Reshaping the Marketplace

The new generation of boutique asset managers

Originally published in the February 2010 issue

The political and commercial drama continues to unfold around the future of the City of London and New York as leading financial centres. But it’s clear that one option for displaced or disenchanted traders is to set up one of a growing number of boutique asset managers (BAMs) and hedge funds.

Indeed, one of the by-products of the economic meltdown is that there is now room – and a growing appetite – for new and different BAMs and funds that can offer a higher return on investment than larger funds. This is leading to a new generation of BAMs and hedge funds that are being created and launched within very tight timescales.

The reason for the trend is not difficult to trace. At the beginning of 2009 funds began to flow back into large asset managers as investors sought security. But despite the size and stability of larger asset managers’ funds, the returns for investors were not always satisfactory and in some cases were failing to match returns on market indexes.

Meanwhile, smaller BAMs and hedge funds were achieving high returns. They managed these returns because they focused on a wider range of instruments and were able to change direction quickly when new opportunities for different investment strategies emerged.

The fluidity of this new market sector is attractive to traders who have either become disillusioned with senior roles in the ‘safer’ world of post meltdown asset management, or who have been one of several thousand financial professionals who have lost their position as a result of the downturn. As a result, we are seeing a growing number of senior players spinning out of the large banks and asset managers to set up their own new funds. Whether this is largely due to the clampdown on bonuses or the tighter regulation of the market isn’t clear, but one key driver is the desire to return to a more entrepreneurial, flexible trading environment in which traders can get back to grassroots.

We’re also seeing a reshaping and renaming of the BAM marketplace, with funds christening themselves as ‘value’, ‘macro’, ‘liquid’ or ‘opportunity’ funds. Increasingly, they don’t want to put themselves in the box of a single instrument such as long, short or credit, but instead want to remain open to new opportunities and instruments as they arise.

A third trend is the move by family offices to extend beyond the management of their own funds to look after investments of a wider range of investors, as well as a wider range of asset classes and instruments. Often built from the ground up, these new BAMs and hedge funds require a new and reliable business model and set of processes to operate. Although the (current) lack of regulation for hedge funds and BAMs on both sides of the Atlantic is another reason for individuals to set up on their own, smaller organisations know that they still need to operate as though they already have to report to the financial regulators.

Another factor behind this trend is that investors need to be encouraged to bring their money back into the marketplace and are risk averse, while still requiring strong returns. This means that BAMs and hedge funds alike are having to adopt tools and technologies that allow them to report transparently and regularly to clients and brokers.

Smaller funds also need to prove to investors that they can get new concepts to market quickly and within stated timescales. And funds increasingly need to operate with multiple prime brokers – giving them the flexibility to move securities quickly between them when necessary.

Yet speed is not the only factor that makes this new breed of entrepreneurial BAMs and hedge funds a success. There is also a realisation that they need a robust and reliable platform in order to cover market risks, credit risks and market fluctuation. Crucially, they need to start out on a platform that allows them to trade in a wide range of asset classes, both now and in the future.

So how can BAMs prove that they have the platform in place to support all of these requirements, from transparency in reporting on one side to an inventory of transactions at the other? How can they convince potential backers and clients that they have what it takes to build a business not just for today but for tomorrow as well?

Sophis has been relatively successful in this area of the market because it can demonstrate a strong implementation track record. We have definitely noted new BAMs and hedge funds using the ‘Sophis Inside’ argument to prove to investors that they have the mechanisms in place to manage and report risk, as well as manage the widest possible range of assets. Indeed, one of the trends that we have seen is that while experience and flair of the fund manager are absolutely imperative to the success of a new venture, having the right IT platform in place is almost as important. One example is 1798 Global Partners, the New York based alternative asset management arm of Lombard Odier’s asset management group. 1798 announced in August 2009 that it would also run its business on Sophis VALUE.

Stephen Grobman, Chief Risk Officer of 1798, commented: “Our primary requirements when looking for a system were firm-wide risk management capabilities and scalability. With Sophis, not only have we put in place a risk system that can be scaled to our future needs, but a portfolio management system that has given us an edge in handling complex instruments.”

A second benefit for 1798 was the ability to manage multiple brokers from one system. Grobman adds: “One of the key benefits is that easily and quickly we can slice and dice our portfolio according to prime broker in order to see which securities are held where. We have a basic understanding of how each prime broker calculates its capital requirements for the positions held. At our end we use Sophis to estimate those calculations, which in turn allows us to manipulate our portfolio in such a way that we optimise our allocation with each of our prime brokers.”

As well as seeing strong demand for our VALUE software in this new area of the marketplace, we’re also noting growing interest in our iSophis tool, which enables smaller funds to manage transparency and reporting without a big upfront investment in IT infrastructure. All of the signs are that new and interesting ventures will continue to be launched in the aftermath of the downturn. Opinion is divided about whether the trend will begin to reverse in line with the recovery – will bigger banks and asset managers swallow up start-ups to increase their asset exposure, or will regulation prevent them from taking this course of action?

Sebastien Roussotte is Chief Operating Officer of Sophis for the UK and Scandinavia. Sophis is a provider of cross-asset, front-to-back portfolio and risk management solutions to financial institutions worldwide.