Since the global financial crisis of 2008-2009 and the Madoff Ponzi scheme (collectively, the “Financial Crisis”), both regulators and investors have significantly increased their demands that hedge fund managers (“HFMs”) develop and maintain an institutional-quality infrastructure. Unfortunately, at the same time, the revenues available to most HFMs to build and support the required institutional infrastructure have diminished, as both fees and AUM have been compressed. The inverse relationship between these two realities has created significant barriers to entry for emerging HFMs, as well as significant impediments to further growth for small to medium-sized HFMs.
The recent (yet not so recent) issues associated with cybersecurity and technology risk represent another major obstacle that today’s HFMs will need to overcome, as many firms have been attacked, or have suffered from outages or losses caused by technology failures. Further compounding the need for attention is the heightened scrutiny being applied by both investors and regulators to the issues and risks associated with cybersecurity. For instance, given the concerns over client money and data loss, the SEC has begun to focus on cybersecurity through a sweep of investment advisers and through guidance to investment managers. Thus, HFMs that already find themselves in a position where they have to do “more with less” will need to act efficiently and effectively to mitigate these risks. Co-sourcing, as a practice, allows the firm to leverage cost-effective expertise to achieve operational goals and address potential shortcomings.