Morten Spenner, chief executive officer of $4.2 billion, London-based International Asset Management, was as stunned as any fund-of-hedge-funds manager when word broke that Bernard Madoff had conned this supposedly sophisticated crowd out of tens of billions of dollars.
“Weren’t we more institutional than this?” asks Spenner, voicing doubts that echoed across the fund-of-funds industry, whose image was badly damaged — both financially and reputationally — by the fiasco. Spenner says that although IAM met with Madoff more than once, it never seriously considered investing with him.
But plenty of other well-known firms, such as New York City’s Fairfield Greenwich Group and Rye, New York’s Tremont Group Holdings, funneled billions of dollars over the years to Madoff without — as it seems now — doing even adequate due diligence. Tremont had $3.3 billion invested with Madoff; Fairfield Greenwich, $7.5 billion. Could there have been a better advertisement for the new strain of portfolio-management software that several companies have developed recently with funds of funds in mind?
Because many funds of hedge funds have been around longer than most technology-service providers, they have relied on in-house proprietary systems, says Tim Knox, product manager for PerTrac Portfolio Manager, a software package made exclusively for funds of funds by New York–based PerTrac Financial Solutions. Newer, smaller funds are the market because all funds of hedge funds are supposed to excel at due diligence, a characteristic that should give them an advantage over the competition, even the most carefully diversified hedge fund portfolio. Ideally, funds of funds have more resources they can devote to the vetting process than do family-wealth offices, individual investors or endowments, and they should have more expertise too from compliance gurus and quant wonks.
However, due diligence is difficult, which is why it is the most obvious and possibly the most important area in which funds-of-funds software can make an impact. The most advanced, responsive and well-crafted databases automate due-diligence workflow, standardizing information and making it more accessible than it is in raw form.
“We make it so that more than one person can look at the information in a meaningful way,” says Erol Dusi, president of Imagineer Technology Group, a New York–based hedge fund software provider.
In addition to Imagineer and PerTrac, firms like Chicago-based Backstop Solutions Group and Netage Solutions in Watertown, Massachusetts, have products that track due diligence by archiving records of meetings, calls and e-mails.
In the Madoff case, such a system could have triggered an alarm over the absence of fund accounting, portfolio-pricing services, trade capture and precise calculation of net asset values. A money manager who does not have an independent administrator merits suspicion, notes Jim Kelly, CEO of New York–based HedgeServ Corp., a hedge fund administration platform. Even if a hedge fund is not required by law to use a third-party administrator — and no such requirement exists yet in the U.S., although it does in the U.K. — having one is fundamental.
Funds of funds also need to be able to monitor exposure to positions across managers. If a fund of funds is invested in 50 hedge funds, for example, it is not properly handling risk if all of its managers put on the same trade. The latest solutions to this problem allow funds of funds to keep precise track of their positions, a capability that is critical to any firm serious about risk management and diversification. Backstop Solutions’ portfolio management software, for one, allows analysts to run reports by performance attribution or allocation exposure, showing at the fund-of-funds portfolio level the aggregated holdings and exposures of underlying managers. Some software makers situate their solution inside Microsoft Corp.’s commonly used Outlook e-mail program. By embedding their databases in Outlook, Netage Solutions and PerTrac, for example, can allow analysts to use one program window to communicate with managers, review their performance and construct analytical charts. More important, the contact databases that track a hedge fund manager’s or analyst’s previous employment and affiliations are useful for background checks.
Software companies are responding, as well, to the looming specter of more government regulation by adding audit trails, streamlining the data-aggregation process and even perfecting portfolio valuation by feeding accounting-grade data at any time to a portfolio manager, as HedgeServ does. The aim, of course, of enlisting a software program as an automated watchdog is to make it more difficult for a fund of hedge funds to make a rogue investment.
