenario, the third-party AIFM is able to outsource the portfolio management to a third-party on the proviso that the third-party is appropriately regulated in the domicile in which they are located. Appropriately regulated means that the jurisdiction of the third-party is broadly in line with Mifid portfolio management regulations, which of course would be the case given that it is extremely unlikely that Mifid will be repealed in the short term in the UK.

THE END OF START-UP MANAGERS?Although most allocations are going to big name hedge fund managers, statistics prove that the highest alpha generators are smaller and emerging managers. Further to this, if the UK were to revert back to the private placement regime, the impact of this on the existing fund distribution status quo in Europe is likely to be minimal as the overwhelming majority of AIFs distributed are done so via private placement rather than through the passporting mechanism.

These are positive signs for new start-up managers but there are other potential issues to consider. Emerging man-agers are often overwhelmed with the operational aspect of fund management such as legal, compliance and IT, which does not leave them much time to do what they are good at, trading and generating alpha. Additionally, the FCA applica-tion process to conduct regulated fund activities can take nine to 12 months to complete by which time, the fund

investors and market opportunities may no long-er exist.

These barriers can be overcome through the use of an outsourced AIFM. Through the appointed representative (AR) model, emerg-ing managers can become an AR of a principal firm, either on a temporary or permanent basis, enabling them to start running their fund within three to four weeks. Fund managers are also able to outsource the aforementioned operational issues and can be introduced to relevant counter-parties such as the best lawyers and administra-tors as well as to seed capital and distributors. This can prove hugely beneficial as the opera-tional aspects of a new launch are critical as it is essential that the hundreds of decisions that need to be made are made correctly.

Taking these considerations into account, launching a fund can remain an attractive pros-

pect as not only can start-ups potentially generate more alpha but they can also benefit from operational cost savings.

BREXIT – CONCERNS? YES. MAJOR DISRUPTION? NO.The potential implications of the Brexit scenario are both uncertain and wide reaching. From a fund distribution perspective, in the short term, it is unlikely that much will change as there will be a period of a minimum of two years that the existing legislative framework will remain. There is also the possibility that the UK will remain in the EEA, despite leaving the EU, which, in theory, should cause little disruption. However, if no new agreements are implemented, then the UK will revert back to the private placement regime. Should passporting still be required, and if Esma’s advice is not implemented, there are alternative models available for managing your fund from London, while still accessing the distribution capabilities of the AIF marketing passport, such as appointing an AIFM in another EEA member state where the third party AIFM can still support the advisory entity in the UK.

So it looks like, in all probability, even in a Brexit scenario, the predicted pandemonium may not necessarily occur, well at least not from a regulatory perspective.

THE QUESTION OF WHETHER THE AIF

PASSPORT IS ACTUALLY REQUIRED DEPENDS ON YOUR INVESTORS

AND WHERE THEY ARE DOMICILED

”



There are plenty of hurdles to starting a hedge fund: gone are the days when “three people and a Bloomberg” were all you needed to se-cure seed capital and launch a new fund. Today, regulations and savvy investors require that managers not only have an investment-worthy

track record but also a robust risk management process, a solid compliance offi ce, and independent valuations – all, of course, in addition to a diff erentiating strategy.

Hedge fund regulatory risk requirements – like Ucits, Mifid, AIFMD and Form PF – are all designed by different committees to require standardised risk controls that can be widely interpreted, shared and compared across man-agers. But these required risk measures rarely satisfy the needs of the portfolio manager, the risk manager or inves-tors, all of whom look for measures of risk and approaches to risk management that aren’t cookie-cutter. Risk man-agement systems that are useful for internal fund manage-ment rely on detailed holdings to generate the statistics and provide the tools for both long-term risk stability and for dynamic use when market conditions demand. A hedge fund’s risk manager may select the most meaningful measures for that fund and monitor those, at every level of the fund, every day. Those levels could be “by trader”, “by sector”, “by strategy” or any other meaningful categorisa-tions. The risk manager then sets practical limits in those measures that, if breached, require traders to return the risk to acceptable levels. That overall control ensures that overall risks are increased only as a conscious decision and never unintendedly. Dynamic uses of internal risk management include a variety of what-if analyses, espe-cially around changing allocations and adding or removing investments – all to understand the impact on a host of risk statistics. Pre-trade analysis as part of risk manage-ment is a staple of dynamic alternative investing, requiring the risk system to handle real-time what-if analysis at the security level, with the ability to re-compute the risk of the entire portfolio and at all levels of aggregation.

Measuring historical performance attribution and contribution can help portfolio managers and investors alike understand how and where returns were earned. Performance attribution decomposes securities’ returns into underlying causal factors. For an equity portfolio, that might be selection or sizing. For a fixed income portfolio it might be interest rates, or credit or carry. Performance contribution, on the other hand, shows how total returns break down into portfolio aggregation categories of the

manager’s choosing like ‘by sector’ or ‘by country’. Such performance analysis is very useful to help managers iden-tify their own skill in generating alpha – by comparing, over time, where a manager thought they would make money to where they actually made money the manager can focus on trading approaches in which they’ve dem-onstrated real skill. By doing more of what they do well and less of what they are challenged at, the manager will improve performance.

Of course, risk management can serve the exact same purpose from the opposite perspective: helping a manager identify which types of trading activity generates higher risk and which generates lower risk. By combining both performance and risk measures in an attribution analysis, a manager is able to simultaneously identify targets for performance enhancement and risk reduction – leading to better risk adjusted returns.

HFMWeek (HFM): What kinds of risk/performance measures should be combined to gain such insight?Damian Handzy (DH): Our recommendation is to keep things simple and insightful. We suggest analysing current investment amounts along with two measures of perfor-mance and two measures of risk that are displayed – side by side – for every level of the portfolio. For example, actual performance and expected performance (over some fixed time period) together with total risk and marginal contribution to risk, measured by sector. Those five meas-ures, when compared with one another, can quickly reveal how the portfolio is currently positioned as compared to recent and expected returns and as compared to poten-tial losses. If the expected returns differ from historical returns by sector, are the portfolio’s current holdings con-sistent with capturing those expected changes in sources of alpha? Are the risks of those sectors increasing faster or slower than the expected returns are changing? For those sectors that show no change in expected returns but show an increase (or decrease) in risk, are the investments reduced (or increased) to maintain risk levels? If the PM has chosen to increase risk tolerance, are the increased risks being equally distributed across sectors or are some sectors over-weighted from a risk perspective, and if so, are those over-weightings justified by proportional over-weightings of expected returns? Of course, this same analysis can (and should!) be done not only by sector, but by all other meaningful aggregation levels – geography/industry/market cap/duration/asset class, etc.

Damian Handzy has 20 years’ experience in financial risk management, having worked with hundreds of Wall Street’s most successful investment managers. He was co-founder, chairman and CEO of Investor Analytics until he sold the company in 2016 to StatPro. Damian is now the global head of risk and a member of StatPro’s executive board, responsible for both strategy and delivery of the firm’s cloud-based risk services around the world.

COUPLING RISK AND PERFORMANCE MEASUREMENT

TO ATTRACT INVESTORSDAMIAN HANDZY OF STATPRO EXAMINES THE LATEST DEVELOPMENTS IN THE INDUSTRY



Showing a graphical comparison of just these five analytics opens up a plethora of consistency-based questions about risk-adjusted returns and how consistently the portfolio matches expecta-tions. Of course, many other analytics can be com-bined to reveal other important questions.

HFM: What’s new about this approach?DH: The combination of performance measure-ment and risk management has been talked about for a long time in the investment management industry, but it’s been historically very difficult to couple systems to provide both of these measure-ments on a single platform and even more impor-tantly, to calculate them consistently. Having a single system that calculates both performance and risk from a single set of position holdings, using a consist-ent set of market data, valuation functions and meth-odologies is only now becoming practical. Delivery of such analytics through a scalable and robust cloud-based system will increasingly be expected by sophisticated investors.

HFM: How can newly launched funds ben-efit?DH: Because this approach is so new in the mar-ketplace, more established funds have only begun to take advantage of combining performance and risk. New launches can use this combined analytics approach as a differentiator to attract investments and to demonstrate a truly forward-thinking approach to portfolio construction.

HFM: What do institutional investors expect?DH: Modern institutional investors expect more transparency than ever before – but that doesn’t just mean access to the holdings. Today, transpar-ency means access to management level analytics

about the short and long term health of the portfolio. Investors want “fly on the wall” access to the decision process and they get that by requiring managers to share detailed analytics on performance, expected performance and risk. Rather than getting separate reports on each of those, combining these analyses provides a fresh perspec-tive on the portfolio.

MODERN INSTITUTIONAL INVESTORS EXPECT MORE

TRANSPARENCY THAN EVER BEFORE – BUT THAT

DOESN’T JUST MEAN ACCESS TO THE HOLDINGS

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HFMWeek (HFM): What different fund structures are available in Malta? Joseph Camilleri ( JC): Malta’s successes in the funds industry over the past years has been, to some extent, underpinned by the available alternative options of fund structures, catering for both the requirements and risk profiles of investors, as well as those of the investment managers pursuing different investment strategies.

The diverse nature of possible fund structures in Malta can be looked at from two angles: on the one hand the legal form, and on the other, the applicable regulation.

LEGAL FORMFunds in Malta may be set up under a variety of legal structures. Undoubtedly the preferred model so far has been the Sicav model, i.e. funds structured as investment companies having a variable share capital. Sicavs cater too for the possibility of segregated sub-funds, each of which in turn may have different share classes.Another legal form is the Inv Co, which is similar to the above, bar that such Inv Co funds are intended for closed-ended funds.

It is also possible for funds to be structured as con-tractual funds, a reality that is also picking up in Malta particularly in the private equity sphere. Moreover, the model is deemed to have a perfect fit for the newly intro-duced notified alternative investment funds (Naifs). Naifs in effect are fast-track-for-launch type of funds, and the contractual fund model aids further this important time to market consideration.

Unit trust funds are there again another option in the legal form of a fund (these have not been used extensively in Malta, yet the possibility is there, tried and tested).

Lastly there is the limited partnership funds legal form; as stated, the prevailing interest in fund structures in Malta has been skewed on the Sicav model, leaving little space for this.

REGULATIONSThe regulation in Malta for funds spans across the entire spectrum, capturing all investment strategies as well as investor types.

On the retail side, Malta, as an EU member state caters for the setting up of Ucits V funds. Several such funds have been set up in Malta by international fund promoters; sev-eral too have been the Malta-based funds that have been passported to other EU markets where they are actively marketed and distributed.

Notwithstanding that this is a level playing field for all EU member states, Malta provides for greater flexibility, which has ensured interest in Malta as a fund domicile with many fund promoters keeping it very much alive. In effect, Malta-based Ucits do not need to appoint a

sponsor, as is the case in other EU domiciles, nor is it a requirement that the fund administrator is based in Malta, which further accentuates the attractiveness of Malta as a flexible fund jurisdiction.

On the alternative side, Malta’s single regulator, the Malta Financial Services Authority (MFSA), has adopted two regulatory frameworks:• With the introduction of the AIFMD, the AIF regime

was introduced by MFSA, catering for the possibility of setting up of funds, rubber stamped as AIFs and fully compliant to the provisions of the AIFMD. This thus enables fund managers set up AIFs in Malta that may benefit from the EU passport when such funds are pro-moted to “professional investors” (as defined in Mifid).

• The introduction of the AIF regime by MFSA was not an “out with the old and in with the new” decision. The pre-dating professional investor fund regime, introduced by MFSA in 2000, which regulatory regime was a boon for the growth of the industry in Malta, has been (wisely) retained by the MFSA alongside the newly introduced AIF alternative.This provided de-minimis fund managers and de-min-

imis self-managed funds to be structured (in any of the above mentioned legal forms) as PIFs; out-of-scope in terms of the AIFMD. While these are somewhat limited from a distribution perspective (given that they do not benefit from the EU passport), it must be stated that many alternative strategies (from hedge funds, to private equity, to high frequency trading, real estate and many others) are many a times distributed through the private placements mechanism, and thus the sparkle attributed to the pass-port is somewhat dimmed!

Apart from these regulatory regimes, catering for the strategies mentioned above, which also address diverse risk profiles of investors, Malta also caters for other fund models as promoted by the EU across the continent, from EU Veca funds to ELFITs and others. All of these may be structured in Malta, with or without the passport…

Loan funds, that is funds set up to carry out predomi-nantly a lending function, can also be structured.

In conclusion, and most importantly, non-regulated notified AIFs, promoted by full scope AIFMs can also be set up in Malta. Such funds may be launched within a 10-day period running from the date of filing of a noti-fication with the MFSA, by a full scope AIFM, to launch such funds.

HFM: What are Naifs and how have they come about? JC: On 11 February 2016 the MFSA announced the launch of a new fund regime for alternative investment funds (AIFs), namely the notified AIF, which will not require licensing by MFSA, will not be subject to on-going MFSA supervision, and will be included in the official

Joseph Camilleri joined the Bank of Valletta Group in 1985, and is currently the executive head of Business Development and Corporate Services at Valletta Fund Services Ltd, which he joined in 2007, following seven years in Italy during which he headed the bank’s representative office in Milan.

MALTA: WE HAVE IT ALL JOSEPH CAMILLERI OF VALLETTA FUND SERVICES EXAMINES THE SHEER VERSATILITY OFFERED BY THE ARRAY OF FUND

STRUCTURES AVAILABLE IN MALTA

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1 2 H F M W E E K . CO M


notified list of “Naifs held in good standing” within 10 days on MFSA’s website.

The notified AIF may be set up in any structure under Maltese law, as outlined earlier, and may target professional investors who meet the requirements of the framework set out by the MFSA.

Any EU/EEA full-scope AIFMs, licensed by the MFSA or in possession of the AIFMD management pass-port, may request to the MFSA for an AIF to be included on the list of notified AIFs. Providing that the AIFs falling within the constraints of the notification criteria are managed by a full-scope AIFM, and jointly with the governing body of the AIF (the board of directors in case of a Sicav) will take full responsibility for the notified AIF. Interestingly, third country AIFMs may also sub-mit requests for a notification of an AIF if pass-porting rights have been granted to the country where the AIFM has been established.

KEY POINTS:Notified AIFs are tax exempt and available to full scope EEA AIFMs which will mean a reliance on the EEA AIFM regulatory status rather than regulating the AIF itself and there are no separate prudential requirements on the notified AIF by the MFSA. The objective is to be quicker to get the notified AIF on to the market and to reduce set up and ongoing running costs. A new rulebook has been issued under the Investment Services Act as well as specimens of all documents which shall accom-pany the notification request to the MFSA. This new regime is applicable to new AIF set-ups and may be promoted to

professional (under Mifid, and qualifying investors). A noti-fied AIF is passportable and can be open or closed-ended. Private equity funds may also be set up as notified AIFs.

NOTIFICATION PROCESS:The AIFs own governing body will need to approve the compliant prospectus following which it can be dated, and

a notification submitted to the MFSA within 30 days from this approval date. The AIF will be pub-lished on the notified AIF list within 10 business days. The AIFM will be required to undertake the responsibility of ongoing management and moni-toring of the notified AIF demonstrating AIFM certification as to competence to manage/monitor.

As Malta is fast becoming the location of choice for many fund managers and entities, with English as the spoken business language, and the regulatory and government bodies actively promoting Malta as a centre of excellence for the asset management industry, it is also an attractive base from a cost and tax efficiency perspective.

VFS has been active in the market providing a full suite of fund administration services, as well as fund formation solutions on a turnkey basis, for 10 years. VFS has in fact assisted several fund pro-

moters set up their investment vehicles in Malta; our expert knowledge of the regulatory framework enables us discuss and put forward alternative solutions to our client base. VFS has in fact been at the forefront to assist new entrants to the Maltese market, identifying the best suited regulatory fund rule book, as well as provide a holistic fund administration and back office support on an ongoing basis.

THE REGULATION IN MALTA FOR FUNDS SPANS

ACROSS THE ENTIRE SPECTRUM, CAPTURING ALL INVESTMENT STRATEGIES AS WELL AS INVESTOR TYPES

”

IN A CHANGING WORLD,

BY THE TIME YOU MASTER THE GAME, THE RULES HAVE CHANGED.

BNP Paribas Securities Services is incorporated in France as a Partnership Limited by Shares and is authorised and supervised by the European Central Bank (ECB) the ACPR (Autorité de Contrôle Prudentiel et de Résolution) and the AMF (Autorité des Marchés Financiers). BNP Paribas Securities Services, London branch is authorised by the ACPR, the AMF and the Prudential Regulation Authority and is subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority and regulation by the Financial Conduct Authority are available from us on request. BNP Paribas Securities Services, London branch is a member of the London Stock Exchange. BNP Paribas Trust Corporation UK Limited (a wholly owned subsidiary of BNP Paribas Securities Services), incorporated in the UK is authorised and regulated by the Financial Conduct Authority. ©“3 man chess”

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world



I don’t think it is any surprise that it has become increasingly difficult to set up a new hedge fund unless it is a spin-off from already established and sizable funds. The sector is suffering from post-2008 fatigue with overall unimpressive results com-bined with extreme wariness on behalf of investors.

Nevertheless, it is still very possible to set up a new hedge fund in today’s environment and succeed – you just need to be pragmatic and take all the help you can get. DIY is not the answer – you will waste much of your valuable skills on mundane and time-consuming tasks that are bet-ter fulfilled by experts who have done it before and can deliver a solution on a plate. As Warren Buffet said: “It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”

In researching and planning this article, I looked back to my previous articles on this subject. I searched to see how my advice reflected market conditions at the time and, based on another two years’ experience working with over 150 clients, how that advice might change. Our clients are all in this sector: managed accounts, wealth management, brokers, etc. of which 70 are solely hedge funds. A very dif-ferent market also raises the question of what you should do now versus in the past.

Summarising my conclusions last year, I noted the fol-lowing:

• It is now significantly harder to attract investors• Fee expectations across the board are significantly

lower • Regulatory pressures are immense • Operational costs have escalated • It is crucial to have an audited track record Altogether it sounds like a tough call and I have not

changed my prognosis. If anything it has become harder to raise capital; fee expectations are being squeezed further and regulatory pressures continue to mount with greater burdens. At the same time operational costs are increasing steeply and the catch-22 requirement for a track record of at least three years’ high yield is a difficult hurdle to meet before serious funds come through the door.

ANSWERS TO QUESTIONS What is happening, why is it becoming more difficult, and what can be done to differentiate yourself and survive while you build that all important track record?

I quote from the Credit Suisse Mid-Year Investor Sentiment Survey as follows:

“73% of investors surveyed indicated they were likely or very likely to allocate capital to hedge funds in the sec-ond half of 2016. However, 84% of respondents reported redeeming from hedge funds in the first half of 2016 (over 60% of those who redeemed where driven by specific manager underperformance or strategy drift). Of those

who redeemed, 82% expect to recycle capital to other hedge fund managers.”

In other words, an 11% fall in capital allocated to hedge funds in Q1 2016. According to another report, in January 2016 alone net outflows from hedge funds were $21.5bn, the largest redemption annual start since 2009, followed by overall losses of over $20bn.

We can see why investors are extremely cautious and nervous of non-institutional hedge funds in why there is huge competition for seed capital between emerging hedge fund managers. Raising capital is therefore a huge challenge. In order to succeed, your emerging fund needs to focus on track record, marketing strategy and your core value proposition – what differentiates you?

DON’T UNDERESTIMATE TRACK RECORD AND OUTSOURCING As I said earlier, track record is critical. You need to be able to start with sufficient friends and family funds to make the track record credible. In order to address the con-flicting issues of increased regulatory burden and other consumers of your time, you need to outsource as much as possible in order to retain your focus. With a small team you cannot afford to cover regulatory set-up and report-ing, compliance and risk management (risk technology and human resource), IT and operational risk, office and facility set-up, legal and structure, as well as put forward a capital raising team and marketing programme.

By outsourcing many of these processes to a platform solution such as Linear, you can demonstrate all the opera-tional technology and compliance/risk controls necessary to convince investors that your fund is of institutional quality. These compliance, operational and risk controls tell the investors that there is a third-party intermedi-ary platform looking after their investment. The platform controls and limits the business risk that often makes insti-tutional investment in an emerging fund impossible. The investor can be certain that the platform will not risk the bulk of its other client and investor relationships because of one small, defaulting fund.

Continued regulatory pressure and increasing opera-tional expenditure creates a need for greater infrastructure, IT systems for proof of best execution, research procure-ment, middle and back office expenses, and so forth. That makes it essential to be regulated while building a track record. Applying for your own FCA licence will now take you around 18 months, a catastrophic delay if you are waiting to build the crucial track record.

OUTSOURCE EVERYTHING WHERE POSSIBLE! Outsource compliance to a simple overhead, become an appointed representative (AR) in a few weeks and establish a regulated record while waiting for the FCA. Outsource office and IT infrastructure to an organisation

Jerry Lees is chairman of Linear Investments Ltd, and has been an active entrepreneur in the success of multiple technology and financial businesses. Linear is FCA regulated to provide prime brokerage, execution and hedge fund platform services, including FCA umbrella, capital introduction, and hedge fund office infrastructure.

SURVIVING CHANGEJERRY LEES OF LINEAR INVESTMENTS INVESTIGATES THE EVER-SHIFTING HEDGE FUND ENVIRONMENT



that is fully compliant with Mifid II and AIFMD. Outsource trading so that you keep execution costs to a minimum and don’t waste time or spend money on trading costs that come straight out of your bottom line.

Middle and back office, risk systems, opera-tional procedures, detailed analytical tools (ana-lysing performance/Beta/Sharpe, etc.), and pro-duction of state-of-the-art performance reports can be added to the outsource product. Office space without a long-term commitment, massive personal guarantees and large deposits can be part of the platform. IT should be private cloud-based to maximise efficiency and meet regulatory stipulations, run by experts in the field. Managing technology is a profession unto itself, unless you spend most of your free time building servers and managing networks, you will need help managing technology at your new firm. Essentially, Linear Investments’ platform will supply all of these ser-vices on a short/medium and long-term basis on a flat fee or a percentage of AuM basis, without taking equity in the venture.

Now to the key topic of raising capital. A piv-otal part of your success will be finding in-house seeder fund capacity combined with a cap intro team specifically focused on emerging funds and working on a results basis. They will bring established rela-tionships with multiple investors and an understanding of the investor requirements.

Don’t believe the larger prime brokers if they tell you they will find seed capital, unless you are already at $300m-$500m, they just can’t help you. They cannot justify the resources,

they don’t have the contacts, and they won’t spend the time, leaving you with false hope. Don’t underestimate the impor-tance of a good capital intro team. The cost and difficulty of an in-house cap intro makes outsourcing vital.

BREXIT, BASEL III AND PRIME BROKERS! Small funds are struggling even more in gaining access to global PBs. Basel III forces PBs to shore up their balance sheets, accordingly dropping smaller clients who do not justify the balance sheet or are simply not profitable enough. This is where integrating with the boutique prime broker brings the advantage of an aggregated platform serving multiple smaller hedge funds.

Your prime broker provides the fundamental services of custody of assets and access to financ-ing and securities lending. Other services that are central to the offering of a prime broker include executing orders and portfolio reporting. The suite of services to be offered by Linear as a prime broker has generally expanded in recent years beyond the core services others offer.

There are very few offerings as extensive in nature as Linear Investments’ platform – which brings all of these elements together under one roof. The platform is fundamentally the most valu-

able asset and tool you could adopt to ensure success in establishing or growing your fund. In addition to having a chaperone agreement, enabling US fund raising within US regulations, Linear operates in London and Hamburg and is therefore in a position to obviate the effect of Brexit in terms of European marketing.

A PIVOTAL PART OF YOUR SUCCESS WILL BE FINDING IN-HOUSE SEEDER FUND

CAPACITY COMBINED WITH A CAP INTRO TEAM SPECIFICALLY FOCUSED ON EMERGING FUNDS AND WORKING ON A

RESULTS BASIS

”

HFM CAN HELP YOU ADVERTISE AND SEARCH FOR ROLES ACROSS A RANGE OF SPECIALISMS AND LEVELS OF SENIORITY

JOBS BOARD

WWW.HFM.GLOBAL/JOBS

T E C H N O L O G Y



HFMWeek (HFM): What is the key aspect of a launch-ing a hedge fund?Lance Peatling: I’ve been a client of netConsult through a number of different launches since 2005 and have just passed the first year anniversary of our fund launch. Taking stock one year on from the fund launch and trying to identi-fy the key points that have contributed to our getting where we are today is incredibly difficult as there are a multitude of factors that all contribute to making your whole offering. However, in one respect it can be boiled down to one simple and vital point: the people.

Not only does ‘the people’ encompass the investment man-agement team that forms your core offering, but also the entire team in the firm. Whether they are your own employees or the many differ-ent service providers that you will come to rely upon time and again to deliver the correct answers that your investors will demand, it is the importance of trust in these people that is unprecedented.

Although, this throws up a rath-er intractable problem. In the most part, any new launch presents an enormous amount of risk, not least to the principals but also to the service providers. Without a deep and credible infrastructural offer-ing (be that soft infrastructure, for example your employees, admin-istrator, prime brokers, lawyers, auditors or hard infrastructure i.e. office space, IT, phone systems, etc.) you risk doing an enormous amount of damage to the ultimate goal of both attracting investment and being able to focus on making a success of managing those assets.

In that respect the starting point of any new launch is in its market-ing, not to investors, that comes later, but to all those who will be supporting you in making your venture a success. Recognising that you want to surround yourself with the best in class is a simple proposition and one we all readily agree with. Attracting those relationships and building on them over time as you go through the various stages pre and post-launch is, to my mind the singularly most important statement that you will be making to the ultimate investors in your product, long after your first investors came on board to help you build and sustain it.

HFM: What are the key success factors when launch-ing a hedge fund?Peter Northcott: There are four, and if any of these are missing, it will be exceptionally hard to make a success of the business. In an environment where the chances of success are slimmer than ever it is important for start-up managers to give themselves the best chance possible.1. Demonstrated ability to deliver risk-adjusted alpha –

preferably with a strategy that is not easily available elsewhere.

An audited track record is the easiest way of demonstrating this, but other routes are pos-sible. For example, a successful proprietary trader coming out of an investment bank would gain credibility through having their former employer become their PB and/or receive an invest-ment from their asset manage-ment arm. Alternatively, a well-known and very credible anchor investor(s) can encourage others in. Regarding the investment strat-egy, it is becoming harder to find niches and inefficiencies – but investors will need a lot of per-suading if it is something widely available. In my view, systematic strategies have a slight advantage here as it is harder for investors to be sure that the strategy is not unique (the “Black Box” effect).

2. Sufficient financial resources (i.e. working capital).

Ultimately, a hedge fund is a busi-ness. This will need substance, in terms of human resources and an efficient infrastructure (see below). This substance will, in turn, cost money. The actual cost

of launching is relatively modest, but investors, staff and other stakeholders need to be confident that the business can finance itself for a couple of years. In addition to this commitment, the principal of the business will also be expected to invest another significant proportion of their net worth in the fund.

3. Investor relationships.Currently, the biggest challenge that managers face pre-launch is raising assets. This is due to the recent shortage of

ESTABLISHING THE BUSINESS, OPERATIONAL

AND TECHNOLOGICAL INFRASTRUCTURE,

INCLUDING THE RIGHT ROSTER OF SERVICE

PROVIDERS, IS MORE EASILY ACHIEVABLE THAN RAISING THE ASSETS – ALTHOUGH THIS REQUIRES A BUDGET, MARKET KNOWLEDGE AND

SUPPORT

” Peter Northcott

Lance Peatling is the chief operating officer of a UK investment management company.

Peter Northcott is an operational consultant at KB Associates who works with new managers from inception through to launch. He supports them in building their infrastructure including the selection and on boarding of service providers.

KNOW EUROPE HFMWEEK HEARS FROM A RANGE OF INDUSTRY EXPERTS ON TOPICS SUCH AS CYBER-SECURITY AND THE KEY

CONSIDERATIONS OF LAUNCHING A FUND IN EUROPE

Phil Ashley is the chief information officer at netConsult . A trained analytical scientist , he has over 15 years’ senior IT experience across a range of industries, with several years’ running both internal IT teams and as an external IT service provider in the finance industry.

T E C H N O L O G Y



capital for emerging managers following the decline of the fund of funds sector. Personal relationships are undoubt-edly the best way to try to overcome this, although, where these are limited, there is still hope through third-party marketers and consultants.

4. Building an efficient, robust and credible infrastructure.Establishing the business, operational and technological infrastructure, including the right roster of service pro-viders, is more easily achievable than raising the assets – although this requires a budget, market knowledge and support, as well as an understanding of what pro-spective investors are looking for from a due diligence perspective.

HFM: What should new funds be considering when it comes to IT and cyber-security?Phil Ashley: Trying to get the most out of technology is a big challenge for new hedge funds. With expectations on technology services growing with decreasing budgets, knowing exactly which services are critical and which are not is paramount to getting the most out of an IT budget. The utilisation of public cloud services and hybrid private clouds can be cost-effective when utilised sensibly, but costs of public clouds can build up very quickly.

Being mindful to maintain perception of the value of IT services as a core part of the business will help in investing in limited technologies in the face of eroding IT budgets. Getting the key pieces you need in place at the earliest opportunity may be more expensive initially and might feel inappropriate for the early stages, but can pay for themselves time and again. Critical services such as email, data storage and communications are key cornerstones of any IT infrastructure and should be given full atten-tion. Without good initial foundations, retrospective data

migrations and system integrations can be often costly, risky and disruptive tasks; wasteful necessities that could have been avoided.

Focus must go into security as a priority. It is simply unacceptable not to have reasonable security measures in place. There is a vast array of security technologies, sys-tems, solutions and providers in the market place offering various levels of protection. Assessing all their features, effectiveness and appropriateness can be a complex task. A good breadth of basic protections, well implemented, securely configured and properly monitored can be a solid starting point.

Focusing on a breadth of solutions can often be more effective than a few specific, advanced solutions. However, most security technologies need involved configura-tions and settings, while forgetting them can be danger-ous. Ensuring that security solutions are professionally installed, well integrated, securely configured and continu-ously monitored is key.

Having the ability to respond meaningfully and in a timely fashion to an actual or near-miss security incident is also very important. Attackers are likely to be aware that organisations might not detect or may take time to react to a successful attack or data breach. This can often result in future repeat attacks as a technique to avoid detection and attempt further security breaches.

Finally, support and management of your IT must not be overlooked. Operating minimalist IT solutions can result in a substantial support overhead. Day-to-day sup-port tasks can be manual and inefficient and may require more care and attention to keep them running well. Well built, well managed and well monitored IT systems, with skilled local IT support, whilst it may be a sizable cost, can prove invaluable in the long run, keeping your business running.



HFMWeek (HFM): What are the key factors that hedge funds look for when deciding on prime brokerage?Lawrence Obertelli (LO): This can vary widely depend-ing on the client profile and on whether or not the pro-spective mandate is to be a core relationship or if it’s in addition to established partners. Of course, there are some factors that tend to capture most people’s attention, for example competitive pricing and the promise of capital introduction (although the latter is increasingly viewed with a touch of scepticism these days). Aside from those there are many other factors that can resonate with some while be less alluring to others. For example, reporting/risk/technology systems can often be a key feature, espe-cially for more quantitative funds. Consulting services can be very useful for new launch-es. Often it just comes down to relationships and trust. This is a people business and knowing that your business (your ‘baby’) will be looked after and well-represented at the prime broker (PB) can be invaluable.

HFM: Is the importance of choosing a prime brokerage firm often underestimated by many hedge fund managers? Why? LO: Overall, this decision is generally taken very seriously. However, managers often look to work with the largest and most high-profile bank, as opposed to one that best fits with their market activity. This can be for various reasons; reputational factors, to appease investors or perhaps in the presumption that bigger always means better. While this sometimes can certain-ly be true it is not always the case. As a result of the recent regulations around Basel III, the traditional Bulge Bracket banks are very focused on the largest hedge funds, those paying well in excess of the minimum fees they charge. This often means the manager working with the largest PBs is not prioritised as he was expecting to be. It’s also fair to say that different PBs have their own strengths and priorities. Without a full ‘under-the-hood’ due diligence of the PB there is a risk of overestimating the service the manager will receive in relation to what they really need on a practical day-to-day basis.

HFM: What immediate practical concerns should a hedge fund address when selecting a prime broker with respect to their market activity?LO: One of the first areas of disconnect could be noticed in market execution. For example, where a particular area of sophistication for the PB is in trading fixed income whereas the manager was looking for specialised offering in equities or listed-derivatives. Ultimately, this could of course result in less than satisfactory trade fills. Some houses are experts in systems and straight-through pro-cessing, whereas some hedge funds need bespoke solu-tions and dedicated attention from structuring experts; managers could find themselves with no one to call when their day moves left of centre. Another area to ensure

a suitable fit is in credit risk, especially on less vanilla trades. Leverage ratios can be a major cause of friction so it is impera-tive that the PB and the manager see largely eye-to-eye on things like volatility and concentration.

HFM: What are the potential long-term consequences for hedge fund managers that are not highly prioritised by their prime broker? How do they recover?LO: Being assigned a low pri-ority can manifest itself in vari-ous ways; perhaps one may not receive the day-to-day care and attention they were hoping for

on the operational side, for example, with enquires not dealt with in a timely manner. As things become more severe, short positions may be re-rated and recalled more often than anticipated, or even not covered at all. The margin-loan book on the long side may even be re-priced. Access to scarce recourses, such as new issu-ance allocations, may become limited or non-existent. And ultimately fund managers may be cut by their PB altogether, which is happening more and more as major banks focus on their core clients due to ever-increasing regulatory pressures, forcing banks to evaluate the return on assets (ROA) of their clients and imposing tougher restrictions on bank capital and liquidity. To remedy the situation, one can always try and work more closely with their PB to help them meet their required ROA and

FUND MANAGERS MAY BE CUT BY THEIR PRIME BROKER ALTOGETHER,

WHICH IS HAPPENING MORE AND MORE AS MAJOR

BANKS FOCUS ON THEIR CORE CLIENTS

”

Lawrence Obertelli works in prime brokerage sales at Global Prime Partners. Having worked in prime brokerage for nine years, Lawrence focuses on providing securities finance solutions to both established and start-up hedge funds across Europe.

UTILISING YOUR PRIME BROKER

LAWRENCE OBERTELLI OF GLOBAL PRIME PARTNERS INVESTIGATES THE IMPORTANCE OF WORKING WITH YOUR PRIME BROKER IN AN EFFECTIVE WAY



make more efficient use of their balance-sheet. If these measures aren’t sufficient then the final solution may be to migrate the business to anoth-er PB. One that is as keen to do business with the manager as the manager is with them. One that can ideally move quickly and work within an off-boarding deadline. This last point can’t be stressed enough, on-boarding times vary hugely across the market; more nimble providers can be live with a client within a month whereas less enthusiastic ones can take six to nine months.

HFM: What key industry trends will be of the most significance to the partnership over the next 18 months?LO: Brexit is on everyone’s minds but at this point in time, given the huge amount of uncer-

tainty, it’s extremely hard to estimate the nature of potential impacts. Hence, for now it will remain a case of wait-and-see but it would cer-tainly be advisable to take early consultation as soon as it becomes possible.

As previously mentioned, regulatory pres-sures – particularly those arising from Basel III or Dodd-Frank – are forcing banks to focus more closely on the profitability of their client base. We expect this trend to continue and pos-sibly even accelerate. Managers would be wise to keep an ear to the ground and try and track which banks are terminating relationships and if possible understand what client profiles are being affected. Some banks are pulling out of the sector altogether, which is obviously some-thing to watch out for.

REGULATORY PRESSURES – PARTICULARLY THOSE ARISING FROM BASEL III OR DODD-FRANK – ARE

FORCING BANKS TO FOCUS MORE CLOSELY ON THE PROFITABILITY OF THEIR

CLIENT BASE

”


S E R V I C E D I R E C TO R YH O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 6

Global Prime Partners, Sean Capstick, Head of Prime Brokerage // T: +44 (0)207 399 9457 // [email protected] Parker, CEO // T: +44 (0)207 399 9450 // [email protected]

Global Prime Partners is a multi-award winning financial services firm that provides prime brokerage, execution and clearing services to hedge funds, broker-dealers, asset managers, family offices and professional traders. Clients are able to access the global financial markets via its multi-asset class trading platform, which provides trade execution, margin financing, securities lending, clearing and custody services. Global Prime Partners prides itself on providing state-of-the-art technology and an institutional strength operational infrastructure, with a focus on tailored customer service.

Lawson Conner, Andrew Frost // +44 (0) 203 696 1302 // [email protected] Conner is an award-winning provider of hosted fund solutions for Hedge Fund managers, Private Equity managers, and other financial institutions. In addition we offer customised solutions in the areas of Fund Structuring, Outsourced Compliance, Global Regulatory Infrastructure, Fund Distribution, Appointed Representative Services and ManCo Services. Headquartered in London and with representative offices in the US and Asia, Lawson Conner has become a leading ‘Launch Partner’ for financial services businesses. Our ‘Discovery’ Investment Management Platform SPC was launched in 2015 allowing start-up and emerging managers to launch their own dedicated and protected sub fund, which is fully compliant with FCA, AIFMD and local Cayman fund regulation, within four weeks and at a fraction of the typical fund launch cost. For more information, please visit www.lawsonconner.com/discovery

netConsult Ltd, Holden House, 57 Rathbone Place, London, W1T 1JU // T: +44 (0)20 7100 3310 // F: +44 (0)870 318 3126 // www.netconsult.co.uk // David Mansfield, COO // T: +44 (0)20 7100 3310 // [email protected] // Laura Zverko, CMO // T: +44 (0)20 7100 3310 // [email protected] // Established in 2002, netConsult is an award winning provider of managed IT Services to the global alternative investment industry. We aim to provide a high level of technical expertise to our clients combined with a dedication to customer service. Our ethos is based upon designing secure IT platforms which are manageable over the long term. We are a trusted technology provider to a large portfolio of clients ranging from small start ups to large global funds. netConsult provides a bespoke service to its clients and provides a full suite of IT services including cloud services, outsourced IT, BCP, virtual CTO and IT security.

StatPro, Neil Smyth, Marketing and Technology Director // [email protected] // +44 (0) 20 8410 9876

StatPro is a global provider of award winning portfolio analytics solutions for the investment community. The organization’s cloud-based platform provides vital analysis of portfolio performance, attribution, risk and compliance. This multi-asset class analytics platform helps StatPro’s clients increase assets under management, improve client service, meet tough regulations and reduce costs. The organization has operations in Europe, North America, South Africa, Asia and Australia, with hundreds of clients in 37 countries around the world.

Valletta Fund Services Limited // [email protected] // Tel: (+356) 2122 7148

Valletta Fund Services Limited (VFS) was incorporated in 2006 as a fully owned subsidiary of Bank of Valletta plc, Malta’s largest banking group, to provide high-end fund administration solutions to the fund management industry. Through the dedication of its highly qualified and professional human resources as well as the significant investment in state-of-the-art technology, VFS has positioned itself as Malta’s leading fund administrator. As at July 2016, VFS was servicing over 124 investment funds representing 3.7 billion worth of assets, in excess of 35% of the local market. VFS is recognised to provide fund administration services by the Malta Financial Services Authority.

Linear Investments Ltd, Jerry Lees, Chairman, Linear Investments // T: +44 (0) 203 603 9801 // [email protected] Mark Burchell, Global Head of Sales // T: +44 (0) 203 603 9809 // [email protected]

Linear Investments Ltd is a prime broker and award winning FCA incubator supporting multiple hedge fund and broker clients, reducing setup costs and operational expenses. With Linear’s aggregated PB relationships we provide leverage, swaps, CFDs, custody and execution (desk & DMA). For capital introduction, Linear provides investment via its B&L Seeder Fund for seed/acceleration capital. In addition, Linear provides outsourced trading, regulatory umbrella, middle & back office, and hedge fund hotel services.

THE ONLY PRIME NUMBERYOU NEED TO KNOW

At Global Prime Partners, we are unique in our off ering. We provide levels of prime brokerage services to emerging hedge funds and asset managers that are traditionally reserved for none but the biggest institutional players.

Work with us, and you will access some of the world’s largest and most experienced clearing and settlement resources, while receiving a bespoke, personalised and fast-to-market service that is, quite simply, second to none.

To see how we can add value to your business, call +44 (0) 20 7399 9450or email [email protected]

PRIME BROKERAGE

TRADE EXECUTION

MARGIN FINANCING

SECURITIES LENDING

CONSULTANCY

globalprimepartners.comFOR PROFESSIONAL CLIENTS ONLY. NOT FOR USE FOR RETAIL CLIENTS. This is not a solicitation of any off er of service to US Persons. Any services described are not intended for US persons. Global Prime Partners Ltd. 4th Floor, 7 Old Park Lane, London W1K 1QR. Company number 06962351. Authorised and regulated by the Financial Conduct

Authority No. 533039

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