Critical Infrastructure: Primary Instrument to Generate Operational Alpha


Excerpt of Liquid Holdings whitepaper

I. The New Asset Class

Prime brokers and hedge funds have a longstanding relationship in the overall hedge fund ecosystem. Through primes, fund managers have access to a suite of specialized services, including cap intro, trade execution, securities lending, margining, international market access, cash trading, derivatives financing, and reporting, all with the goal of enabling managers to generate alpha and communicate performance back to their investors.

Prime brokers have been the indispensable infrastructure partner and one of the most important relationships for any fund manager.

Today, relationships between the two are evolving. The alternatives industry is transforming from a pedigree-oriented, performance-based environment to a transparency-focused ecosystem, with expanded fund manager requirements.

Fund managers are starting to take advantage of services that not only enable the generation of alpha from an investment strategy, but also uncover ‘operational alpha’ – hidden capital usually locked up within unduly expensive operations.

The ability to extract a return on investment from operations will have a direct impact on how competitive fund managers remain going forward and the amount of capital that will be free to invest in alpha generating research, analytics, personnel, and core fund marketing activities over time. In essence, operations represent a new quantifiable asset class—one that not only supports performance but is a source of capital through the elimination of overhead costs.

II. The Infrastructure Instrument

According to a November 2013 Preqin survey, investor satisfaction is not solely predicated on returns and performance when it comes to alternative investments. Consistency and the ability to adjust risk are important as well. Long-term consistency and real-time adjustment strategies are core components of today’s new fund reality, and like any business the ability to lower overhead costs and extend operating runway will determine success.

Investors are now basing allocation selections, in part, on the presence of key infrastructure elements that provide controls to mitigate risk and stay within mandates. The challenge for funds is to address investor expectations while simultaneously minimizing overhead costs in order to execute on long-term business plans. Harnessing operational alpha from the early stages of the business through to maturation will keep funds competitive.

By focusing on operational alpha as they would any other instrument in their portfolio, fund managers can position their infrastructure as a direct source of capital that not only buys runway, but attracts and retains new allocations, in three business stages:

• At launch

• In acquisition

• Over time

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