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2013 Business Expense Benchmark Survey
average spend by $4.03 million to reach a total of $7.2
million—127% more than the $3.17 million spent on
investment support and business management from
firms with $500 million AUM.
The emphasis of where they invest in their business
also shifts.
As in the earlier period, investments in business
management remain a substantial outlay, rising by
$946,343 in our model — 23% of the total increase
in spend. Also, as before, business management
remains the single largest expense for these hedge
funds, accounting for 24% of their total spend across
investment support and business management.
Our model shows total expenditures on business
management by firms at the $1.5 billion AUM
threshold equating to $1.73 million.
Outlays in other areas are beginning to rival the
amount spent on business management, however. As
shown in Chart 9, spending in both operations and
technology jumps sharply as firms extend beyond
the institutional threshold. Collectively, investment
in these two functions amount to $1.89 million, or
47% of the total rise in expenditures. Spend across
operations and technology accounts for 41% of the
total for firms at $1.5 billion AUM, up from 35% of
total for firms with $500 million AUM.
While not as substantial an outlay as that allocated
to operations and technology, expenditure on
compliance is the other area that shows a sharp jump
on a percentage basis as firms move from $500million
to $1.5 billion AUM. Our model shows that outlays on
compliance jump from $212,611 to $607,115, a rise of
186%. A likely driver for this increased compliance
expense for funds managing $1.5 billion is the “large
filer” status that goes along with this increased asset
level. Surpassing this threshold requires a more
frequent and more in-depth regulatory filing to the
SEC and/or CFTC via Form PF, per the provisions of
the Dodd-Frank Wall Street Reform and Consumer
Protection Act.
All of these investments in operations, technology
and compliance are hallmarks of firms moving into a
more institutional phase. Ensuring more professional
operations and oversight, and upgrading systems
to meet institutional demands for a strong control
environment, are required to attract institutional
dollars. These investors typically rely on industry
consultants to perform operational due diligence on
the hedge funds they are considering for an allocation.
A key milestone for firms rising above the institutional
threshold is passing the robust due diligence exams
performed by the industry consultants and qualifying
to be placed on their “approved list” of hedge funds
deemed suitable for their clientele.
Becoming Profitable: Moving from
$1.5 Billion to $5.0 Billion AUM
While passing the $1.0 billion AUM threshold qualifies
a firm to be institutional, reaching the $5.0 billion
AUM threshold is where the venture becomes highly
profitable based on the size of their assets alone,
regardless of their investment performance. This
was illustrated in Chart 7. Our analysis indicated that
while firms with $1.5 billion AUM were generating a
$13.7 million operating margin, the size of this margin
increased dramatically, to $47.7 million, for firms at
the $5.0 billion AUM mark, a rise of 3.5x in profitability
versus a 3.3x increase in AUM.
This analysis supports the “sweet spot” identified
back in our 2011 Industry Evolution survey that
focused on those institutional investors that chose
to directly allocate their capital. In that report, we
noted that leading investors sought firms above the
institutional threshold but with less than $5.0 billion
AUM. The reasoning of these investors was that firms
at $5.0 billion AUM and above were not as incented
by performance, and that they were not as willing to
negotiate with investors on terms and customizations
because they were already highly profitable based
solely on the level of assets they were managing.
The changes in expenditures that characterize a $5.0
billion versus a $1.5 billion AUM firm are noted in Chart
10. As shown, this is the largest jump yet in spending
as outlays rise to $21.7 million, up $14.5 million from
the level being spent at $1.5 billion AUM and 301%
more than the total spend for those firms.
Large increases occur across several categories,
but by far the most dramatic increase is around the
amount spentontechnology. Technologyexpenditures
increase by 418% as a firm moves from the $1.5 billion
to the $5.0 billion AUM level. This sharp jump reflects
an important developmental shift that occurs.
Many hedge fundmanagers that have been performing
upgrades to their original launch infrastructure now
reconsider the efficacy of their platform and may
choose to make a more substantial and strategic
investment. Much of this has to do with the need to
better manage data. Often, firms have put into place
different order and portfolio management, risk,
compliance, financing and accounting systems that
are each generating their own data outputs. Pressure
to integrate these systems builds as a firm nears $5.0
billion AUM.
Some of this pressure arises from stakeholders within
the firm. Overseeing and optimizing the firm’s use of
capital and collateral becomes increasingly important,
especially because this is also the threshold where,
developmentally, many of these organizations begin