There has been somewhat of a sea change recently in the relationship between hedge funds and the providers of financial technology applications. Many mainstream providers of IT solutions to the investment management industry have tended to focus their marketing efforts – and indeed their product development – on the more lucrative mainstream fund management and banking sectors. The hedge fund market was seen as too small or too specialised to develop tailored products for.
For hedge fund managers, primary technology decisions were restricted to the systems they would be using for receiving data feeds, as well as the other software tools they would require to manage their portfolio, including risk management and modelling applications. For a manager leaving the prop desk of a big bank, or going it alone from the blue chip asset management house where he earned his spurs, the process was frequently about putting together the front-end trading system which had helped him to achieve his all important performance numbers in the first place. Often, he would turn to his prime broker to help him with setting this up, leaving the PBs in a very influential position when it came to providing technology advice to hedge funds.
All that has now changed. For starters, the companies that develop and sell IT products for the financial services space have woken up to the increasing size and importance of hedge funds in the global marketplace. We are now starting to see applications being specifically targeted at hedge funds, either products that have been adapted from an existing proven model to serve the more specialised needs of hedge fund managers, or indeed being built from scratch and often at great expense.
And the story is no longer about what a manager is installing to trade the market with. I have spoken with a number of the CEOs of leading European hedge funds operations this year, and one common denominator has been their emphasis – and indeed enthusiasm – for technology. These are not people being shoe-horned into embracing a new world order of IT due diligence, but professionals who have a great understanding and appreciation for the benefits that technology can bring to their businesses, both in the front office and the back office. We are increasingly hearing them speak of appointing chief technology officers within their organisation, to stay on top of the highly sophisticated internal operating structure of hedge fund firms with over 100 employees and $3 billion in assets under management.
But in addition to this, the regulatory environment, and the quickening pace of institutional investment in hedge funds is forcing smaller managers to embrace IT as well. A report from Datamonitor released at the end of August this year predicted that investment by hedge funds in IT services globally would top $3.3 billion by 2009. In addition, it pointed to evidence that hedge fund service providers would also be revamping their IT infrastructure going forwards. This is part of a broader trend in the asset management industry highlighted by a report Investit released in September, which revealed that investment management companies have increased their IT spent by 10% year-on-year since historic lows in 2003. Much of the investment in this case is being focused on business generation and front office projects in preference to their traditional efficiency targets in operations. Beneficiaries include CRM systems, client reporting, and supporting derivatives.
According to the Datamonitor report’s author, Nii Barnor, hedge funds are beginning to resemble traditional asset managers by placing cost control and efficiency higher in their priorities, as despite growing market size, and the large number of start-ups entering the field, there have also been numerous instances of funds collapsing due to the competitive pressures of the industry. In tandem with this, the hedge fund industry is also facing increased levels of regulation, putting yet more pressure on managers.
“The shift of the hedge fund industry into the retail space has prompted an increased focus on execution capability,” says Barnor. “The availability of real-time data to enhance the investment decision making process, direct market access, and algorithms are all key areas hedge funds are beginning to focus on as they search for new trading opportunities.”
What was interesting about the Datamonitor report was its emphasis on how service providers would also be to upgrading their technological infrastructure. Prime brokers, for example, are finding hedge funds more demanding in terms of the support they require for complex strategies, and also from a connectivity and operational aspect. IT spend by prime brokers is expected to be focused on the European and Asian regions in the next few years, with over $400m earmarked to be spent by PBs in Europe alone on IT by 2009. Focus areas look likely to include margin and stock lending systems, as well as settlement systems which will need to cope with the high volume and more complex instruments hedge funds are trading. On the fund administration side, Barnor says that technology will need to be taken “a step on from solutions for the mutual fund industry by focusing more on how to provide a consolidated view to cater for the demands of each kind of investor.”
As the market develops, fund administrators will be pushed to offer customisable real-time reporting with web-based user interfaces. Technology spend and proper deployment, something that used to be a marginal criterion on the shopping lists of COOs looking for an administrator for their hedge funds, is now creeping rapidly towards the top of that list as they realise, along with experienced personnel, how critical IT is to the fund administration offering.
Our report this month focuses on what will be an exacting area for differentiation between hedge funds. Managers are still being failed on a regular basis in due diligence reports through their inadequate infrastructure and the high level of operational risk this brings with it. Our articles tackle a range of different issues, from the generalist to the very specific, and will demonstrate the degree to which effective IT systems can rapidly improve how hedge funds operate, provide radical cost savings, and help firms to meet the increasingly demanding requirements large investors will be making of them going forwards.
“A report from Datamonitor released this year predicted that investment by hedge funds in IT services globally would top $3.3 billion by 2009”
