Hedge Fund Margins Squeezed by Compliance Costs

The vast majority of the $3 billion spent industry-wide on compliance has come out of managers' bottom lines, according to a survey. 

(October 17, 2013) — Hedge fund managers have put substantial resources into achieving regulatory compliance, according to a survey.

A survey by the Alternative Investment Management Association (AIMA) found that a majority of 200 managers representing $910 billion in assets invested heavily in this respect. The industry has spent more than $3 billion, or an average of 7% of total operating costs. 

The hefty cost of compliance technology, headcount, and strategy has taken a toll on the industry, AIMA said, as managers were reportedly absorbing 76% to 100% of the costs.

“For established funds and managers, the rising cost of compliance is squeezing margins, and for some is influencing product and operating model decisions,” the report said.

The burden was heavier for smaller firms, the survey found. Funds with less than $250 million in assets under management were spending more than their bigger peers. Over a third said compliance costs amounted to more than 10% of their total operating costs.

North American firms reported to have spent more on compliance than their European and Asian counterparts.

Managers also said regulatory requirements such as Form PF and Alternative Investment Fund Managers Directive (AIFMD) involved much time and legal counsel. A third of those surveyed said they’d spent between 50 and 100 hours preparing and filing for the US Securities and Exchange Commission (SEC) registration and a quarter dedicated between 100 and 500 hours.

“We’ve had to almost double the size of our legal and compliance teams to deal with these regulatory changes,” said one hedge fund manager. “It’s made it challenging to grow.”

Outsourcing the work has become necessary for some managers, the survey found.

“Form PF is hundreds of pages long,” said one US-based manager. “We had to outsource the heavy lifting to serve providers and pay technology providers for risk and data warehousing services.”

Increasing operational focus on compliance could have significant negative impacts on the hedge fund industry, some managers said.

“The entire nature of the alternative investment industry—particularly the hedge fund industry—is one of innovation and finding new ways to achieve alpha,” said one fund manager in Asia. “There’s no doubt that regulation is constricting this and making it harder for new players to enter the market.”

Andrew Baker, CEO of AIMA, agreed: “It is important that regulation does not raise barriers of entry to the industry. Next generation managers are an important source of new ideas and talent.”

Despite potential dangers, regulatory compliance is expected to grow over the next five years, AIMA said. Almost 90% of surveyed managers said they predict their compliance-focused technology spending to rise.

The continually changing regulatory schemes also led managers to more directly-operated products, the survey found. One in five managers already had a UCITS fund and one in ten are currently managing a “40 Act fund.”

But the hedge fund industry’s continuous effort to comply with regulations is good news, AMIA said. The data showed that manager are striving for improved transparency and investor protection.

“In supporting the goals of global financial reform, and reinforcing that support with these investments in compliance, the industry has acted as a willing partner with regulators and policy makers in creating a safer, more stable, and efficient markets for investors,” Richard Baker, president and CEO of Managed Funds Association, said.

Related content: Are Hedge Funds AIFMD Ready? Er, No., Controversial European Tax to be Watered Down

By Sage Um