Boom or bust?

In volatile markets, technology must enable managers to navigate these difficult conditions. Can the current systems feed the market?

The proliferation of hedge funds is creating momentum for a supporting IT industry which has, to date, not been the sector's most dedicated servant.

With the number of hedge funds growing at around 16% annually, software developers are finding an increasingly hungry market to which they can sell everything from end-to-end risk analysis and trading solutions, to affordable ASP-based portfolio management systems. In these turbulent times, hedge funds appear more attractive to institutional and high net worth investors, but are the current volatile market conditions placing more stress on the software that enables critical decision making?

Robert M Hegarty, research director at TowerGroup, recently produced a report specifically on the subject of hedge fund technology, claiming that opportunities are emerging, 'from behind a veil of secrecy'. He notes how market conditions have already started to attract software developers to hedge funds. 'This really has prompted a significant push towards hedge funds from a few companies who used to build software for day traders, like Tradescape and Protrader. This kind of technology is built to give traders an advantage in arbitrage opportunities within a high volume environment. All of the data it feeds to the user's system is in real-time and it combines this with analytics to give traders better information which they can react to.'

He adds that growth is continuing for systems that are purely designed for hedge funds themselves. 'This is particularly evident in areas like order management,' says Hegarty. 'Eze Castle is marketing a good order management system in the US and a British software company, Beauchamp, has built an end-to-end solution for all types of hedge funds.'

Mobile Solutions

Notably, the buzz surrounding mobile solutions last year seems to have fizzled out as quickly as it arrived. While software suppliers were adapting their systems to work on hardware such as Compaq's handheld iPaq, hedge funds continued to demand extensible risk analysis and strategic tools, making mobile solutions redundant in a flash.

Hegarty disagrees, suggesting mobile may still have a place. 'Wireless systems have a fairly limited usefulness, but I do not think they are totally outmoded.

They could have a place with the most aggressive and dedicated hedge fund managers to look at their positions with a few stocks and trades, but that's about as far as it will go.' Gavin Lavelle, president of Panorama ' Sungard's end-to-end risk and trading solution ' offers his take on where mobile solutions might have gone wrong. 'The idea seemed interesting but if you look around, there was so much money put into marketing them that vendors are now going out of business, because hedge funds are not looking to be on the move. They want all the right information on their desktops.'

Risk analysis

The basis of Sungard's Panorama solution is in risk analysis. Lavelle says that although it has the ability to work through the entire investment process, its primary function is advanced portfolio analytics. Recent customers include Systeia, Dexia Asset Management, Credit Lyonnais Asset Management, Romagest and Arca. 'I think the most important aspect of any new software coming onto the market is that it should utilise Microsoft platforms,' Lavelle continues, 'these people do not want a system that will require much training and operating systems like NT and the new. NET technology ' which Panorama uses ' are the only real choice.'

For boutiques, the options for technology investment are throwing up some interesting choices in the fields of risk management, analytics and portfolio optimisers. Brainpower is a provider of investment analysis and decision-support software tools and has recently announced two new contract wins with Manhattan-based hedge funds, Forstmann Asset Management and Porter Felleman. The two funds have opted for Brainpower's 'Finest' solution which they will be using for their complete portfolio risk analysis, matching long and short equity positions. Yiannis Yianni, Brainpower's head in the UK, explains. 'Our software allows for sophisticated, in-depth quantitative analysis and correlations to any benchmark index, as well as performance forecasting and reporting. The fund manager can create or import his portfolio into the system and produce dynamic reports for either internal purposes or for his clients.' He continues, 'The other analysis packages on the market, like Thomson Financial and Bloomberg, cannot calculate the beta relationship between longs and shorts, which makes this extremely useful for hedge funds. One fund manager's jaw dropped to the floor when he saw the beta information appear on the screen in a matter of seconds. He told us that it had taken him five years to develop his own software to do that.'

Brainpower's solution relies on daily market updates from Reuters, which also acts as a reseller of its products in certain regions. Yianni argues that as a strategic tool, 'Finest' should only require day-end pricing. 'There is no demand for real-time data. Fund managers will use our software to predict market conditions and stress test their portfolios ' it is not for reactive trading decisions.'

Real-time data is provided by another solution, RiskTrade, from RiskBox, whose online risk management and trading platform was launched in the summer, specifically for futures and options. The solution offers a real-time portfolio and cash management system; multi-exchange currency and P&L analysis, in addition to global currency consolidation.

Frederic Lefevre, head of marketing and sales at RiskBox, explains, 'RiskTrade is the first fully integrated web platform merging the necessary functionalities to trade and manage risk in derivatives, in real-time. The system has been designed for a broad community of professional investors, involved in trading, advising or managing risk on these products globally.'

Competition hots up

Prime brokers are also making headway with new IT to justify their position in the marketplace. Morgan Stanley announced this summer that its prime brokerage operation had co-developed a new ASP-delivered risk management solution with Algorithmics, entitled AlgoLink. The fully interactive version will be available to hedge funds in the new year and will provide clients with risk exposures by industry, sector and index as well as 'Value at Risk' reports and stress testing capabilities.

Guru Ramakrishnan, managing director at Morgan Stanley, says the broker's partnership with Algorithmics will provide a framework for transparency and benchmarking ' key trends for the sector, which only technology can fully realise. 'Asset managers, asset owners, regulators and credit providers all benefit from the creation of clear standards which illuminate the risk and reward characteristics of hedge fund investments. We are finding that the needs of hedge funds are surpassing the natural limitations of today's simple risk measurement approaches. Algolink provides forward-looking risk-return analysis and not just retrospective performance attribution.'

In competition with Morgan Stanley's operation, Dresdner Kleinwort Wasserstein (DrKW) is planning to launch its own full-service prime brokerage largely in response to the demands of new hedge funds in the UK and Europe. The bank will be using its EQ Finance platform to process all equities trades from start to finish, but with competition seemingly coming from all sides ' such as Lehman Brothers' and Barclays Capital offering services based around online stock loans and securities lending ' prime brokerage could be heading for a bumper year.

Foreign exchange trading is also set for a shake up in business processes, if the people at Currenex get their way. The online FX trading hub has recently announced the launch of Enhanced Market Access (EMA) ' a service allowing companies and fund managers to trade with any one of a panel of 45 banks on its system. ABN Amro, Barclays and Standard Chartered joined the panel in November to further extend Currenex's capabilities in providing extra market liquidity.

Roddy Boulton, managing director, EMA, at Currenex, comments: 'The market has been waiting for a system that will simplify the legal process and will allow funds to reach into a much broader universe of banks. Hedge funds are typically looking at arbitrages and markets and they spend an enormous amount of money building their own research efforts. They now just rely on the market for execution as they want to be sure there is maximum liquidity and minimum price slippage. In addition, they want to hide what they are doing from one counterparty to the other.

'The upshot of this is that a hedge fund might have something like 12 prime brokers, because they need their tentacles out in the marketplace and to be able to cover their tracks. Most of them simply have so much stock settling all the time they have to do this to avoid having a single point of weakness.'

EMA lets banks become 'hubs' on the Currenex system through which corporations and other buy-side institutions can trade directly with additional banks using the hubs' range of existing credit lines. 'This is an electronic 'giver' system,' says Boulton. 'At the point of trade with prime brokers, you always had to have a three-way, tripartite agreement. With EMA we can do it electronically, authenticating precisely who each party is, so there is no reason for the tripartite agreement anymore.'

Boulton explains that there are two separate strands to the business benefits of hedge funds and hub banks using the Currenex EMA system. Firstly, hedge funds that prefer to make their FX trades anonymously can do so, as well as cutting time scales with only a bipartite agreement. Conversely, the sell-side institutions can charge premium rates in order to support the anonymous trade.

A final, additional benefit according to Boulton, is for those funds with multiple prime brokers. 'Traditional fund managers look at it and say, 'well I don't really need the best price, and I don't really need the execution issues, but I would like to consolidate my credit line down from 12 counterparties to two.' From a fund management perspective, this is the first advance in the FX market for going on twenty years.'

Despite Boulton's assertion that speed of execution may yet be a top priority, there is a growing feeling throughout the securities industry that straight through processing (STP) is a logical step and one which hedge funds must avail themselves of. Damon Kovelsky, analyst for risk and trading technologies at Meridien Research, explains: 'Once the securities industry reaches an STP environment as a whole, hedge funds ought to be able to reap the benefits higher than most other types of firms. Since many hedge funds require faster execution than other participants (for example, taking advantage of arbitrage opportunities), an STP environment will facilitate that. Also, with the quicker settlement schedule that ought to come out of STP, having one's cash sooner is always better.

'A real problem for most hedge funds is that they do not want to keep fixed costs down (as they are supposed to spend money on making money by trading), this technology is not cheap. So it is understandable that hedge funds will not be leading everyone else here.'

Kovalsky adds that there are various levels of influence, with smaller hedge funds exerting little unless they create demand from prime brokers and institutional hedge funds. 'Prime brokers have a lot of influence on several other types of participants, and since they require data feeds from their clients, they should take advantage of this by offering easier and cheaper ways to connect to themselves and their data. Smaller hedge funds have got to create a demand. The problem is that since they have less amount of money to spend individually, they have a hard time getting vendors and other participants to listen to them. I think they should be getting themselves ready, so when the technology does come out, they are set to buy it.'