NEWS FEATURE: Analytical data may help funds avoid investor redemptions

By Ron Kashden, TKS Solutions Hedge fund administrators and managers are worried about maintaining a stable capital base and avoiding mass redemptions. One way to do this is to initiate liquidity gates and longer notice/lock-up periods.

However, there are other alternatives. Managers can proactively review investors and work to cultivate a naturally stable capital base that is diverse and strong enough to weather the tough economic climate.

Hedge funds are best prepared if they can start with their own data trends and analysis. Investor quality data can guide funds to help them understand performance trends and similar characteristics within their investor base and make more informed decisions on future planning and growth. This data can help determine if investors move in packs or whether changes in investor decision-making are geographically based. For example, are European investors moving differently than Asian investors and vice versa.

While managers use quantitative methods and complex algorithms to move liquidity and review their portfolio, hedge funds do not have an analytical framework for managing investor quality. Funds are usually more worried about the investor's due diligence efforts.

Hedge funds need a way to analyze and quantify their capital base. Investor quality metrics are among the more vital statistics. With accurate measures managers can create a stable capital base and make the investment process much easier.

Investor quality contains four components: size, longevity, frequency and sensitivity. By applying various weights relative to a manager's concerns, it is possible to derive an overall measure of the quality of the capital base. For example, if the main concern is the possibility of the majority of the investors redeeming at one time, then investor concentration should carry the most weight. If slight or large downturns triggering redemptions is the prominent concern, then the focus needs to be on sensitivity.

Size is the amount of capital that an investor has in a fund. Size equals investors balance/total capital balance. Although this may seem straightforward, the implications of investor size are not. A fund with a few substantial investors holding the majority of the capital will be held captive to the whims of these investors. A diversified capital pool containing many types might require more support by investor services, since each investor may have different needs.

Longevity is the length of time an investor has been in the fund. Analysing longevity is most useful when combined with other characteristics, such as type and geography. Using the combined metrics methodology makes obtaining desirable investors a more focused effort.

Frequency is the number of times an investor makes additional contributions. When frequency is combined with cash from the investors, a fund will have more accurate forecasting of future subscriptions.

Sensitivity is the measurement of an investor's tendency to redeem if the fund suffers a loss. This is the least direct metric because it is difficult to determine what time period affect an investor's decision. Mechanically the redemptions are associated with the funds returns, while a manual review should be performed to verify patterns.

Hedge funds are increasingly faced with the need to provide complete investor transparency as well as demonstrate ongoing revenue growth in an uncertain financial climate. Managers are forced to be more sophisticated because of the consolidation of hedge fund and an increasingly difficult investment environment.

In addition the trend of applying discipline, now present in investment decisions, needs to be present in all aspects of fund operations. A more prominent concern is effectively managing the capital pool.

Office systems and administrators need to give funds the rich analytics needed to operate effectively rather than just churn out simple investor statements.

Companies need access to sophisticated data analysis functionality that is intuitive, manageable and cost effective. There are various approaches to managing investor quality that provide various ranges of functionality to help with accounting practices.

Some points to consider when evaluating investor reporting and accounting processes include reporting accurately and speedily. Ad hoc investor reporting is a growing priority for hedge funds. Investors are evaluating closely a fund's ability to do this and are much more stringent today than previously.

Investors want complete transparency and are demanding ad hoc reports from their funds. They want instant review and accountability and will not tolerate restatements. To provide optimal investor reporting response and accurate daily, weekly and/or monthly statements, funds must focus on the back-end processes as well. This includes expanding the focus beyond the portfolio valuation and integrating systems so that reporting becomes easy to manage and not an end-of-the-month task.

Many hedge fund managers and administrators evaluate financial decisions and manage investors' funds with limited forecasting options. Funds either need to spend a great deal of money to purchase forecasting software or spend large amounts of time and resources to create an in-house solution.

Funds need to be able to tailor their data analysis based on individual and varied market strategies and concentration areas. A fund should be able to forecast its capital base as close or far out as needed to review accurately performance, fees, withdrawals and other elements.

While funds traditionally focus on using sophisticated algorithms and analysis tools for the front office, the back-office accounting structure can be limited to Excel documents and manual entry. An option that offers a business intelligence (BI) approach to data is needed.

A fund needs to be able to see the data behind the data and analyse performance based on specific business rules and parameters. A fund should be able to compare performance against other industry indexes and performance areas to check growth against outside market parameters.

An analysis and best practices needs to be in place to help a fund avoid large groups of redemptions, initiate liquidity gates and pinpoint potential issues. Having access to expanded performance calculations goes a long way for forecasting and trending the capital base as well as providing a tremendous competitive advantage. Also, this expanded view provides a chance to calculate fund and investor returns, providing firms with an idea of how they are performing net of any fees on a daily basis.

Having a centralised data approach gives funds complete access to all financial data leading to more informed decision making.

Funds should evaluate whether data is housed compartmentally or if it is part of a larger data repository, interfacing with customer relationship management tools, data warehouse solutions and business process management as well as prime broker and custodial systems for a holistic view of all data. This approach helps funds expand analysis beyond manual spreadsheets and gives them the ability to make decisions based on hard data.

The last situation a hedge fund wants to be in is answering questions about reporting and accuracy when it comes to performance statements. This report is the only tangible product an investor receives. If it is incorrect or miscalculated, it will raise questions about the fund's credibility and the administrator's ability to manage operations.

Questions about back office systems and accounting practices can be avoided by measuring investor quality using both quantitative and qualitative approaches.

A combination of committing to best practices and employing data analysis solutions can help a fund succeed in uncertain times by decreasing manual errors and mistakes. As this combined approach makes its way into more fund infrastructures, the burden of generating consistently correct statements and long or infrequent reporting to investors will be an historic anecdote.

In today's economic environment there is little room for error when it comes to managing investors and their money. Partnership and shareholder accounting are critical functions for any fund.

The good news is that in addition to anticipating future trends and pitfalls, as well as reviewing and updating month-end procedures, hedge funds can use real-time data to stay ahead of the market and competition.