Could technological advances hold the key to hedge fund managers meeting both the increased service expectations of investors, and fulfilling new regulatory requirements? Joe McGrath investigates…
Buy-side firms have long recognised the importance of technology in today’s market, and nowhere more so than in the case of hedge funds, which have historically attracted investors and amassed capital by being at the cutting edge of both technological and market developments. In recent years though, investors have been demanding even more in terms of tech-driven services from hedge fund managers.
According to interviews with industry professionals, investor expectations with regard to enhanced levels of reporting and analysis have risen dramatically over the past five years. Having responded to these demands, and with fees and charges coming under increasing pressure, hedge funds are now finding that investors are unwilling to pay for these additional levels of insight.
Speaking on condition of anonymity, one hedge fund manager told Hedgeweek that recent fee renegotiations have seen investors outline a series of additional expectations that they expect the fund to provide at no additional cost.
Adrian Holt, a product manager and strategy owner at hedge fund software group FIS, recognises this trend all too well.
“Hedge funds are currently experiencing challenging times. Performance has been perceived to be uninspiring, it remains a crowded market and the benchmark for new manager and fund launches is set to a very high level,” he says.
“In response, hedge funds are turning to technology, in particular automation, to give themselves an edge over the competition, and satisfy the demands of their investors. Established managers are also reviewing their technology infrastructure to deliver operational efficiencies as a way of managing and maintaining their margins in an environment in which fees are being compressed.”
This investor squeeze on fees however, has motivated hedge funds to show that they deliver value in other ways.
Alpima is one of several ‘buy and build’ platforms that have sprung up to provide hedge funds with specialist artificial intelligence and machine learning capabilities. The company’s managing director is industry veteran Matt Johnson, who is leveraging his vast industry experience gained during spells with a host of big-name institutions including Morgan Stanley, Nomura, Invesco and Bank of America Merrill Lynch, to alleviate pressures in the hedge fund industry.
“Margin compression in the industry and the pressure for managers to demonstrate that they add differentiated value, combined with the fact that their clients demand greater digital engagement and personalisation, has resulted in quantitative analysis and visualisation going mainstream and becoming enmeshed within the investment process even for non-quant managers,” he says.
“However, there are also many firms still running important processes on antiquated systems and spreadsheets with operational and key person risks, as systems were often developed and re-developed many times by a limited number of individuals.”
Regulatory headaches
Additional pressures are also surfacing from increased regulatory obligations. Whether it’s requirements for best execution under the second Markets in Financial Instruments Directive (MiFID II) or beneficial ownership reporting requirements, hedge funds are now incredibly mindful that having the ability to process vast amounts of data quickly is essential.
Morris Tucker, managing director of US-based activist equity hedge fund Starboard Value, explains that the industry has learnt to “adapt”.
“The big one was MiFID II, everyone got nervous, but that has kind of died down. People are saying now that the industry has digested it, what’s next? Is the US going to apply a MiFID type approach?” he says.
Dan Shepherd, chief executive officer of outsourced dealing desk BTON Financial, says that MiFID II, specifically, has been responsible for technology and automation playing a far greater role in the industry than ever before.
“The dawn of MiFID II has pushed technology into the marketplace a little bit faster than it might have otherwise done,” he explains.
“In terms of trading technology, MiFID II mandated the use of electronic trading, but technology has as well.”
According to data from Greenwich Associates, more than 70 per cent of US corporate bond market trades under USD100,000 are now traded electronically – a world away from the ‘high touch’ voice trading of the past. “Market participants have had to keep up,” says Shepherd.
Spending squeeze
However, despite the pressing urgency for hedge funds to embrace technology to meet regulatory demands and keep pace with competitors, service providers say that some hedge funds are resisting upping their spend.
Specifically, concerns have surfaced that hedge fund managers are not allocating enough money to improving their trading, portfolio management, risk management and data management systems.
A survey of 50 global service providers and hedge funds, conducted by fintech automation platform Truss Edge, found that nearly a third of respondents (62.5 per cent) feel hedge fund managers are not dedicating enough of their budget to trading and data management activities.
“The fact that hedge funds have historically spent on technology does not mean they are now in a position to be able to not spend, in fact the opposite, as other asset managers have started spending more it could be said there is a technology ‘arms race’,” says Alpima’s Johnson.
The Truss Edge survey revealed that investment in IT has become quite the challenge for new market entrants, with more than 20 per cent of respondents saying that IT spend has become a cost which could potentially threaten the success of a business. A further 35 per cent say that they now consider IT a ‘significant cost’ for new hedge funds.
Savings in the cloud
Part of the reason for this is that new automation techniques and successful machine learning approaches are becoming essential to today’s hedge funds, with many looking to migrate operations to the cloud, as opposed to hosting technologies on their own internal infrastructure.
In fact, advances in cloud computing have proved quite seductive to hedge funds who have led the financial services industry in embracing the potential of the cloud.
“Cloud computing has had a huge impact,” says Adrian Holt of FIS.
“Portfolio management systems, which can benefit from cloud native features like elasticity, have driven down the price and cost of ownership of these platforms. The cloud has also enabled portfolio managers to adopt new emerging technologies such as AI, machine learning and automation, to push their strategy into the digital space when managing portfolios.”
