The value of experience

Sunil Chadda was recently installed as head of Citisoft's hedge fund and derivatives practice. Victor Anderson speaks to him about trends that he's identified since his appointment, the impact Mifid (the Markets in Financial Instruments Directive) is likely to have on the global hedge fund industry, and how sell-side systems are finding traction on the buy side.

I understand that you worked on the buy side for a number of years before joining the ranks of the consultants?

Yes. I started my career working for Schroder Asset Management in 1986 in contracts, corporate actions and dividends. I moved into special projects, which looked at systems to improve workflows and cut costs within the company. I then worked as an IT manager on the fixed-income desk, where I was involved in developing trading systems and improving data management. I joined Citisoft four-and-a-half years ago.

What was your remit at Citisoft prior to heading up its hedge fund practice?

I concentrated on front-office technology, specifically trading, compliance and decision support. A couple of years ago the market for front-office systems slowed, which forced me to assess a number of other opportunities on the buy side. We were looking at the hedge fund space at around the time that our first hedge fund client walked in the door with a proposal. That client consisted of a bunch of sell-side people who had established a hedge in the West End [of London] and then subsequently launched three 'mirroring' long-only funds. Now they've set up a structured products desk – they're a hedge fund, an asset manager and investment bank all at the same time.

You've also consulted with a number of large long-only asset managers?

Yes. After that first client we moved on to a large UK-based asset manager – the leader of the pack in the traditional asset management space – and we ran a systems selection for it. From there we went into a beauty parade with five other technology consultancies for International Asset Management [a UK-based fund of hedge funds]. We're still at IAM running workshops and helping it with contract negotiations and implementations.

What do you believe to be the key criteria during the beauty parade process?

Experience.

So it doesn't necessarily boil down to price?

No. In fact we know we haven't been the cheapest in some beauty parades. Price is not the thing for us – we concentrate on quality, and in this industry if you want the best you've got to pay for it. It comes down to experience, and in that respect we straddle buy-side systems, hedge fund systems and now sell-side systems.

Have you noticed any trends in the hedge fund space since you turned your attention exclusively to this industry?

Definitely; the explosion in interest in derivatives – specifically OTC derivatives – which has primarily been led by hedge funds, although the asset management space has started jumping on board. They are seriously behind the curve, though, and they need help. They have been complacent; asset managers have talked about trading CDSs [credit default swaps] and IRSs [interest rate swaps] for example, but nobody really does it and they definitely don't do it in terms of the volumes that they should be doing it.

But isn't that symptomatic of the industry as a whole? For example, a lot of buy-side firms say they're using Fix for the bulk of their trade volumes but when you look at them closely they admit that in fact this isn't the case. Isn't the CDS/IRS example just another instance of the buy side talking a good game?

Yes, I completely agree with that. It's only when you walk in the door that you get that impression. A lot of the time it's a case of window dressing.

Every now and again you get to hear anecdotes of well-established hedge funds with pretty rudimentary technology supporting their entire business. The same goes for the asset management industry where, for example, risk management is something of a joke in certain circles. They talk about accurate value-at-risk and net-asset value (NAV) figures, when they know full well that they don't possess the technology or inclination to manage their risk that closely.

I agree with that as well. There are obviously houses out there like Gartmore whose alternatives division is leading the pack. They have the right systems and they do things properly. We have a pipeline of four asset-management derivatives projects that we're about to submit proposals for. The interest in derivatives has ballooned and everyone seems to be jumping on board simultaneously.

Have you noticed any technology-related trends recently?

If I look at BGI [Barclays Global Investors] – and this is a definite trend that started last year and is going to pick up this year – I would say that sell-side systems are finding traction on the buy side. BGI has bought Summit [Systems] and Calypso, for example. I'm aware of two or three large asset managers that are currently in the system-selection process looking at sell-side systems.

So what you're saying is that buy-side firms are starting to mimic the sell side in terms of their trading operations?

Not really. They are beginning to mimic the sell side but what they have realised is that the only systems that are going to give them real-time profit and loss and the proper clean instrument coverage are from the sell side.

Are hedge funds looking for third-party supplied systems as opposed to white-labelled or prime broker-supplied systems?

Sell-side systems are the ones with the correct instrument coverage. Another driver is real-time P&L – most funds want real-time P&L.

Granted, but if you're a hedge fund with $100 million under management it's going to be very difficult to justify spending large amounts of capital on your IT infrastructure – like a Summit system – that has ostensibly been developed for large investment banks.

Yes, those are big implementations, but this is another trend we've seen: sell-side vendors have had to reduce their prices to sell into hedge funds and asset managers. We're currently working on a systems selection for the alternative arm of a traditional asset manager that has opted for a sell-side system and the price that's been negotiated is, let's say, 'half book'.

Are funds looking for service-orientated delivery of their technology – like the classic application service provider (ASP) model for example – as opposed to running the technology in their own environment? Or does that consideration boil down to the size of the organisation and its level of IT infrastructure?

The hedge funds that we've worked with are all large – over $1 billion under management – and they typically have a large infrastructure and are therefore not looking at ASPs. There has been lots of talk over the past 18 months about hedge funds wanting ASPs, but that's not the case for the large end of the market. There are a number of vendors that have either launched ASPs but haven't found traction in the market, or a number of vendors that have kept their ASP offerings secret; I'm aware of two that have done that.

What's the point of developing a service and keeping quiet about it?

It's an issue of scalability; the offering hasn't got sufficient scalability for the vendor to publicise it. Those services that do not pick up clients shortly will close.

In your opinion has there been any substance to the perceived security-related fears traditionally associated with the ASP model?

No. They are professionally run outfits and that type of stuff hasn't happened. What I would say though is that a big factor for all the funds that I have been involved with is that they all have high net-worth individuals – or what I would call sophisticated investors – and they won't consider placing capital with a fund if its data centre is in the US, Switzerland or Canada.

Why is that?

The US does not comply with the EU data storage directive, and since 9/11 the US federal authorities – the FBI, the CIA and the SEC – have the jurisdiction to walk into a data centre and subpoena a database and the data and remove it. If you're a high net-worth individual or a large pension fund, you don't want that type of thing going on. That's an absolute show-stopper for vendors in these countries. India is another good example where there are no data protection laws.

Is there a difference in technology requirements for start-ups as opposed to established funds?

We don't work with start-ups because they typically don't spend on systems – they take white-labelled systems from their prime brokers or administrators. What we are seeing is a 'formalisation' where funds that started life five or 10 years ago using proprietary or white-labelled systems have got to the point where they recognise that they need to invest in technology to further grow the business and attract new money. That's where we've really been involved.

What areas of the industry are being underserved in terms of technology?

The STP [straight-through processing] side of OTC derivatives is underserved. Asset managers want to see an electronic process from start to finish and that isn't necessarily there.

Isn't the Novation Protocol a move in the right direction?

It is, but if you take an equity, the minute you trade it it's all electronic from execution through to settlement. That's what we want to see for all instruments.

Isn't it a bit unrealistic to expect that to happen any time soon, given that these instruments are traded over the counter and that many of these contracts are 'one-offs'?

Yes, but at the end of the day you're buying an instrument or a security and someone is paying money for it and there has to be a way of automating that process. We've seen Swapswire and the DTCC [Depositary Trust and Clearing Corp] reduce the levels of risk and increase the levels of automation with their systems, and we know they are going further down the STP chain. That's the type of initiative we're looking for alongside the Novation Protocol.

How is Mifid going to affect the global hedge fund space?

I've got a serious problem with Mifid; I think it's a complete waste of money and space. The UK market is the leader of the pack compared with the European markets and I think the UK is surrendering its position by adopting Mifid. I think it's a ridiculous requirement. I don't see it impacting the hedge fund space at all apart from hedge funds having a database with all their trade information.

Some of the Mifid requirements still aren't published. It's supposed to be implemented next year and the EU has been messing about for the last 10 years trying to get all the legislation together and they still haven't sorted it out. I find the whole thing overly bureaucratic; I can't think of anything positive to say about Mifid.

What's the next big thing in the alternative asset management space?

Mergers and acquisitions will become more common, especially in the funds of hedge funds space. We've seen Schroders and ABN Amro in the last three months acquire funds of hedge funds, and that's because currently there simply aren't the skills in the market. Many of the well-established funds of hedge funds like International Asset Management are already in all the best-performing hedge funds, which are close to capacity. You simply cannot get in there as a start-up fund of hedge funds.

Hedge Fund & Investment Technology

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