Hedge fund managers appreciate more than ever the benefits of technology in developing and implementing effective trading strategies, but the effects of the market dislocation are set to depress the industry's aggregate investment in technology next year, according to Hedge Funds and Technology: Automation and the Feedback Loop, a study published by the Tabb Group.

Although hedge fund managers now find themselves in a precarious position, firms that survive will continue to make investment decisions, trade, manage risk and report to investors, says the report, which notes that firms are already upgrading their trading systems to handle automated markets and increasing back-office efficiencies.

Although the market turbulence facing the industry is likely to result in fewer hedge funds and a decline in total assets under management, Tabb Group says that more than 75 per cent of managers clearly appreciate the benefits of electronic trading for asset classes including listed options and futures, fixed income and foreign exchange.

Despite forecasting a 40 per cent drop in total IT spending to USD882m in 2009 due to reduced revenues, the study's author Cheyenne Morgan believes that front-office trading operations will not suffer as radically as other departments.

'Any software or service that directly supports the investment process stands a far better chance against this inevitable tide of cost cutting,' says Morgan, whose analysis is based on interviews with 61 US-based hedge fund managers with a combined USD227bn in assets.

As firms try to switch budgets from fixed to variable costs, Tabb Group believes that there will be an increase in buying rather than building solutions to help traders execute orders within a complex structure of lit and dark markets.

'Competing within Wall Street's new ecosystem, technology vendors that develop smart order routers, order management systems and execution management systems need to insure that their solutions are flexible enough to accommodate several asset classes, addressing the interoperability of systems throughout the life of a trade, backed by end-user support services,' she says.

Hedge funds may be characterised by their sophisticated clientele and complex strategies designed to exploit market fluctuations, but Morgan says few hedge funds are actually at the cutting edge in applying technology to generate returns. The majority use traditional investment techniques, which is why although nearly 80 per cent use an order management system, it is difficult to use efficiently, particularly for non-equity trading.

She adds that as firms implement new technology, nearly a third say that their trading desks are the most challenged area of the automated operation. Because the feedback loop between the front office and other systems is short, with firms now holding positions for bare minutes, if not seconds, 'over 40 per cent are committed to making improvements, recognising that the back office can become compromised as a result of their fast-moving front office.'

'Speed will always be important, but there is a focus is on integration as well,' says Tabb's director of research Adam Sussman (photo). 'Hedge funds are now trying to 'feng shui' their desktops, creating environments that allow for the smooth transition of liquidity and process. The front office will continue the effort to shave microseconds from each trade without leaving the back office trailing far behind.'

Founded in 2003 and based in New York and London, Tabb Group uses an interview-based research methodology developed by founder Larry Tabb to analyse and quantify the investing value chain linking the fiduciary, investment manager, broker, exchange and custodian.


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