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Fund managers tend to be sceptical of technology and their interest in IT traditionally stopped at the Excel spreadsheet.
However, spreadsheets and other stand-alone tools are out of place in an industry where integration and economies of scale are the watchwords and compliance has become a big concern.
In addition, the growing popularity of non-traditional assets such as commodities and derivatives is obliging fund managers to use sophisticated software to manage complex portfolios.
TowerGroup, a financial services research company, says these trends are causing those on the buy-side – mostly funds – to invest in technology in a fashion unseen since the heady days of the late 1990s, when fears of the Y2K problem led to replacement of IT systems.
“There has been a fundamental change in the [investment management] business in the past two years,” says Sunil Chadda, head of derivatives practice at Citisoft, a UK-based consultancy focused on investment management. He believes much impetus for change has come from rapid expansion of hedge fund trading. In the past, hedge fund managers could get by using spreadsheets and a Bloomberg screen. But as the business has grown, they find themselves juggling multiple strategies and relationships with brokers.
That requires more sophisticated technology so stand-alone tools are giving way to integrated platforms that provide everything from data and analytics to clearing and settlement services.
The influx of institutional investment into hedge funds has made a big difference. In the 1990s, hedge funds were mostly bought by high net-worth individuals and private banks. Today, pension funds and other institutions are piling in but are reluctant to invest in funds that cannot meet due diligence requirements.
For example, one of the biggest weaknesses of start-up hedge funds is that they neglect the operational side of the business. While an investment strategy may work well on paper, those paper returns can easily be wiped out if the trades do not settle on time or are rejected because of errors.
This is why institutions employ operational specialists to assess hedge funds’ operating environments and look for weakness in their business processes. What they aim to achieve is “straight through processing” (STP), which electronically links all stages of the deal flow and eliminates re-keying of data.
Mr Chadda argues that hedge funds are better placed than the rest of the industry to take advantage of technology as they are not held back by legacy systems. On the other hand, they are particularly demanding in technology needs and typically have small IT budgets.
So, IT vendors hoping to drum up business from hedge funds – Citisoft recently launched a practice focused on hedge fund managers – see more opportunities with mainstream fund managers.
Despite apparent similarities, the technology needs on the buy-side are distinct from those of the sell-side – the investment banks. “Sell-side systems offer excellent coverage of financial instruments but the difficulty comes when trying to integrate them into existing systems,” says Mr Chadda.
Buy-side systems offer fewer bells and whistles for traders and instead focus on integrating portfolio management with the front-office functions of marketing and customer relationship management, as well as back-office operations such as accounting and reporting.
Sophis, a French vendor, is best known for its portfolio and risk management software for banks. Four years ago, it spotted the technology gap between the sell-side and the buy-side and developed a product for fund managers: 30 per cent of its business now comes from the buy-side.
Daniel Abitbol, business development manager at Sophis, identifies three reasons for fund managers’ new interest in technology.
First, compliance issues that require asset managers to control risk, record transactions and “generally make sure the money is invested properly”, he says.
Second, there is the new popularity of asset classes such as commodities and derivatives. “Managing derivatives is very complex and you need continually to monitor data such as yield curves and volatility,” says Mr Abitbol.
The latest version of Sophis’ buy-side solution includes a module that manages a wide range of commodities including energy, base metals, precious metals, carbon emissions and soft commodities. Experts say this is an area in which earlier generations of buy-side systems, designed principally for listed instruments such as equities, cash and bonds, tend to fall down.
“Some existing systems have not been able to cope with these new over-the-counter asset classes and fund managers have realised that you cannot use generalist tools to trade specialist assets,” says Citisoft.
Finally, there is growing pressure from institutional investors for so-called structured products, which aim to deliver pre-defined levels of performance, risk and volatility. To achieve this, managers use complex cross-asset trading strategies and need IT systems that can measure risk correlations between multiple instruments and provide detailed benchmarking and client reporting.
But despite the growing impact of IT on the fund management business, old habits die hard. Mr Abitbol knows of one leading company whose fund managers continue to run their positions on spreadsheets.