Opalesque Exclusive: A Case for Outsourcing - Hedge funds outsource investment research, a recent trend

20 July 2007

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Opalesque Exclusive: A Case for Outsourcing, Part 2 – Hedge funds outsource investment research, a recent trend

From Benedicte Gravrand, Geneva: In addition to hiring their own researchers, some hedge funds use analysts from outsourcing firms, such as Amba Research, who assign analysts to do research for specific clients. Amba Research has some 70 clients in the financial arena. Mr. Anand Aithal, one of Amba’s partners, gave an overview of the nascent industry to Opalesque.

The big picture

“Hedge funds have to do more and more of their own research. In the old days, The Street relied on the sell-side brokerage firms to provide not all research but at least a lot of the initial background work. Now the sell-side is covering less research and is being much more discriminating in whom they are speaking to. We have seen that trend in the equity space. I think it is even more pronounced in the credit space because a lot of investment banks are closing down their own research departments or merge them with the trading desks.”

“The big macro trend is that in the old days, research was provided centrally and now today everyone has to do more and more research on their own. That puts a tremendous strain on the hedge fund community and it makes the screening processes harder.”

FSA regulations on commission unbundling came into force in January 2006 and required UK fund managers to state explicitly in client reports the cost of execution and external research. This drove down the volume of broker equity research. The SEC took similar steps.

The importance of time

“Most of our clients do not have enough time to stream as many ideas as they would like,” Mr. Aithal said. “The proposition that we have is: we will save you time. What is the most valuable commodity in a hedge fund? It is the time of the hedge fund’s team. “

Hedge fund managers are the people who have the unique insight and years of experience: all the really important decisions belong to them. But the background work, the information gathering, the basic levels of analysis, even the back-testing of hypothesis can be done by someone else, whilst the fund manager concentrates on the big decisions, on alpha. “I think the big trend is that hedge funds are short of time.”

Information overload problem

“Three years ago, this industry (of investment research providers) did not exist within the

hedge funds industry. Before then, hedge funds could get information from the Street. Now either the Street does not have it or hedge funds have the opposite problems; there is too much information.” People helping to screen the information, to distinguish between real news and noise can be useful. Today, hedge fund managers recognise the need for extra help. “Not just for screening information but also for independent research, new technology, anything that can save time.”

Maturity more important than size

“We tend to work with large funds but we also work with the whole spectrum. Usually very small managers want to do everything themselves. The key thing is, hedge funds need to understand their own research process very well. Very young funds are usually too early for us; they should spend time to figure out their own research process before deciding what they are comfortable outsourcing. Once they realise what works for them, where the bottlenecks are in their day, then we can help. So it is more a matter of maturity.”

The other advantages of outsourcing

“The hedge fund community has bee very open to the idea of outsourcing in general; it uses prime brokerage, back-office functions… outsourcing basic research is just an extension of that.” The other attraction of outsourcing research is less human resources management, which is a lot if one takes the turnover of junior analysts into consideration. Outsourcing is also a cheaper alternative to expending the fund’s research department.

Amba researchers

Amba has around 500 employees who are trained in compliance and technical expertise. Amba’s expertise is in equity research, fixed income, credit and quantitative research. “We provide the junior and mid-level analysts,” said Mr. Aithal. “The clients are the senior analysts. Our researchers are based in 3 main countries: India, Sri Lanka and Costa Rica. Their average age is 26 or 27. They typically have background in finance, qualifications in accounting, business, MBA, or CFA. Their work experience may not be in the capital market but in general analysis. They all do our own training program. People who founded this company, including myself, (there are 4 partners) all come from Wall Street and we have all trained over 1,000 analysts each. We also have account management offices in New York, London and Singapore.” Corporate website: Source

New report on financial services firms outsourcing to India

Dushyant Shahrawat, a research director for the Tower Group, NeedhamMass., is drafting a report about financial service firms outsourcing research to India, Pensions & Investments recently reported. His preliminary estimates indicate that 20% of U.S. institutional money managers have part of their research conducted in the overall offshore market. “By 2010, I would expect 70% of institutional money managers to have something in the offshore market,” Mr. Shahrawat said.

According to Mr. Shahrawat’s preliminary estimates, investment management firms have spent $165 million on outsourcing investment research, a jump of $40 million in the past two years. The bulk of that money is going to India, he said.

Those figures pale in comparison to the amount of research investment banks have outsourced — $385 million, Mr. Shahrawat estimated. Banks moved their research to India after the U.S. Securities and Exchange Commission cracked down on the way banks generate revenue from sell-side research. Once analysts could no longer receive compensation from investment banking fees, costs had to be cut on the research side, and outsourcing made sense.

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