Alternative Funds Industry Tackles Data Culture

Chief data officer (CDO) may not the most sought-after position at hedge fund management shops, but that isn’t stopping the C-level executives from pushing hard to create a better data management culture — including finding someone to take on the role, with or without the title.

To support this effort, a new group calling itself the Data Management Working Group for the Alternatives  Industry (DMWGAI) has just formed. Its agenda: to come up with a top-down model for data management governance and best practices that works for hedge fund managers as well as their external service providers.

Pricing data, reference data, corporate actions data, transactions data, positions data are just the tip of the iceberg in what’s necessary to execute successful investment strategies, strike correct asset and portfolio valuations, and compile the necessary reports for regulators. “We are looking at all types of data and the pain points involved across the alternative fund manager’s enterprise and in communications with critical external players,” says Marshall Terry, managing director and chief operating officer of Rotation Capital Management in New York who heads up the newly-created DMWGAI.

Showing up for the organization’s first meeting at PwC’s headquarters in New York last month were more than 200 representatives from hedge fund management firms, their service providers, as well as pension plans and other buyside firms. Their roles ranged from chief operating officers and chief financial officers  to directors of fund administration firms and technology providers, directors of investment consultancies servicing as asset allocators, and due diligence officers.

Data management isn’t a foreign concept to hedge fund managers. However, their process may not be as formalized as it could be, resulting in more risk of errors and high costs. Hedge fund managers have no problem buying tons of data from data vendors or ingesting just as much data from fund administrators, prime brokers, investors or regulators. At issue is whether they can ensure data accuracy and consistency in these data stores. Wrong or mismatched data can turn into costly mistakes in asset valuations, portfolio valuations, performance results, risk metrics, regulatory reports and investor reports.

“While alternative fund managers have invested heavily in trading, risk and portfolio analytics they have not done enough with end-to-end data management,” says Eric Reichenberg, managing director of valuation and middle office outsourcing services for alternative fund administrator SS&C Technologies in New York, who is also a member of the DMWGAI. “With the amount of data handled skyrocketing, it’s time to take a top-down approach.”

As is the case with other fund managers, banks and broker-dealers, too many hands are touching and altering the same data which is then stored in multiple applications in different formats. Such an approach results in duplicative and often inconsistent data sets. Corrective measures are typically handled on an application-by-application basis by human technologists, a costly approach. “The alternative funds industry needs to move towards more application-agnostic approaches and develop an internal data set that represents a digital version of the truth,” says Terry.

The need for accuracy is not only in-house but extends beyond the walls of the hedge fund management firms. In particular, allocators — the critical decisionmaking middlemen, whose advice institutional investors seek before deciding where to park their monies — also need to understand the alternative fund manager’s strategy, performance history and pedigree before they can give their seal of approval. Alternative fund managers might not want to spill the beans on their secret trading sauce, but they do have to provide some transparency or risk losing out on new funding.

“Allocators may differentiate themselves based on the specificity of the questions they ask and they may want different types of data depending on the alternative fund manager’s strategy,” says Robert Goldbaum, senior vice president of Backstop Solutions, a Chicago-headquartered firm specializing in investor relationship management, research and and portfolio technology for alternative funds. “However, the fund manager still needs to have the right information available.”

Take It from the Top

The DMWGAI envisions a top-down data management culture which would incorporate ideas from key players in the hedge fund manager or communities — the managers, institutional investors, allocators, service providers and technologists. At the top of the pyramid would the accountable person for deciding  the data models, access rules, and rules about distribution to investors and regulators. Next down are the data stewards — the business line managers who will implement those rules and policies, while data users need to understand what those rules and policies are about. “Regardless of whether a hedge fund manager has a data czar, data governance is critical to accurate consistent data,” explains Terry. “And that data needs to ultimately be communicated to the fund manager, investor and regulator.”

The alternative fund manager’s rules and policies affecting data should include not only who should have access to the data, who should be allowed to change it, but also an audit trail of the source of the data and all of the alterations. “Standards also need to be created for identifying financial instruments, counterparties and transactions,” says Subhra Bose, chief executive of Financial Fabric, a New York firm offering a data hub for alternative investment fund managers. “The lack of common identifiers, differing practices in reporting positions, the manual nature of data exchange and reconciliation are just a few examples of problems alternative fund managers deal with every day. Industry best practices and standards can address these, resulting in a single version of the truth for data.”

Security controls are also significant. “Cybersecurity breaches involving critical customer and other non-public data ultimately involve poor data management,” says Bose. “Using unsecure communications channels, such as emails, for transporting critical data should be prohibited and employees of the alternative fund manager should have a clear understanding of how they can prevent a cybersecurity breach.” Creating a blueprint for data flows is the first step to recognizing potential vulnerabilities of sensitive data. Implementing the best blueprint, which must include steps for effective data acquisition, storage, protection, retrieval, and dissemination will create a culture of data-driven business.

All this interest doesn’t necessarily mean a sudden spike in new employee opportunities for CDOs. Handing the responsibility to an officer already familiar with governance principles — such as a chief technology officer or chief compliance officer — may a more attractive short-term solution. “What we are really hoping for is to have someone in the hedge fund or private equity fund manager own up to the title of chief data officer,” says Reichenberg. “Within the next five years, about fifty percent of alternative fund managers should have established a robust data management framework.”