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Emerging Managers Insight Ar cle Series
Advice for today’s hedge fund managers from experts in prime brokerage, legal, compliance, technology and more
TABLE OF CONTENTS Unveiling our Emerging Managers Insight Ar cle Series ………….………….……………………………...….3 The Prime Brokerage Perspec ve for Emerging Hedge Fund Managers ………...………………..…....4 Should I Go With the Flow Into Liquid Alts? ………………………………………………..……....…………..…...6 Assessing Never‐Examined SEC‐Registered Investment Advisers: An SEC NEP Priority ….….….12 A Hedge Fund’s Guide to Technology Decisions: From Cloud to DR ….…………………………….…...15 Can an Alterna ve Strategy Investor Know the Valua on Given is Correct? .…………………….….19 At Hedge Fund Trading Desks, Furniture Ma ers …………………………………………………………………22 About Eze Castle Integra on ……………………………………………………………..….……………………….…….24
© 2014 Eze Castle Integra on 2
UNVEILING OUR EMERGING MANAGERS
INSIGHT ARTICLE SERIES
3 © 2014 Eze Castle Integra on
The start‐up environment for hedge fund firms con nues to evolve as
managers face changing investor and regulator expecta ons, increased due
diligence, new investment opportuni es and advancing technology innova ons.
To help firms navigate the new launch environment, Eze Castle
Integra on is excited to share our Emerging Managers Insight Ar cle Series. The
Series, created for emerging hedge fund managers, brings together expert
guidance from industry insiders across prime brokerage, legal and compliance,
technology and fund management.
Contributors to the Series include senior leaders at Eze Castle
Integra on, Jefferies & Company, Rothstein Kass, Tannenbaum Helpern
Syracuse & Hirschtri LLP, Wells Fargo, FQS Capital Partners, and CFS Group.
4 © 2014 Eze Castle Integra on
THE PRIME BROKERAGE PERSPECTIVE FOR EMERGING
HEDGE FUND MANAGERS BY: GLEN DAILEY, FORMERLY OF JEFFERIES & COMPANY
Star ng a hedge fund is easier than ever with
many vendors offering turnkey services to get a fund up
and running quickly. The challenge is star ng a successful
hedge fund that will grow and become a viable
organiza on. With over 8,000 hedge funds opera ng
around the world, the compe on to a ract hedge fund
investors is greater than ever. For someone star ng a
fund, you have to rely on your own capital and that of
your friends and family to get the fund
off the ground. From there, the key to
success is outstanding performance.
Someone star ng a fund
should set a realis c schedule to
launch and not rush to get the fund up
and running too quickly. Take the me
to partner with the right service
providers that will support your
business from the start and be there
as you grow. Have a plan going into your new venture,
which should include lining up friends and family as day
one investors as well as reaching out to other investors
to start a pipeline before you actually launch the fund.
Once you are under way, you will end up ge ng ed to
your screens, focused on performing, and me for
marke ng becomes scarce.
I would also recommend for a new fund to
budget for a marketer in their first two years of
opera on. You can contract with a third‐party marketer
or hire an in‐house person. If you look at the largest
funds in the industry, they all have substan al investor
rela ons teams that keep current investors informed
while prospec ng for future investors. The largest funds
did not get to where they are by wai ng for someone to
knock on their door looking for a good hedge fund. They
built their funds by ac vely seeking new investors and
building a brand that becomes known in the market
place.
With so many compe tors in every strategy, you
have to be proac ve in your approach to make sure that
when an allocator is looking for a
par cular strategy, you have already
laid the ground work by having a pre‐
exis ng rela onship, which makes it
easier for an investor to perform due
diligence and ul mately make the
investment.
Prime brokers offer services
such as por olio and risk repor ng
which makes your ini al technology
investment fairly minimal. There are other outsourcing
services for technology, compliance, trading and
accoun ng that are very economical and provide an
ins tu onal infrastructure. Capital introduc on is a
much sought a er service from prime brokers which
could be very helpful in providing a new fund exposure
to poten al investors. Capital introduc on is exactly
what a prime broker provides.
A fund has to take advantage of introduc ons
and begin to build rela onships and add to their list of
investors and poten al investors. All professional hedge
fund investors want to know about new funds and funds
that are performing well. They may not be willing to have
“The largest funds did not get to where they
are by wai ng for someone to knock on
their door looking for a good hedge fund”
5 © 2014 Eze Castle Integra on
mee ngs up front, but they all want to be on your
mailing list and follow your fund’s performance and
growth through your monthly le er.
Star ng a fund is about star ng and managing a
business. Most new managers come with great
investment capabili es and li le business opera ng
experience. The services of your prime broker and other
service providers can make the transi on a whole lot
easier.
Many prime brokers offer consul ng services to help
guide you through the maze of real estate, technology,
benefits and staffing. These services can be a great value,
and their experience can help you avoid costly mistakes
that may distract you from your real mission, which is to
make money for your investors.
The hedge fund industry has grown and become
more ins tu onalized over the past 25 years. The
industry is expected to con nue to grow for years to
come as absolute returns become the only alterna ve in
a vola le market for corporate and state pension funds
that are underfunded with huge obliga ons to meet in
the years ahead. There will always be room in the market
for talented individuals, and the most successful will be
the ones that start with a solid founda on.
A A
Glen Dailey is the former Managing Director and Head of Prime Brokerage at Jefferies & Company. He
previously founded Banc of America Prime Brokerage in 1995 and was most recently their Chief Opera ng
Officer. Prior to Banc of America Securi es LLC, Glen was a Managing Director and Head of Prime Brokerage
for twelve years at Furman Selz LLC.
6 © 2014 Eze Castle Integra on
As regulatory requirements become more
complex and onerous in the alternative investment
space, there is clearly an evolution taking place in the
market. There is an ongoing trend toward adding
registered or retail products among many hedge fund
managers. They are seeking new structures to bring their
strategies to market while putting themselves in the best
position to tap retail investors and wealth advisors in the
new competitive landscape.
It’s no secret that a significant amount of capital
is looking to move into the alterna ve investment space
– just look at the numbers. According to Ci group, assets
in liquid alterna ve funds have surged from $95 billion in
2008 to more than $300 billion last year. Ci es mates
that number will hit $1 trillion by 2017.
If you look at the trajectory, what seems to be
clear is that liquid alterna ves are here to stay. What
may not be so obvious to some alterna ve managers is
whether they should stay on the private fund side or
follow the asset flow into the retail space by adding
addi onal product offerings. It’s not a move that should
be taken lightly.
Managers have to make smart, informed
decisions about whether a registered product is right for
them, and how they can best implement the strategy if
they decide to make the move. There are many
ques ons that need to be answered, and many op ons
that need to be considered before making such a cri cal
decision.
To help managers make more informed
decisions in the new liquid alterna ves reality, Rothstein
Kass has compiled a set of important ques ons
managers must ask themselves, and other cri cal
considera ons that should be part of their decision‐
making process.
For hedge fund managers, the potential to tap
into the mass affluent market through retail distribution
channels is extremely enticing, but not if it comes at the
expense of their current business. The goal of launching
a liquid alt fund should be to gain access to a new pool of
investors that could not be reached with a private fund,
not to move current investors from one product into
another. Managers have to take a hard look at how a
SHOULD I GO WITH THE FLOW INTO LIQUID ALTS? BY: FRANK ATTALLA, CPA, AND MARC J. WOLF, CPA, ROTHSTEIN KASS
1.Will a registered product cannibalize my exis ng private fund business?
7 © 2014 Eze Castle Integra on
registered product will impact their existing private fund
business.
For example:
Will it be additive or will be it be competitive?
Can you clearly articulate the differences between
the product offerings and the value to different
investor segments? If not, then it is unlikely you will
be successful long‐term.
If investors feel they can get the same
diversification and upside in a retail product — without
paying the performance fees of a hedge fund — why
wouldn’t they simply move their assets from one
product to another at the first opportunity?
Beyond investor perception, managers must also
consider operational resources and other elements that
may take away from the success of a current business. It
may seem like a product extension but, in reality,
launching a liquid alt fund is like launching a new
business that requires a:
Well‐thought‐out business plan,
Thorough competitive analysis, and
Realistic view of what impact that new business will
have on your existing revenue.
This may seem like a simple question, and for
some managers it is. The reality is that most strategies
can fit into a mutual fund or liquid alt model, as long as:
You have the proper structure for trading
commodities,
You don’t have a significant amount of illiquid
assets, or
You’re not highly levered.
And, in some cases, even if managers do have
significant illiquid assets, they can utilize a listed or
unlisted closed‐end fund and still reach a new pool of
investors.
So, instead of thinking of this as simply a yes or
no question, this decision may come down to a question
of nuance. The following are all questions that managers
should not only consider, but talk through with their
team of experts:
Do you fully understand what you can or cannot do
from a strategy standpoint inside a registered
vehicle?
Do you understand how you can or should alter your
strategy to be most effective in the registered
arena?
Are you aware of the registered product structures
that would be most conducive to your particular
strategy?
The reality is there is no typical alternative
mutual fund, and there is no cookie‐cutter approach to
being successful in the liquid alts space.
Distribution is critical to the success of any
investment product, but in the increasingly competitive
world of liquid alternatives it’s even more so. Managers
can have the best investment strategy out there, but if
they do not have a sound distribution strategy with the
right distribution partners and channels, it will not
matter.
What managers have to understand is that retail
distribution is a whole different animal than private fund
distribution. Hedge fund distribution is more
relationship‐driven, while mutual fund distribution
requires systematic institutional selling. Mutual fund
distribution requires managers to consider everything
from strategic product positioning and pricing to
2. Will my strategy fit inside a mutual fund?
3. Do I understand the distribution landscape?
8 © 2014 Eze Castle Integra on
understanding the peer group that a fund is competing
against.
Managers have to be confident that they can
execute their strategy effectively either by themselves or
with a trusted partner.
Organizing a registrant and launching a mutual
fund is a complex process with a lot of requirements. The
first decision that managers need to make is whether
they will set up their fund as a stand‐alone trust or
through a series trust. The decision often comes down to
weighing multiple factors such as cost, time to market
and control over the process.
With a series trust, the regulatory compliance
and operational structure is already in place, which can
reduce startup costs, administrative burdens,
operational costs and, ultimately, time to market for
managers. The trade‐off is that the manager is fitting
into an existing structure and inheriting an existing board
that might not be tailored for their specific strategy.
If you do decide to go the series trust route, it’s
important to understand that there are a growing
number of options and there can be huge disparity when
it comes to everything from expertise and assets to costs
and technology. So, you have to do your series trust “due
diligence.” For example:
Talk to managers who are in the trust already.
Look at the trust sponsor’s experience.
Gain a full understanding of the expertise and
reputation of the board, the audit firm and the legal
counsel.
Understand the distribution channels being utilized.
While many managers may think the answer to
this question is yes, this response may be anchored more
in perception than reality. The operational, compliance
and reporting responsibilities may seem more onerous
and costly in a registered fund, but the reality is that
they are just different. If a manager works with the right
partners to put the right infrastructure, processes and
controls in place, the operational efficiencies and cost
savings will follow.
4. Should I use a stand‐alone trust or a series trust? If a series trust, how do I choose the right one?
5. Is a registered fund too expensive?
9 © 2014 Eze Castle Integra on
All registered funds are not created equal. There
are many different varieties of mutual funds and closed‐
end funds, each with different:
Tax considerations,
Reporting requirement, and
Fee structures.
Managers should have an understanding of all
the options and determine what works best for their
strategy and their business.
While every product structure has different and
often complex tax requirements, managers also need to
be aware of the tax implications of a registered fund at a
higher level. For example, they need to have the
answers to the following questions:
Will my strategy qualify from a tax code
perspective?
Will my investment mix pass the asset
diversification test?
Do I have a firm grasp of ”good” income versus
“bad” income?
Do I understand how the structure impacts the
needs of different types of investors?
These may seem like obvious questions to some,
but if they are overlooked from the onset, problems will
arise further down the road. In addition, there are
significant advantages for tax‐exempt and pension plan
investors, such as the elimination of unrelated business
taxable income (UBTI) and an exemption from the
ERISA1 rules, that could be touted if the advisor is aware
of them. The answers to some of these questions may
eliminate the possibility of a move to retail altogether.
What’s most important, however, is that you are
thinking about them.
When alternative managers make the decision
to launch a registered fund, they have to be sure they’re
fully committed – both mentally and financially – for the
long haul. While there is the potential to access a whole
new pool of investors and assets in a registered fund,
it’s not an overnight proposition.
It takes time to build assets and a track record
and it takes a financial commitment to fund operations
while the assets are building. Like with most hedge
funds, managers will have a management fee to cover
expenses, although the fee could be limited by an
expense cap. Therefore, a fund manager should prepare
a break‐even analysis, which the fund’s administrator
can usually assist with. In the absence of this
commitment, it will likely be a waste of time and money
for managers to jump into the liquid alts arena.
Many investors make investment decisions
based on a fund’s track record. Unfortunately for
alternative managers making the shift into the
registered space, their track records are rarely portable.
Beyond that, it takes three years for a fund to get
Morningstar® rated, which is a major validation point in
the retail space.
In some cases, there are product structures that
can potentially allow managers to leverage their track
record from the alternative space. Managers need to
fully understand track record implications before
making the move to the registered space and work with
a legal or compliance expert to make sure they’re taking
all the right steps along the way.
6. Do I understand all my product options?
7. Do I understand the tax implications of a registered fund?
8. Am I ready to make the commitment for the long haul?
9. Do I understand the track record implications?
10 © 2014 Eze Castle Integra on
Some alternative managers look at the mounting
regulations in the private fund space and see the move
into the registered space as an obvious one. They think
that if they’re already dealing with increased regulation,
they may as well make the move to retail and reap the
rewards of gaining access to a new and larger capital
base. But it’s not that simple.
The regulatory requirements in the registered
world—from the need for independent boards to
required compliance with a
whole new set of SEC,2 CFTC3
and FINRA4 regulations — is
different from the private fund
world. Managers who aren’t
realistic about this fact will be in
for a rude regulatory awakening.
It’s critical for managers to work
with seasoned experts to gain a
full understanding of the
regulatory landscape and the implications it will have on
their business in both the short‐ and long‐term.
However, advisors to registered funds get the benefit of
avoiding the Form PF filing requirement.
Transparency has become the norm for
managers in all asset classes since the financial crisis.
That said, when an alternative manager crosses over into
the registered space, transparency becomes a regulatory
requirement as opposed to simply an investor demand.
You need to be aware of this shift and make sure you’re
ready to execute on it. From a practical standpoint, this
means:
Disclosing all investments over 1 percent or, at a
minimum, the top 20 positions on a quarterly basis
as opposed to only those that make up more than 5
percent of the total fund, and
Daily asset valuation and liquidity, if organized as an
open‐ended (mutual) fund.
These are all factors you need to consider before
making the move and deciding whether your strategy
and your business are ready for the leap into the
registered space.
Moving to a liquid alts
strategy seems simple enough for
most hedge fund managers. It’s just
a matter of executing a proven
strategy in a different product
structure, right? Well, not exactly.
What’s important to
remember is that in a mutual fund
structure, fund managers must
report to a board that has a fiduciary responsibility to
ensure that the shareholders’ best interests are being
considered, such as reviewing investment decisions and
fees charged to a fund. This requires a major change in
mindset for most hedge fund managers who essentially
ran their own fiefdom, answering only to investors with,
in most cases, long‐term lock‐ups provisions.
Many managers can and have made the shift,
but those who go in with that understanding from the
get‐go are much more likely to be successful long‐term.
The liquid alternative space has grown at a
breakneck pace in recent years, and there doesn’t seem
to be any slowdown in sight. But while there is clearly a
lot of opportunity, there is also a lot of competition, as
“Before making any move, managers need to take a
hard look in the mirror and consider all the business
implications”
10. Do I understand the regulatory implications?
11. Is the additional transparency that a registered product requires acceptable?
12. Am I prepared for the change in mindset required to operate a mutual fund structure?
The Last Word
11 © 2014 Eze Castle Integra on
well as the need to create the correct operational
infrastructure, and it’s not the right fit for every
manager.
Before making any move, managers need to take
a hard look in the mirror and consider all the business
implications — and consult with their service providers
— before getting caught up in all the liquid alts
excitement. The questions above may not be the only
ones that need to be asked, but they’re a good place to
start for any manager who’s thinking about following the
flow of liquid alternatives into the retail space.
A A
Frank A alla is a principal at Rothstein Kass, located in the firm’s Roseland, N.J., office. He has over 15 years of experience
exclusively in the financial services industry. He specializes in audit and tax services for a variety of investment partnership
structures, including domes c and offshore funds, master‐feeder structures, funds of funds, and registered investment companies.
Frank is a cer fied public accountant in New Jersey and New York.
Marc Wolf is an audit principal in Rothstein Kass’ Beverly Hills office. Marc’s areas of specialization are focused within the firm’s
Financial Services Group, specifically hedge funds, regulated investment companies (RICs), commodity pools, real estate, private
equity and other types of investment vehicles, broker‐dealers, private foundations and family offices. He is a certified public
accountant in California, Colorado, New Jersey, New York and Texas.
12 © 2014 Eze Castle Integra on
ASSESSING NEVER-EXAMINED SEC-REGISTERED
INVESTMENT ADVISERS: AN SEC NEP PRIORITY BY: SHELLEY ROSENSWEIG AND BETH SMIGEL, TANNENBAUM HELPERN SYRACUSE & HIRSCHTRITT
On January 9, 2014, the Office of Compliance
Inspections and Examinations (“OCIE”) of the Securities
and Exchange Commission (the “SEC”) published its 2014
examination priorities for its National Exam Program
(“NEP”). While the examination priorities include
multiple areas that OCIE believes are higher‐risk areas of
the business and operations of investment advisers, this
article focuses on the NEP’s initiative (the “Initiative”) to
conduct focused, risk‐based examinations of investment
advisers who have been registered with the SEC for at
least three (3) years (including non‐U.S. advisers) but
have not yet been examined by the NEP and are not
subject to the “Presence Exam” initiative discussed
herein (“Covered Advisers”).
The examinations conducted by the NEP in
accordance with the Initiative focus on two
approaches. The first approach consists of risk‐
assessment reviews which allow the NEP to obtain a
better understanding of each Covered Adviser and
include a high‐level review of the Covered Adviser’s
overall business activities, with a particular focus on the
compliance program and other essential documents
needed to assess the representations made on the
Covered Adviser’s disclosure documents. The second
approach utilizes focused reviews which emphasize
certain high risk areas of the Covered Adviser’s business
and operations, including the following:
Compliance Program: NEP staff will examine the
Covered Adviser’s compliance program and the
effectiveness of such program (including a review of
its books and records, even such records existing
prior to such Covered Adviser’s registration with the
SEC) to determine if a Covered Adviser has
adequately identified conflicts of interest and
compliance‐related risks, adopted appropriate
policies and procedures to mitigate and manage
those conflicts and risks, and empowered a
competent chief compliance officer to administer
the compliance program;
Filings/Disclosure: NEP staff will review the Covered
Adviser’s filings and disclosure documents to assess
the content and scope of disclosures that have been
made therein (in particular whether conflicts of
interest and potential conflicts of interest have been
adequately disclosed);
Marketing: NEP staff will review the Covered
Adviser’s marketing materials and evaluate whether
a Covered Adviser has made false or misleading
statements about its business or performance
record, made any untrue statement of a material
fact, omitted material facts, made any statement
that is otherwise misleading or engaged in any
13 © 2014 Eze Castle Integra on
manipulative, fraudulent, or deceptive activities in
such marketing materials;
Portfolio Management: NEP staff will review and
evaluate the Covered Adviser’s portfolio
decision‐making practices, including the allocation of
investment opportunities and whether the Covered
Adviser’s practices are consistent with disclosures
provided to clients; and
Safety of Client Assets: NEP staff will review a
Covered Adviser’s compliance with the relevant
provisions of the Investment Advisers Act of 1940, as
amended (the “Advisers Act”) and other applicable
laws that are designed to prevent loss or theft of
client assets.
The SEC specifically excludes registered
investment advisers to private funds from the Initiative,
as those advisers are subject to examination pursuant to
the SEC’s “Presence Exam” initiative launched in October
2012. The Presence Exam program focuses on newly
registered private fund investment advisers that
registered with the SEC as of July 21, 2011, the date
when the definitional rules under Dodd‐Frank Wall
Street Reform and Consumer Protection Act of 2010
became effective (which, among other things, removed
the “less than 15 clients” exemption from SEC
registration on which most private fund advisers
previously relied). It is worth noting for those advisers to
private funds subject to Presence Exams that the five (5)
key focus areas (some of which overlap with those
mentioned above) are the adviser’s marketing, portfolio
management, conflicts of interest, safety of client assets
and valuation procedures.
Covered Advisers should anticipate being
examined by the SEC pursuant to the Initiative. To
prepare for such exams, compliance officers of Covered
Advisers are encouraged to review their compliance
policies and procedures to ensure that such procedures
(i) adequately address the foregoing matters, (ii) are in
compliance with the Advisers Act and SEC guidance and
(iii) accurately reflect the operations of the Covered
Adviser. Covered Advisers should also ensure that
disclosures made to its clients are consistent across all of
its disclosure materials including ADV filings, offering and
related documents, client agreements and marketing
materials. We note that OCIE indicated its intention to
invite Covered Advisers to attend regional meetings later
in 2014 where they can learn more about the
examination process.
As the SEC’s Division of Enforcement has the
ability to bring charges against a Covered Adviser based
on deficiencies discovered by OCIE in the course of
examination, Covered Advisers should consider meeting
with their legal advisors to better understand what to
expect during the examination process and how best to
prepare.
If you have any questions regarding this update, please
contact Shelley Rosensweig at 212‐508‐6774 or Beth
Smigel at 212‐702‐3176.
14 © 2014 Eze Castle Integra on
A A
Shelley Rosensweig is a partner in the Financial Services, Private Funds and Capital Markets
department at Tannenbaum Helpern Syracuse & Hirschtritt LLP. Shelley advises clients regarding
matters which include design, structure and operation of US and non‐US investment funds and
portfolios, distribution and marketing issues as well as commodities, futures and derivatives issues.
Shelley also advises and assists clients with regard to seeding arrangements, managed account
platforms and the organization of joint ventures. Further, Shelley advises investment advisory clients
regarding investment products and services, SEC, FINRA, CFTC and blue sky regulatory and
compliance matters, as well as trading issues and employment matters.
Beth Smigel is partner in the firm's Financial Services, Private Funds and Capital Markets
department at Tannenbaum Helpern Syracuse & Hirschtritt LLP. Beth's practice includes forming and
structuring domestic and offshore private investment funds (including hedge funds and private
equity funds) and advising with respect to ongoing operational and U.S. regulatory matters for the
funds. In addition, Beth advises U.S. and non‐U.S. investment advisers with respect to registration
(and exemptions therefrom) under the U.S. Investment Advisers Act of 1940 and compliance matters
arising thereunder, including assisting in preparation of compliance manuals and code of ethics.
Beth also counsels investment advisers, fund operators and investment funds with regard to various
U.S. regulatory matters, including those arising under the U.S. Securities Act of 1933, the U.S.
Investment Company Act of 1940, the Commodity Exchange Act as well as SEC, FINRA, NFA and CFTC
compliance and registration issues.
15 © 2014 Eze Castle Integra on
A HEDGE FUND’S GUIDE TO TECHNOLOGY DECISIONS:
FROM CLOUD TO DR BY: MARY BETH HAMILTON, EZE CASTLE INTEGRATION
The Cloud: Every Hedge Fund is Doing It
Here at Eze Castle Integration, we see that 9 out
of 10 hedge fund startups are selecting a cloud‐based
solution versus a traditional on‐premise solution. If you
aren’t already sold on the cloud, here are a few reasons
we typically see clients select the cloud:
Easy and Complete IT Package: Cloud computing
can support front‐, middle‐ and back‐office functions
– everything from business applications and client
relationship management systems to data
management solutions and accounting systems
Cost Containment: CapEx to OpEx: While building
out a Comm. room or data center requires capital
expenditures, using an external cloud service that
offers a pay‐as‐you‐go service falls into ongoing
operating expenditures. The transition to a cloud
service provides many cost‐savings beyond just
eliminating the need to purchase and refresh
equipment.
Improved Flexibility and Scalability of IT: Cloud
computing is uniquely flexible and scalable,
operating on a utility basis ‐ allowing firms to pay as
they go and only for the resources they will use.
Simplified IT Management = Less Maintenance:
With cloud services, firms no longer need to handle
server updates, patches, hardware installs and other
computing maintenance issues. This saves firms from
having to hire dedicated IT resources or allows them
to focus IT staff on higher value projects.
Mee ng the SEC’s Cybersecurity Expecta ons
Regardless of whether your firm opts for an on‐
premise solution or the cloud, security is fundamental
when considering a fund’s technology setup and network
infrastructure. It is so important that the SEC this month
issued a risk alert providing additional clarity into how it
will examine registered investment firms regarding their
cybersecurity practices.
All financial firms are at risk because hackers see
value in gaining a firm’s business secrets and intellectual
property ‐ such as business plans, trading programs,
market forecasts and investment strategies. Therefore, a
multi‐layer security approach is essential to protecting
the critical information that passes through the
organization’s system every day.
This strategy, known as Defense in Depth,
recommends that investment firms maintain up‐to‐date
anti‐virus and anti‐malware software as well as network
firewalls, deep inspection proxy and intrusion detection/
prevention (IDS/IPS) to reduce the amount of traffic on
the network, thereby decreasing opportunities for an
intrusion. In addition to these technical layers, firms
should also implement the following policies and
procedures to ensure their critical systems and data do
not fall into the wrong hands.
Acceptable Use Policy. Define what acceptable behavior
is for your employees as it relates to their technology
usage. It is best to be specific within this policy regarding
what activities and programs employees are or are not
permitted to access. Firms can employ web filtering
16 © 2014 Eze Castle Integra on
practices to block access to identified websites. They can
also use third‐party software to log activity around which
employees are accessing what and what other actions
they are taking (e.g. printing, copying, forwarding, etc.).
Principle of Least Privilege. This involves restricting
access to only those employees who need it. Keep access
control lists on all applications and data and inbound/
outbound Internet access to keep track of who can gain
access to what. Also, log the use of audited one‐time
passwords and minimum privilege shared accounts.
Secure User Authentication
Protocols. Secure user
authentication protocols include
assigning unique domain user IDs
to each employee, implementing
strong domain password policies,
monitoring data security passwords
and ensuring that they are kept in a
secure location and limiting access
to only active users and active user accounts.
Information Management Security Policy. Develop a
plan that details how the firm will handle a security
incident. The plan should outline who is in charge of
managing a security incident, the required reporting and
investigation procedures, communications policies for
contacting clients and the post‐incident remediation
procedures.
Visitor/Contractor Premise Access Policy. It is essential
that firms keep track of all people who have visited the
site through the use of physical security checkpoints and
surveillance.
Mobile Device Policy. Develop guidelines for the use of
personal mobile devices in the workplace, and train staff
on mobile device security practices. Employ security
measures such as requiring passwords, having the ability
to remotely wipe devices and employing encryption
tools.
Preparing for the Inevitable Disaster
Disaster recovery and business continuity plans
are crucial for sustaining operations during outages or
disasters. A disaster recovery plan addresses how the
business will resume normal operations in the event of a
catastrophe. A business continuity plan is somewhat
broader in nature and deals with sustaining normal
business operations during periods of disruption.
Both disaster recovery and
business continuity planning are
essentially means of systematically
assessing the potential impacts of
various unexpected incidences and
determining the organization’s
preparedness to deal with such
events. During the planning process,
firms should aim to ensure little to
no business and project interruption during either a
planned or unexpected event. In this planning phase, be
sure to take the following steps:
1. Assess the business risk and impact of
potential emergencies.
2. Prepare for possible emergencies.
3. Document a disaster recovery plan.
4. Outline the business recovery phase.
5. Train staff for the business recovery phase.
6. Test the plan with a realistic dry run.
7. Keep the plan timely.
Avoiding Common Technology Mistakes
Finally, following are five common technology
mistakes that new funds make and what you can do to
“All financial firms are at risk because hackers see value in
gaining a firm’s business secrets and intellectual property”
17 © 2014 Eze Castle Integra on
avoid them.
Looking for the perfect solution. During the
planning phase of your new fund, the idea that there
may be one or more solutions that can meet 100% of
your technology requirements can be an appealing
thought. Some vendors are attempting to develop a
turnkey platform to deliver on this promise. However,
unless your business is narrowly focused, the chances
that a single vendor will meet every aspect of your needs
are very slim. Realistically, you will likely need to
negotiate, purchase and deploy systems from multiple
vendors and service providers. Selecting a single vendor
and relying on it to be around in the years ahead may
cause your firm to assume more concentrated business
risk than you are willing to accept.
Insufficient planning for the future. Without
envisioning how your practice will look over the longer
term—in three or five years—you may be setting
yourself up for some short‐sighted solutions. Despite
your intense focus on completing the immediate tasks of
launching your fund, understanding what your firm will
look like in the future is important as well. If your fund
grows significantly, will you have the necessary
technological systems to support that larger business?
Failing to understand how much you rely on
technology today. Think about the work you currently
do today and write down some notes on which systems
you use to complete that work (email, reports, phones,
quote feeds, etc.). Now, consider the work that will need
to be done in your new hedge fund and what systems
you and your team will require to complete it. More than
likely, you will need most – if not all – of the same
systems, with some additional ones as well. Use this list
as a shopping guide when building out your technology
platform.
Overestimating your capacity to manage
technology. Managing technology is a profession unto
itself. Unless you spend most of your free time building
servers and managing networks, you will need help
managing technology at your new firm. For project‐
related work (“one‐and‐done” jobs), you can use
consultants and contractors. For ongoing interaction and
maintenance of the technology, you can contract with a
third party. Also, be sure to consider hiring support or
administrative personnel that is skilled with technology.
18 © 2014 Eze Castle Integra on
Shortchanging the training options and resources. Once
you have all of your new systems lined up, you need to
learn how to use them. Most vendors provide some sort
of onsite or web‐based training options. If it is
reasonably priced, you will most likely want to take
advantage of it. Often, the vendor’s professional services
arm will know all the quirks of the software package so
well that many important details are glossed over
during the sales process. They can help you develop the
correct workflow to maximize your investment, as well
as get you past some of the inevitable challenges. Also,
ask the vendor whether there are any established user
groups for their so ware and systems. O en, these
communi es can be invaluable resources for ge ng up
and running more quickly and with less frustra on.
Avoid rushing the installa on in order to make a set
deadline and address any subsequent issues that may
arise.
A A
As vice president of marke ng for Eze Castle Integra on, Mary Beth Hamilton is responsible for mar‐ke ng strategy and integrated marke ng programs to drive awareness and demand for the company’s IT services and solu ons. With a decade of marke ng experience, Mary Beth is skilled in guiding mar‐ke ng efforts for services organiza ons. She holds a BS from Loyola University New Orleans and MBA from Boston College.
© 2014 Eze Castle Integra on 19
CAN AN ALTERNATIVE STRATEGY INVESTOR KNOW THE
VALUATION GIVEN IS CORRECT? BY: DANIEL JOHNSON, OF WELLS FARGO GLOBAL FUND SERVICES, AND ERIC LAZEAR, OF FQS CAPITAL PARTNERS
Traditionally, for most investors, the main
concern when investing in a hedge or private equity fund
was whether the manager could generate a sufficient
level of return for an acceptable level of investment risk.
But operational matters have increased in
importance and operational due diligence has now
evolved to the point that many investors will reconsider
an investment on operational grounds alone, regardless
of the return profile.
Operational risk can take many forms, but
valuation is a good place for investors’ initial focus: are
the holdings of the fund accurately valued, and is there a
process in place to ensure that they are
accurately valued at each dealing period?
Valuation risk is particularly critical for more
complex strategies, such as structured credit, where the
risk of pricing irregularities is significantly higher.
However, it is also important to review and understand
pricing policies and procedures for strategies that trade
listed securities. For example, it is useful to know
whether the manager marks their equity longs at the bid,
mid or close and, if it is the mid, if the manager
determines the impact on the portfolio if priced at the
bid. It is also important to understand if adjustments are
made for large positions, less liquid holdings, or for
securities that trade less frequently.
How the holdings of a fund are valued is
important for many reasons: it drives the net asset value
(NAV); it sets the price for subscriptions and
redemptions; and it determines the level of performance
fees. While this point may be obvious for most investors,
many investors are often unsure of what detailed
valuation related questions to ask the manager and,
equally as important, the administrator who is
responsible for producing the NAV.
Valuation Risk
Unlike reviews of performance, it is essential that
any review of valuation risk include all parties involved
in valuing the assets of the fund. This will often include
speaking to the administrator about their role in the
process and what the involvement of the investment
manager has in determining the final prices.
However, when reviewing the valuation process
it is often too easy to adopt a checkbox approach. It is
essential for investors to understand that the questions
one should ask must change depending on the strategy
of the fund and the assets it trades. The questions asked
of a distressed debt manager are different from those
that should be directed to a long/short equity manager
who only trades listed securities.
But there are also some common questions that
should be asked of all funds and questions for fund
administrators covering key areas (see boxes). These
questions are just some examples to help investors more
20 © 2014 Eze Castle Integra on
fully understand the valuation process for funds they are
considering investing in.
Common Ques ons to All Funds
Who approves the valuation policy, how often is it
reviewed and re‐approved?
How are policy exceptions reported and to whom?
What is the role of the governing body in the
valuation process? How much knowledge do they
have of the asset class being traded by the fund?
What valuation service providers are used and
exactly what type and level of service is being
provided?
What due diligence was performed on the provider?
How involved is the investment manager in the
process? Can they pick the price‐providers and, more
importantly, can they change the providers each
month?
Are third parties involved in the pricing process at
any stage?
Does the investment manager have a valuation
committee to review valuation processes, approve all
policy exceptions and if necessary approve all
investment manager prices?
Key Questions for Fund Administrators
Is there a clearly defined and documented process
that covers how all major asset classes will be valued
for the fund? This is normally more detailed than the
NAV section of the prospectus and provides specifics
on what the administrator will actually do to value
the investments.
Does that process cover not only the primary and
secondary data sources, but which prices should be
used (mid/bid/ask, and so on), what time the prices
are taken, how the prices can be independently
obtained and what to do when the process cannot be
followed?
Is the administrator SSAE16 Type II or ISAE 3402
certified? This shows they have documented
processes that have been reviewed by a third party.
Is the administrator independently valuing the
portfolio, or acting as a price validation/ verification
agent?
Do investors or the fund’s directors receive any kind
of NAV transparency report showing a breakdown of
pricing sources and methods, as well as a breakdown
of assets by ASC 820 levels?
Most administrators can provide this and should
be able to walk investors through all of the numbers.
“Valuation risk is particularly critical for more complex strategies, such as structured credit, where the risk of pricing irregularities is significantly
higher.”
A A
Daniel Johnson is vice president, valuation services at Wells Fargo Global Fund Services and Eric Lazear is head of
operational due diligence at FQS Capital Partners (US).
© 2014 Eze Castle Integra on 22
AT HEDGE FUND TRADING DESKS, FURNITURE MATTERS BY: JEFF BRECHMAN, CFS GROUP
There are many layers to creating a successful
launch of a hedge fund, and often one that is overlooked
is implementing the right furniture, while keeping in
mind budget, timeline and dimensional restraints for
your new office space. For someone starting a fund, and
relying on your own capital, creating an office space
within a budget is essential. In order to do so, you must
partner with a furniture dealership that understands the
marketplace and has the creativity to provide a solution
that is light on the wallet but has the feel of stability and
success.
As you would expect, just like many other
businesses, the commercial furniture industry is a very
competitive, relationship‐driven sale, and unfortunately
the client is usually on the raw end of the stick. Let’s give
an example:
Hedge fund A has six traders, and in their mind “we
need a trading desk.” But the fund's users only have one
PC and two monitors each, which equates to a minimal
technology requirement. The fact is that a full‐blown
trading desk can range from $2,000 to $5,000 (for height
adjustable product) per user.
Here is what the fund manager needs to know.
There are other options that will adequately handle your
technology, save you up to 60‐70% and give you the look
and feel of a trading desk solution. Savings of $10,000
just by having the proper relationship and information.
Hedge fund B has six traders, and they are looking for a
new trading desk. The fund’s users have two or three PCs
and three to six monitors each. Based on the amount of
technology required, a trading desk does seem like the
© 2014 Eze Castle Integra on 23
right fit and would run on average between $20,000 and
$24,000. Having a relationship with a furniture vendor
that stocks used trading desks may just save hedge fund
B 100%. This is another example of making sure a
vendor’s vision is aligned with the fund.
The world of technology platforms is ever‐
changing. Therefore, knowing the technology is the key
to understanding the furniture requirements to any
successful hedge fund build out. As a result, hedge funds
should look for a furniture partner that has the ability to
identify each client’s specific needs and provide them
with the right product for their furniture application. As a
specialist in the industry, CFS Group knows hedge funds
need a “go to” to embrace change as it unfolds. A typical
build‐out provides practical solutions that elevate the
aesthetics and performance of each hedge fund's
facilities.
The secondary key is having the right dealership
to align each hedge fund with the manufacturers based
on their budget. Besides looking at the technology and
aesthetic requirements, understanding the budget is just
as critical. Our job as a dealership is to remove that
stress of purchasing furniture by creating furniture plan
layouts and managing projects from start to finish.
A A
Jeff Brechman is the Director of Sales at the CFS Group. Prior to CFS Jeff was a Principal and Sales
Director of one of the leading trading desk manufactures in the country. With over 15 years of
industry experience, Jeff is helping to build the business as well as taking the financial furniture
arm of CFS to new heights.
ABOUT EZE CASTLE INTEGRATION Eze Castle Integra on is the leading provider of IT solu ons and private cloud services to more than 650
alterna ve investment firms worldwide, including more than 100 firms with $1 billion or more in assets
under management. We provide one global financial cloud pla orm that is complimented by excep onal
service and opera onal excellence.
Our Eze Private Cloud is built to deliver the high performance, applica ons and excep onal user experience
demanded by the hedge fund and investment industry.
To learn more about Eze Castle Integra on, contact us at 800‐752‐1382 or visit www.eci.com.
24 © 2014 Eze Castle Integra on
Complete Managed IT — So ware as a Service Eze Managed Suite is a fully managed IT solu on that provides flexibility and
simplified IT opera ons. The hosted IT solu on combines a robust, highly secure
private infrastructure via the Eze Private Cloud with key business applica ons and
professional IT management.
Applica on Hos ng — Infrastructure as a Service Eze Managed Infrastructure provides clients easy access to an enterprise‐grade
private environment with the latest hardware and so ware without capital
expenditures, expensive upgrades or ongoing maintenance and monitoring. It is ideal
for hos ng applica ons used by hedge funds and investment firms.
Disaster Recovery as a Service Eze Managed Data Availability delivers a full range of business resiliency services
including Disaster Recovery, Online Backup and Message Archiving. Via the Eze
Private Cloud, your cri cal data and applica ons will be available and protected
24x7x365.
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