The Five IT Secrets of Successful Hedge Funds

Feb 25 2011 | 9:33am ET

By Arup Das, Alphaserve Technologies -- These days, everyone from institutional investors to prime brokers wants to be a strategic partner with hedge funds. But, before their dance cards get full, hedge funds should save a spot for the information technology provider. That’s the strategic partner they should take home from the dance, the one with whom they need to form a strong and lasting relationship.

The most successful hedge funds know this. They have blended technology so seamlessly into their operations that it is difficult to tell where investment skills end and technology begins. Like the Renaissance, when the reputations of great artists like Michelangelo and Leonardo da Vinci rested partly on the fact that they knew how mix their own paints, the best hedge fund managers rely on their understanding of technology to produce superior results. In short, the best hedge fund managers realize a simple truth: their Information Technology defines their funds.  With this in mind, here are five IT secrets that the best hedge funds possess.   

1. They treat their IT provider as a partner. Your IT provider should understand your business so well that he or she can anticipate problems—what the business community likes to call “being pro-active.” For instance, a pro-active IT provider keeps track of new regulations and tries to anticipate their impact on your operations. If you add a new investment strategy, your IT partner should understand how it affects the front office operations (for instance, what market data will you buy and what information will the analysts have access to?), the middle office (how will risk management data be affected) and the back office (how will new a strategy’s trades be integrated and reported?).  Your provider should be able to understand the cost implications of your IT investments and constantly work with you to minimize your CAPEX and OPEX investments, optimize your IT investment and increase the longevity of your investments.  They should also understand cost allocations and implications between management company expenses and fund expenses.

2. They kick their own tires.  For years, the big banking institutions have set the technology standard and defined the “institutional class” benchmark against which all other financial services companies are measured.  Not every hedge fund meets this standard, but all hedge funds need to aspire to it. For instance, most hedge funds, especially start-ups, underestimate how much IT risks matter to potential investors.  When presenting your investment strategy to potential clients, be prepared to answer the tough questions regarding your IT.  Due diligence questionnaires have as many as 300 questions, and increasingly, they deal with technology related issues.

Institutional investors have come to expect a comprehensive picture of how well information flows through your business. How well is your fund prepared for the unexpected outage, server crash, or network catastrophe?  How sophisticated is your physical and electronic security?  More subtly, how does each member of your firm contribute or obstruct the free flow of data from each of your divisions?  Are there key man risk issues? If you employ an IT person, build on his or her skills. Outsource the rest to an expert who can fill the gaps, or as I like to call it, employ “smart sourcing.” 
 
3. They know IT is the lingua franca of all information divisions. New managers, especially, look at technology from their own perspective, i.e., how can technology make me a better stock, currency, bond or high frequency trader? Meanwhile, your chief information officer has his IT and your chief operating officer has her IT. But if technology is central to your CEO, CIO, COO and the CTO, why shouldn’t information flow between them? IT in silos is not nearly as effective as integrated IT.  Technology underpins all functions of the CIO, COO, and CTO and facilitates all operational and strategic compliance systems. Therefore it should be included in most ‘C’-level conversations and considerations.

4.  They realize ignorance is not bliss. The best hedge fund managers have a clear picture of their IT architecture. Too many hedge fund managers outsource their IT to rid their desks of “tiresome” operational details. By outsourcing, they think those details become the IT providers’ problems. I couldn’t disagree more.  Just as it is unwise to leave the construction of your house entirely to your contractor, hedge fund managers should not leave their IT solutions to the provider.

At every step, the IT provider should present you with a “good, better, best” option. Take the example of disaster recovery. The good option is an on-site data back-up capability. The better option is a duplicate structure at another location. The best option is an off-site back-up center combined with cloud computing. Make sure your IT provider is vendor agnostic. In my experience, most IT providers care more about pushing products than educating the hedge fund managers and explaining options.

A strategic partner can explain the real costs versus the real benefits - the so-called Total Cost of Ownership (TCO) of a product or a system.  Moreover an ideal strategic partner will know which of those costs should be allocated to the management company or the hedge fund itself. 

5. They insist on documenting the process. Investors (and the SEC in years ahead) want to know the what, why and how of hedge funds’ procedures to reduce operational risks.  The best hedge funds can immediately produce this documentation, while it may take other hedge funds three or four weeks to assemble it. That delay will not suffice in the future. The SEC will expect you to have this information up to date and on hand. And right now, you risk losing business if you cannot provide it to potential investors.

Every bit of data that flows into your hedge fund has to be identified, captured, stored, analyzed and/or archived. Like the postal delivery service collecting and delivering mail, data travels around your company, “visiting” the trading desks, the legal department, human resources, compliance, numerous computers, telephone lines, email accounts and client accounts before departing for the prime broker. There should be a map of every stop that data makes. I call this the “Information Life Cycle.” Information requires cradle-to-grave attention from your IT provider. 

Arup Das is the founder and Chief executive officer of Alphaserve Technologies. Based in New York City, Alphaserve Technologies provide IT solutions to alternative asset management firms, law firms and government agencies worldwide.


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