Can hedge funds turn fintech into an opportunity?
The hedge fund industry is facing disruption from fintech companies offering investors new ways to generate higher risk-adjusted returns – Hedge funds need fintech partnerships. By this, we mean that they either need to work with fintechs to develop solutions addressing critical challenges – or they need to invest in them. Hedge funds need to adapt, They need to hedge the risk fintechs pose to the industry. (Just like banks and others in financial services.)
Fintech is also catering for hedge funds – facilitating trading, improving efficiency and cutting costs. Furthermore, fintechs may represent an investment opportunity for some hedge funds.
Where hedge funds work with fintechs
Here are some of the areas where hedge funds already work with fintechs:
- Automated trading fintechs help hedge funds trade financial instruments on public exchanges automating part or all of the trade cycle. They do so by offering third-party platforms or direct market access (DMA). Exchanges include NYSE, LSE, CME, LIFFE and other venues. Some fintechs even help hedge funds trade cryptocurrencies
- (The simplest form of automation comes from opening or closing positions when a set price level gets hit. The most complex form employs quasi-AI based, such as machine learning)
- Robo-advice fintechs develop tools that build and manage investment portfolios tailored to clients’ financial goals, using automated processes, based on quantitative finance. Some of these offer solutions that cover the investing needs of all sorts of institutions, including hedge funds and funds of hedge funds
- Blockchain fintechs allow hedge funds to improve efficiency and cut down operational costs with distributed ledger technology. Their applications include instantaneous settlements, smart contracts and pre-agreed execution. They can also help hedge funds raise capital through ICOs
- Big data research fintechs are entering the equity-research space challenging the dominance of securities firms. They use computers to crunch tons of information and predict companies’ earnings
- Last but not least, more and more fintechs offer regtech solutions that cut down compliance costs. These companies develop technology to make it much easier for financial companies to comply with all sorts of regulations
(We have included the areas we focus on as a business, at present.)
Where hedge funds invest in fintechs
Meanwhile, hedge funds with billion-dollar reserves are becoming the new venture capitalists, according to the New York Times. Here are a couple of examples:
- Coatue Management invested in Lending Club (NYSE: LC), the large, US-based P2P lending platform where investors can search and browse the loan listings and select loans that they want to invest in. (The fund invested in the fintech before its initial public offering in late 2014)
- Third Point Ventures has backed SoFi, an online provider of loans, mortgages and student loan refinancing
The pace of fintech investments by hedge funds picked up in 2014, according to CB Insights. The initial investments in fintechs start-ups from hedge funds started two years earlier and focused on P2P lending. Now, hedge fund money is starting to move into other fintech areas such as insurtech and small business management systems.
With lots of money from all sorts of investors rushing into fintech, some fintechs might be getting more credit than they deserve. Many hedge funds, particularly the small and mid-sized ones (the vast majority of them), have little experience working with early-stage fintechs. Most fintechs in the areas above were founded post Credit Crunch (2007/2008). The combination could result in hedge funds allocating too much capital too soon to fintech projects.
Hedge funds need fintech partnerships, where the project team has certain key roles and realistic implementation plans which make tech projects more likely to succeed. Within timelines that are acceptable by their often not so patient institutional and high net worth investors. Independent advisors and experts may help fill key project roles, keep plans real. And therefore increase the chance of delivering these projects on time, on budget and on value.
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