Will Adapting To Today’s Evolving Demands Help You Stand Out Tomorrow?

Originally published in the March 2017 issue

Talent management
Talent management has been increasingly on the radar of fund managers and investors alike. The industry has always been on the lookout for the next generation of star managers. However, rarely in the past did hedge funds find themselves competing against other industries for the top talent. Today, not only do fund managers compete against each other, but they are also battling technology and Internet giants as well as venture capital and start-up companies across all industries for the best people. Additionally, managers need to be cognizant of the changing demographics of the workforce — what attracted and retained talent a decade ago is significantly different than what today’s employees are looking for. Managers big and small alike are taking notice and implementing programs that they believe will help them secure the talent that will drive their business forward in the future.

Talent management programs are evolving, as managers focus on attracting and retaining talent
After growth, talent management is viewed as the top priority of hedge fund managers. In many ways, the twoobjectives — growth and talent — are aligned. A manager requires the right employees to execute on their growth objectives.

The skillset of today’s talent and what will be needed in the future also continues to evolve. As managers increase their reliance on automation and outsourcing, employees are less often involved with performing routine tasks. Today’s talent and that of the future need to be prepared to handle complex tasks that cross-functional groups. Individuals with a deep understanding of the business will be of the upmost value to managers.

Aside from all-in compensation, managers see culture and reputation as keys to attracting and motivating talent. Larger managers also say that opportunities for advancement are essential.

As the industry has matured and many areas of managers’ operations have become more institutionalized, one area that has lacked attention is the talent management programs. Managers should continue to formalize their talent and career development programs and focus on areas such as generational needs and diversity and inclusiveness programs.

The millennial generation recently became the largest percentage of the overall workforce. Just like Gen Xers differed significantly from the Boomers prior to them, Millennials have significantly different desires and need to be incentivized. Millennials place a high emphasis on compensation, but almost equally important to them are jobs that promote upward mobility and ability to support personal goals, two considerations that fund managers do not currently think are the most important to their talent programs relative to other factors.

Three-quarters of investors request information about a manager’s talent management program during due diligence
Talent management also plays a critical role in the competition for institutional assets. Investors are increasingly requesting details on managers’ talent management programs as part of their due diligence. 75% of investors indicated that this was a key consideration of their due diligence process.

Compensation and retention strategies were the two most critical considerations. Investors want to ensure that their managers attract and retain the right talent and that incentives are aligned with their interests. One in three investors are also interested in how managers are developing and training their personnel. Investors want to understand the efforts being taken to enhance skillsets of other personnel, so they are relevant and keeping pace with the rapid evolution of the industry.

“Lack of growth and talent are related. If organizations aren’t really growing, it’s tough to attract talented people. People naturally want to go where the business is growing and where there are personal growth opportunities. As an investor, we are focused on our managers’ ability to grow, as it will have a direct relation to their ability to employ the best people.”
(Europe, Pension and Endowment)

Investor loyalty — a disconnect between manager perception and reality
Although managers are confident that client loyalty is rooted in strong relationships with the firm’s founding principals, investors state clearly that their primary allegiance is to their portfolio managers. In periods suchas this where attracting and retaining capital is so critical and challenging, managers would be wise to recognize that 55% of investors say they are most loyal to individual portfolio managers, and not necessarily the founder or firm as an institution.

This suggests that managers should be focused on ensuring their talent program is appropriate to grow and retain talented investment professionals. Succession plans should be put in place for their portfolio managers to give investors confidence in the institution’s ability to generate returns if a “star” leaves.

However, few managers are planning for the succession of their critical front-office personnel. There have been various high-profile examples of effective succession planning, where investors were comfortable remaining with an institution long after its original founders and/ or key portfolio managers stepped away from leading the organization. As managers increasingly view themselves as franchise institutions, adopting more formal succession plans will be critical.

Investors also focused on the non-trading executives
Due diligence on talent is not limited to the front office. Most investors believe that vetting the chief operating officer is critically important. A high proportion of them also vet a firm’s chief financial officer and value the role of an empowered chief compliance officer.

Roughly half of managers have documented succession plans for certain positions, but relatively few have plans for critical operational roles. Across all of the key noninvestment executive roles, less than 2 in 10 managers have documented succession plans.

Given the importance investors place on the individuals fulfilling the chief operating officer and chief financial officer responsibilities, we would expect more managers to prepare contingency plans and succession plans for these roles to avoid investor concern and disruption to the operations of the firm in a period of transition.

Future risks and opportunities
Greatest risks facing hedge fund managers

Hedge fund managers and investors agree that changing investor preferences represents the top risk for managers going forward. Managers that are able to adapt to the changes in demand will be most likely to succeed in the future. Interestingly, this risk is most prevalently identified by the largest managers. The survey has shown that these managers have been most proactive at insulating themselves from the risk by diversifying their offerings to investors.

Regulatory and reputational risk often go hand in hand and likely will always be top of mind given the low tolerance for errors and the significant price to pay when such an issue arises.

Lack of growth remains a constant threat but is viewed as a significantly larger issue for the smallest managers. These managers struggle with the increased barriers to entry. With costs on the rise, smaller managers need growth to survive, as well as facilitate their future business goals. At 61%, this was, by far, the top risk noted by the smallest managers.

Subsequent to the financial crisis, managers have become very proficient at addressing operational, liquidity and counterparty risk. While each represents a significant risk, managers and investors appear relatively comfortable with the measures in place to mitigate such matters.

“Our industry is based on having investors. If investors choose not to be in hedge funds, which they have been actually doing, then that’s a risk for us. For example, there’s been more than one endowment or big investor base that’s decided 100% to pull out of hedge funds. We need to be better at understanding what investors need.”
($2b–$10b, North America, Multi-strategy)

The largest hedge fund managers are advanced in thetransition to becoming diversified alternative asset management platforms
Managers today continue to hold steadfast to their goal of growing into larger, diversified asset managers. Seventy-one percent of the largest managers describe themselves as multi-product asset managers, and a significant percentage of midsize and smaller managers expect to move from offering solely one core strategy in a hedge fund product to a greater diversification of offerings.

We saw this trend last year and continue to see hedge funds expecting to have bigger ambitions about their future state than how they currently describe their business. The largest managers are well along this path, and the number of managers that focus solely on core hedge fund strategies continues to decline. Managers that have not reached the same scale show ambitions of moving in this direction also, but need to be aware of the operational challenges that come with customization and product proliferation and prepare accordingly.

These transformational changes cannot occur without the leadership and support of the entire organization. Hitting these goals requires the alignment of the business — front to back — alongside strategic and thoughtful collaboration with counterparties and third-party service providers so that the manager can package an optimal offering to best partner with its investors.

Today’s hedge fund industry is rapidly evolving — managers run businesses and operations that more closely resemble institutional financial franchises and investors are more sophisticated and tactical in analyzing their investment portfolios broadly and how hedge funds specifically fit into the mix. On account of modest hedge fund performance, as well as a plethora of investment opportunities in the alternatives universe, leverage has swung significantly to the side of investors who are demanding more from managers — both with regards to terms that are more aligned with investor interests, but also for product offerings that are catered to their specific needs and identified objectives. Many managers have been quick to adapt and are having success operating on this new playing field. Others who have been slow to react or who have dug in their heels in resistance to change are finding it very difficult to attract, and retain, investor capital.

The issues and dynamics unfolding today show no signs of abating in the future. So what does this foretell for the industry? Managers who take all measures to best partner with their investors will find success. This means recognizing that each investor is different andone-size-fitsall solutions likely will not appeal to the masses.

Innovation will be front and center — both in utilizing a variety of ways to differentiate from an investment strategy perspective, as well as for purposes of designing a best-of-breed operating model. Next-generational data analysis is increasingly being utilized by managers of all strategies to identify alpha. In the back office, robotics and other automation are creating efficiencies and driving savings necessary to counteract margin compression. The financial barriers to entry are not scaling back and the reality is that it will make the path to prosperity more onerous for smaller and midsize managers. Like other mature industries, one has to think that consolidation will be a trend to monitor. Larger managers have the scale and infrastructure to be opportunistic in acquiring teams or entire fund groups from smaller managers, where such acquisitions give larger managers the ability to further diversify their business.

Periods of change, while often difficult to manage, always result in opportunities. Those managers who are embracing this new environment, taking stock of their capabilities and identifying the threats posed by competitors and other forces, are positioning themselves to surge ahead and not just survive, but thrive in the future.

“In the struggle for survival, the fittest win out at the expense of their rivals because they succeed in adapting themselves best to their environment.”
Charles Darwin

Background and methodology
The purpose of this study is to record the views and opinions of hedge fund managers and institutional investors globally.

Topics include managers’ strategic priorities and product demand, cost management, evolving prime brokerage relationships, talent management and the future landscape of the hedge fund industry. From June to September 2016, Greenwich Associates conducted:

  • 10 telephone interviews with hedge funds, representing nearly $1.1 trillion in assets under management (AUM).
  • 63 telephone interviews with institutional investors (fund of funds, pension funds, endowments and foundations) representing more than $1.5 trillion in assets under management, with roughly $280 billion allocated to hedge funds.