Hedge funds are well known for developing advanced technology solutions that meet exacting standards and demanding requirements. Now, as their sophisticated investment strategies enter the mainstream, there is also a need for technology solutions to become more mainstream.
Two decades ago, when derivatives trading was still rare, hedge funds needed accounting systems that could help them understand their notional exposures, monitor leverage and liquidity, manage collateral and counterparty risks, and value complex instruments.
At the time, package software solutions that could address such needs were exceedingly rare. For many, manual workarounds evolved – such as using spread sheets to track derivative positions offline, then booking a single journal entry for net unrealised gains/losses into a portfolio accounting system.
However, those fortunate enough to have in-house development capabilities began developing proprietary systems to address these needs. Industry-leading technology became a distinct source of competitive advantage for these pioneers.
Fast forward to today, and according to Tyler Kim (pictured), CIO at Maples Fund Services, the breadth of organisations requiring the level of technological sophistication previously needed only by hedge funds has expanded to include other players, such as traditional asset managers, institutional investors and private banks.
In Kim’s opinion, many financial institutions are becoming hedge fund-like in their investment strategies and operations, and hence can benefit from the technology and capabilities once reserved for this specialised niche.
“Hedge funds are like the asset management industry’s space programme,” says Kim. Amongst the benefits afforded by hedge fund technology is the enablement of new business models, leading to trends such as increased insourcing by institutional investors.
“Institutional investors are getting more actively involved in the investment process, in hopes of reducing costs and improving performance. However, they need the talent and technology to compete effectively with external managers they are seeking to displace. With access to tools that have been developed by and for hedge funds, such investors face less of a barrier to implement sophisticated investment strategies.”
This insourcing trend is not the exclusive domain of the biggest industry participants. Innovative mid-sized pension funds with access to the right technology have also found ways to increase their involvement in the implementation of sophisticated strategies.
“There are USD7billion pension funds in the US, like San Bernardino County Employees’ Retirement Association, that have gotten very sophisticated – actively hedging their books, selling covered calls and buying put options to lock in equity gains, employing total return swaps, and co-investing with hedge funds,” confirms Kim.
Indeed, Kim says that a significant part of the firm’s growth over the past three years has been driven by pension funds “taking increased responsibility for investment decision making, and hiring us to provide the systems and operational infrastructure required to do so”.
And while the likes of Form PF is pushing hedge fund managers to present complex data in a distilled format that regulators can utilise, Kim notes: “Eventually, institutional investors that have insourced the execution of hedge fund-like investment strategies will need the ability to provide the same quality of reporting that external managers have been pushed to produce.”