17/03/2005

The Hedge Fund Manager 2005 IT survey

Several IT providers to hedge funds are enjoying annual revenue growth of 34% or more as IT becomes more crucial for funds. While the strong growth enjoyed by the hedge funds themselves may slow over coming years, or even stall, hedge fund managers' desires for superior data management capabilities and tougher regulatory demands will continue to drive providers' revenues.
Mason Snyder, senior manager, capital markets practice at Deloitte & Touche, says: "Hedge funds as a product are relatively nascent in securities investment. They have traditionally been small operations focused on investment performance than information technology issues. With the rapid growth in the sector over the past two or three years, partly fuelled by strong interest in alternative investments by pension funds, there is a need to increase the complexity of strategies, performance reporting and transparency.
"The industry has reached a point where to move up the competitive curve requires more technology expenditure. To attract and retain investors - especially institutions - hedge fund managers must provide some transparency to their portfolios and deliver this information to clients in a timely manner."

Data and accuracy
High on the list of issues raised by the Hedge Fund Manager survey are security and data accuracy. And within security one of the biggest drivers is fear, according to UK network security specialist Grade A Computers, whose client base includes six European hedge funds.
Kelvin Wheat, general manager at Grade A, says: "All our new hedge fund clients are scared when we first meet them. Network security is a real concern. Many people do not have any understanding of IT - they understand how money moves, how markets react, they know all about derivatives and they know how to manipulate it to show a profit. But not understanding IT leaves them concerned about the impact of a virus or a hacker."
One effective virus hit could put them out of business at a time when they are just trying to roll out plans to take them to the next level of profitability, he says. "It sounds alarmist, but there is a good deal of truth in the argument that it could cripple them."
He has good reason to argue hedge funds are under-protected. On a recent visit to a potential new client, a European bank with a substantial hedge fund business, a system integrity check brought up a series of immediate concerns, the majority high or critical.

Maintaining high standards
High standards of data, meanwhile, are absolutely crucial in the hedge fund sector, according to Willem de Geer, chief executive of Panopticon, whose product for the hedge fund market is a tree mapping system, Visual Portfolio. "If the data being analysed is not accurate then it makes a mockery of any risk control measures in place," he says.
"Visual Portfolio turns a vast amount of market data into valuable information so a hedge fund manager can determine where best to invest his time and money."
Panopticon's hedge fund clients range from two to 200 people and from 100m to 18.5bn under management. They include several of the top 10 managers by funds under management.
A conventional graph can be illustrated in 16 colours, but a fund manager requires a much higher level of detail, he says. "This system groups data together, real-time adjusted and broken down by sector. It works by combining historic absolute and real time data feeds and any number of sources of data and gives access via one interface. It is always transparent precisely where the data is from, he says.
For example, with a long/short hedge fund Visual Portfolio shows the aggregate and individual positions, illustrating their performance with shades of red versus blue. "It's impossible to get this kind of overview via traditional means. It shows where most money is being lost and gives a real time ability to slice and dice data and create interactive value-adding reports."
JPMorgan uses Panopticon software to display the credit and emerging bond markets and to show market movement, either real time or historical. Most of the bank's fixed income sales staff use the system whose heatmap is able to access all proprietary research and prices. Silvio Oliviero, vice-president of JPMorgan, says: "In the past two years there has been more interest in the system from people both within JPMorgan and its clients."
When the bank acquired the system two years ago there were other products available, but Panopticon was more functionally rich, he says. Panopticon allows JPMorgan to offer its clients the ability to seamlessly upload and change their portfolios online and to customise their portfolios in real-time. It also allows them to change the portfolio composition independently from the dealer's interaction.
The biggest single issue is quality of price execution, according to Brian Maccaba, chief executive and founder of Cognotec. "If banks don't have the most accurate pricing tools, then they are at a grave disadvantage," he says.

White-labelling
Cognotec provides an ecommerce solution for banks which then whitelabel the product for hedge fund managers. "There is a great deal of work-flow asset allocations to hedge funds which have been heavily invested in over the past 12 months," he says.
Cognotec's Market Rate Manager (MRM) enables banks to provide quality rates. "Hedge funds are important players in the forex market and the next big trend is to deepen integration," says Maccaba.
Although security is seen as the biggest concern facing hedge funds within banks themselves, concerns over system stability and security have lessened in recent years, Maccaba says.
"Several large banks wanted to get their products to market between 1999 and 2001, but they were essentially prototypes and systems now are much more sophisticated able to handle vast volumes."
Backstop Solutions is another provider expecting to benefit from the increased emphasis on IT. Jeromie Bacon, president of the company, says: "Family offices and funds of hedge funds are increasingly looking for software that reports exposures tracking of portfolios and allows managers to carry out 'what if' assumptions.
"We are getting more demand from family offices and funds of funds for a unified system. Traditionally, a variety of software systems have been used in hedge funds. Over the past 18 months, there has been a significant increase in those looking for one platform. Over recent months, IT costs have become more of a factor.
"Backstop's software is designed for regulated hedge fund businesses and can help verify the growth of a fund, from say US$250m to US$2bn. In this respect, moves by the US financial regulator to force many hedge funds to register is helping promote the business.
"Backstop's average hedge fund client has US$650m under management and its median has US$300m under management. The firm believes hedge funds want to be able to customise the platform to their own needs and the system is compatible with other systems.
"The company has added 12 hedge fund clients since October and aims to add 40 hedge fund clients - both single funds and funds of funds - during 2005. It is forecasting a doubling in revenues year-on-year for the next few years as more hedge funds unify their IT systems. Indeed, after the strong growth in the number of hedge funds over recent years, we expect to see the market contract."

Compliance
Perhaps the biggest driver of change among hedge fund's IT capabilities will be regulatory. Deloitte warns the introduction of the Securities and Exchange Commission (SEC) registration regime could have far-reaching consequences for data management, extraction and performance analysis among other areas.
Paul Doherty, senior manager, capital markets practice at Deloitte & Touche, says: "Compliance with the Investment Advisers Act will require hedge fund advisers review their books and records - ensuring data is assembled in a manner which supports the record keeping requirements of the Act. Hedge fund advisers will need to be able to respond to SEC requests for information and deliver this information in a timely basis. This includes performance data, information about the investment process, and due diligence information as requested by the regulator - in other words, information which provides transparency into the adviser's operation. As a result, the ability to store, assemble, and extract data is critical. Smaller hedge funds relying on Excel spreadsheets may find they will have to invest in new technologies to support the record keeping requirement.
"Among hedge fund of fund managers, there are additional issues. Hedge fund of funds will need to supply information to regulators which provides transparency into the underlying funds. In other words, fund of fund managers will need to demonstrate to regulators that they are in possession of relevant data that supports their investments."
And Snyder says: "Fund of fund managers will need to demonstrate that managers selected are investing according to the strategy. For example, the manager would need to determine and demonstrate a convertible arbitrage manager is investing in the strategy as expected - without straying from the mandate."
The registration regime will force hedge funds to review another area of weakness - disaster-recovery planning. Snyder says: "Disaster-recovery planning for hedge funds IT system failure may be an area of weakness when compared to recovery plans in place at the investment banks. Since the Y2K issue, banks have developed robust disaster recovery plans for computer system failures. This was also spurred by the 9/11 terrorist attacks. Among hedge funds there is recognition of this gap. Indeed, a recent survey conducted by Deloitte across all industries showed 65% of businesses acknowledge the importance of creating business recovery programmes."
Doherty says: "One of the implications of the hedge fund adviser registration requirement will be that those hedge fund advisers required to register will need to demonstrate they have adequate business recovery plans. The SEC has already indicated that this is one of the areas that will come under scrutiny in their review of investment adviser operations."