31/10/2007

IT set to be the biggest cost for hedge funds

LONDON: Three quarters of global hedge funds have identified technology as making up their biggest expense over the next two years, with more than half of them expecting expenditure on risk management systems to be the biggest proportion of that spend, according to a poll by Ernst & Young. Investment in portfolio management systems comes a close second in the survey, with 48% of respondents say­ing it will attract the largest amount of their technology spend over the next two years.

“Over 70% of our respondents state that technology would receive a sizeable part of their budget. This is consistent with an industry that is mid-point in its development cycle,” the report stated.

The poll was taken from a sample of more than 100 top global hedge funds and fund of hedge fund managers, who collectively represent some $900bn in assets under management.

With $41.1bn pouring into the industry in just the second quarter of 2007, the global hedge fund industry now manages $2.5trn in assets and managers are rethinking their infrastructure and operations to cope. “They need to not only to ensure scalability but, more importantly, to minimise any drag on performance,” according to Art Tully, co-leader of Ernst & Young’s global hedge fund practice.

According to Charlie Tritton, head of alternative investments at New Star Asset Management, there are managers who spend up to $100m on IT per annum.

“An average equity long/short hedge fund with around $200m in assets under management spends between $200,000 to 500,000 a year on software, and the same on hardware and infrastructure,” said Stuart Farr, the chief executive of Linedata’s Beauchamp Hedge Fund Solutions, a hedge fund technology provider.

He estimates hedge funds’ expenditure on IT will increase by more than 20%, especially for those funds that are looking to attract institutional money.

The main areas warranting greater IT spend will be in operational controls, such as reconciling cash and security positions with prime brokers and the ability to take on more than one prime broker.

“Other areas include innovations in the equity markets, namely in the realm of synthetic equities, which require sophisticated software to trade and, also, funds have become more interested in real-time technology following this summer’s [increased] volatility. Finally risk management is another area of cost, driven by requirements from institutional investors,” he added.

Moving towards an industrialised landscape

According to Julian Young, a partner in Ernst & Young’s hedge fund practice: “An increase in IT spend in the coming years will be a result of hedge fund managers becoming more industrial in scope and scale, and there­fore less reliant on people so they can deal with the volumes they are trading.

Young adds: “The bigger managers are making heavy investments into technology. The smaller managers will continue to outsource to prime-brokers and administrators but as you grow and develop in complexity and volume, the smaller managers will need the industrial strength to process in-house.”

Greater regulatory scrutiny is also fuelling the need for better systems that ensure greater transparency around valuation and attribution of returns. Currently managers still depend on human skill, but, the report adds, “as the industry matures, the requirement for greater levels of automation will be unavoidable”