KPMG: Hedge funds to invest more in technology and cyber defence

Investments by hedge funds into technology advancement is set to increase in the coming five years, as more executives within the industry become concerned about the impact of technology on their competitiveness. A new report finds that they will leverage a broad range of investment strategies to meet needs, from building their own systems to outsourcing. Cyber security, particularly among large firms, is set to see increased focus and investment.

Hedge funds are, like wealth managers and the financial services industry more widely, seeing the effects of digitalisation on their wider business. In a new report from KPMG, the professional services firm explores current trends around technology and innovation affecting the industry. The the report involved around 100 hedge fund leaders and executives, who together represent around $300 billion of assets under management (AUM), of the total hedge fund market of around $2.9 trillion.

Innovative IT

According to 94% executives, technology will have at least some impact on competition in the coming five years, 38% of whom said that the impact will be significant. Some disparity between executives from large funds, those with more than $500 million AUM, exists – citing a 10% higher claim to significant impact than their smaller rivals. The report cites that larger fund managers tend to provide larger scope for delivering efficiencies through technology, boosting the group’s interest in the segment. 

The respondents were also asked to list the key reasons for investing in technologies. The top cited reason (90%) was to ‘improve controls and compliance’, followed by ‘efficiency objectives’ (88%). ‘Meeting investor expectations’ was cited as important by 51% of respondents, while 48% said ‘improved competitiveness’ was the key reason to invest in technology. ‘Cost reduction’ was cited by 47% of respondents, while 42% believed technological investment could ‘reduce complexity’.

In terms of willingness to actually invest, considerable differences exist between the past and the coming five years, as well as the amounts. The number of companies investing less than $500,000 is set to decrease slightly, from 50% of respondents over the previous five years, to 42% over the coming five years. Those spending between $500,000 and $1 million are up slight, by 1% to 17% for the coming five years, while those spending between $1 million and $2 million increases from 13% to 17%. Companies saying that they will spend between $2-5 million are up 2% to 10%, while those stating an intent to invest more than $5 million are up 1% to 15%.

The research finds that there are differences between regions. In North America for instance, 20% of respondents said that they are keen to spend more than $5 million, compared to 12% in Europe. Mid-sized firms (>$500 million and <$5 billion AUM), are also more likely to spend larger sums, with 36% spending up to $1 million over the past five years, while 47% saying that they will invest more than $1 million over the coming period. 

Current and future IT

In terms of the key areas (front-, middle- and back-office) that currently have technology, some variation exists between areas in terms of whether they still use legacy systems or whether they are up-to-date. In the front-office, around 14% of companies still continue with outdated but functional legacy systems, while 53% say that their reliance on such systems is on par with industry wide trends (some legacy systems). 21% of respondents say that their front-office IT systems is ahead of the industry pack, while 12% say that that their systems are innovative and nimble.

The middle-office has somewhat lower levels of outdated but functional system use, at 8%, followed by 56% of respondents, who say that their systems are on par with current trends. 25% say that they are out ahead, while 13% believe themselves to be innovative. For the back-office, a similar trend unfolds, 8% reliant on legacy systems, 48% on par, 31% out ahead, and 13% innovative.

In terms of investing in their future IT system, a number of different models are projected to be deployed, depending on functional area. For the front-office, 43% of respondents say that they will build their own system, 31% say that they will buy one, 12% report a plan to outsource while 14% don’t know. For the middle-office, outsourcing is increases significantly, in a similar proportion to losses from building it themselves, at 30% and 27% respectively. The back-office is, according to the respondents, the most likely area to see outsourcing, at 35% of respondents, followed by 25% who say that they will buy and 26% who say that they will build.

Cyber defences

Cybercrime is rapidly climbing the corporate agenda as large scale, and small scale, attacks mount increasing losses across industries. Across the hedge funds surveyed, 83% cited cyber security as an important technological capability, 65% of respondents are putting their money where their mouth is, to invest significant or very significant investment into cyber capabilities. For large hedge fund managers (>$5 billion AUM), 31% say that their cyber security strategy is a differentiator relative to the competition, compared to 14% for middle sized firms. As it stands however, most firms (64%) say that they intend to keep investment into cybersecurity on par with current investments over the coming five years, while 36% say that they will increase investment. 

“You can’t count on simply meeting current cyber security regulatory standards as a strong defense against the evolving cyber threat,” notes Mirsky, Partner in KPMG’s Financial Services Practice and Global Head of Hedge Funds. “You need to be at least as good as the industry and — if you hope to avoid litigation and regulatory fines — you probably want to be above average in your cyber capabilities.”