Although hedge fund managers now find themselves in a rather precarious position due to their close relationship with struggling banks, roiled markets and nervous investors, firms that survive will continue to make investment decisions, trade, manage risk and report to investors. A new research study from TABB Group, “Hedge Funds and Technology: Automation and the Feedback Loop,” examines the impact of electronic trading on the hedge fund industry, analyzing the effect of automated trading and the feedback loop between the front office, other systems and the entire marketplace.
Due to a variety of alpha-generating tactics within the hedge fund community, there is a wide range of trading needs that depend on the strategy, size and structure of a firm. This study explores the role of technology within these firms, and according to TABB Group, hedge funds are already upgrading their trading systems to handle automated markets and increasing back-office efficiencies.
With tremendous pressure facing the industry resulting in fewer hedge funds and reduced total assets under management (AuM), TABB Group found that over 75% of these firms clearly appreciate the benefits of electronic trading and want to trade multiple asset classes electronically, including listed options, listed futures, fixed income and FX. Despite a 40% drop in total IT spending to $882 million in 2009 due to reduced revenues, Cheyenne Morgan, research analyst and author of the study, says that front-office trading operations will not suffer as radically as other areas of the firm. “Any software or service that directly supports the investment process stands a far better chance against this inevitable tide of cost cutting,” writes Morgan, based on interviews with 61 U.S.-based hedge funds with a combined $227 billion AuM, representing approximately 15% of total U.S.- based hedge fund assets.
As budgets attempt to move from fixed to variable costs, TABB Group believes that there will be an increase in buying rather than building solutions to help hedge fund 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 (SOR), order management systems (OMS) and execution management systems (EMS) 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.”
Although known for their sophisticated clientele and complex strategies swiftly and accurately exploiting market fluctuations, there are actually few hedge funds at the cutting edge in applying technology to generate returns. The majority use traditional investment techniques, which is why Morgan says that although nearly 80% use an OMS, 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 minutes, if not seconds, “over 40% are committed to making improvements, recognizing that the back office can become compromised as a result of their fast-moving front office.”
Adam Sussman, TABB’s director of research, commenting on the study, says, “Speed will always be important but there is a focus is on integration as well. 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.”