Alex Tsigutkin, Industry Leader

Hedge Fund Technology Evolves to Meet New Industry Demands

New technology is playing an increasingly vital role in hedge fund operations, not only improving the chances of a small hedge fund succeeding but also helping large funds to develop into operationally efficient ‘superfunds’. PROHEDGE’s Nigel Someck speaks to leading industry figures to find out how technology is responding to the changing needs of the hedge fund industry.

Here in hedge fund world, we find ourselves at an interesting crossroads. Increased investor due diligence, scrutiny from regulators, a rough trading environment, are familiar themes in the hedge fund press. All these factors have conspired to apply immense pressure on the industry. As a result, hedge funds have had to respond by upping their game, investing in infrastructure and technology, consolidating with other firms and becoming more operationally efficient. Adaptability is the name of the game if you are going to survive in the current climate and utilising technology provides a lot of the answers.

Turn the clock back just a few years and hedge funds were trading and operating in a completely different fashion. “Our development priorities have shifted to reflect the evolution of our customers,” says Rob Mackay, COO of SunGard’s newly launched Hedge360 service, a cloud-based application suite combining several of SunGard’s hedge fund solutions under one hosted umbrella. “Seven years ago many funds managed their risk on home-grown spreadsheets and were less concerned about their operational infrastructure or risk management practices, so our focus was on adding new functionalities, ensuring that the full range of traded products were covered. Over time, however, our clients’ priorities have shifted to focus on reducing cost of ownership, operational due diligence and the increasingly demanding regulatory environment.”

As well as the growth of operational requirements, fund managers today simply expect more from their service providers. The challenge is to cover multiple functions through one solution. Caspar Marney, founder of Marney Capital a London-based hedge fund, feels that the goal for technology providers should be to create solutions that “simultaneously satisfy the needs of the investor, investment manager and regulators in one system”. He adds: “At the moment one has to use separate software to satisfy each requirement.”

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The panacea for most hedge funds today is to create a technology eco-system from day one that can organically grow as the fund launches new strategies, grows assets and operates in an ever-evolving global regulatory environment. A $50 million start-up will actually build an infrastructure capable of managing $2 billion – that is what it takes to attract ‘sticky money’ and keep on the right side of the regulators. How have technology providers responded to such regulatory and investor pressure?

PerTrac, a provider of a range of risk assessment and tracking tools for investors, has been updating its development priorities to cater for the investors themselves. MD Jed Alpert comments: “Investors are looking for better ways to monitor and manage liquidity in their portfolios of investment funds so they don’t face the surprises of 2008 when fund gates and suspensions were enacted.” Solutions such as PerTrac Portfolio have directly responded to this change in the market as it “removes the guessing game”, according to Alpert, since investors can now have a view of liquidity at any point in time.Regulators have played a significant role in changing the way the industry behaves, influencing the evolution of technology. AxiomSL is a leader in the field of regulatory reporting and data warehousing. CEO Alex Tsigutkin says that his firm is currently focusing on “providing infrastructure-oriented solutions… which encompass high-end analytics historically provided by front-office tools with data warehousing and reporting engines”. Interestingly, Tsigutkin points out that sound compliance infrastructure actually paves the way for better investor servicing and transparency, meaning investment in compliance will have a knock-on effect of improving investor servicing.

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Another area of change in the industry that has had a major impact on the development of technology is the change in fund sizes, largely through the rise in the number of mergers and lower AUMs of startups. “There has been a tremendous amount of consolidation,” says Andrew Schneider, CEO of Global Hedge Fund Advisors, a provider of consultancy services to hedge funds. “Managing a hedge fund has two parts: one is the fund management and the other is the business or operations side.” Thus, it makes a lot of sense for hedge funds to consolidate and share operational management tasks, enabling fund managers to focus on generating alpha returns. AxiomSL has developed IntegrationCenter which, claims Alex Tsigutkin, “allows us to integrate a multitude of source systems”. Without doubt, the surge in mergers and consolidation will lead to greater emphasis being placed on the need to integrate inherited systems and processes.

There are still success stories out there of small funds that have grown organically through stunning performance and solid operational infrastructure, as well as guile and determination. Technology providers need to get very creative from a cost of ownership perspective in order to provide these small funds with the tools they need to flourish. “The challenges facing a hedge fund depends on the size of the fund,” says Rob Mackay. “For example, small funds have to attract institutional money, and simply generating good returns is no longer sufficient to do this. It is now imperative that small funds demonstrate that they have an institutional-strength infrastructure, even if they do not have the internal resources to build or support it themselves. Hosted solutions are often the answer.”

SunGard, like some of its peers, has recently begun to offer small funds hosted versions of previously unattainable solutions, so now even small funds can boast an institutional-grade operations platform. On this trend, Caspar Marney comments: “While the latest cutting-edge technology, such as that for the lowest latency solutions, is still very expensive, the financial barrier to entry for many technology solutions has certainly come down.”

Furthermore, Jed Alpert believes that a small fund with solid infrastructure will gain a competitive edge when doing battle in the fund-raising arena, where they can be joisting against billion-dollar giants: “If a fund has a better infrastructure than its peers, that will provide some competitive advantages in an environment where asset raising is fiercely competitive and most allocations are flowing to the biggest funds with over $1 billion in assets under management.”

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Clearly, some significant strides have been taken by technology providers, but what do the next five years hold? What are the next big changes that will need to be addressed? “Now that restrictions on hedge fund marketing have been relaxed, social media like LinkedIn and Facebook will be the new forum for investor marketing and interaction,” predicts Andrew Schneider. So perhaps we will soon witness some leading providers integrating their reporting and communications platforms with social networking sites. Schneider continues: “We will also start to see the larger hedge funds behaving like banks, as they are fast becoming a source of financing for private equity and real-estate deals due to the heavy lending restrictions placed on banks.”

Hedge fund technological solutions of the future will need to keep pace with these new ‘bank-like’ structures. Caspar Marney also sees managed accounts assuming greater significance in this context for hedge funds and technology companies alike. “Managed accounts are more complex, with trades needing to be split into different allocations, and across counterparties,” he explains. Over the coming years, managed accounts will become a standard feature of every hedge fund and, therefore, robust allocation functionality will be critical components of all hedge fund technology.

Jed Alpert of PerTrac adds that eventually “the scramble to comply with regulations will come to an end”, thus allowing technology providers to refocus on building alpha-generating tools. SunGard’s Rob Mackay holds the view that “the niche point solutions will no longer be able to meet industry and investor demands”. As funds look to maximise efficiency and find themselves operating in an ever-decreasing management and performance fee-earning environment, he believes that “funds will look for flexible, full-service platforms that maximise functionality, increase efficiency, and help them excel in the face of change. This philosophy is driving the development of Hedge360.”

It appears that we are in the early stages of a momentous period of change in the hedge fund industry and the technology industry that supports it. The dialogue between hedge funds and technology providers needs to remain open in order to meet the challenges and opportunities that will arise over the coming years.

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Reprinted from