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FINAlternatives Hedge Fund

  1. 1. Hedge Fund Technology & Trading 2009 sponsored by ®
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  3. 3. Inside This Issue Overview: The Changing Hedge Fund Landscape Shapes Demand For Technology 2 From CRM To Compliance: The Madoff Effect Drives Demand For A Data Trail 7 Risk Management: The Pros And Cons Of Building Your Own System 10 FINalternatives Survey: High-Frequency Trading Has a Bright Future 15 Need For Speed Drives Technology 15 Q&A: PerTrac Execs Say Hedge Funds Need to Step Up Transparency, Risk Management To Lure Investors 19 Hedge Funds Slash Overhead, Vendors Reap The Rewards 23 Hedge Fund Software & Technology Providers 27 Copyright 2009 by Stone Street Media, LLC. Copying or distributing without permission is prohibited. Please call +1.212.966.0047 to inquire about reprints and permissions. FINalternatives 1 Hedge Fund Technology & Trading 2009
  4. 4. The Changing Hedge Fund Landscape Shapes Demand For Technology By Deirdre Brennan Last year’s major shakeout in the hedge fund their core bread and butter. So, for those industry—with roughly 20% of all funds clos- guys, the building of technology is some- ing up shop—has radically altered its technol- thing that they are going to continue to do.” ogy and risk management landscape. Those funds that did survive and the new ones just Hedgies Split On Strategy entering the market are scrambling to equip In fact, Simon, who has been studying the their operations with the best platforms to ap- industry in preparation for a report due out pease both their investors and the regulators in September, says that the hedge fund tightening the screws on them. universe is increasingly breaking into two But after the recent market bloodbath, camps—the “Warren Buffet-style, buy- and the attendant disastrous returns and and-hold” camp, where managers study huge redemptions, building operations in- balance sheets and read sell-side reports, house, or even supporting existing technol- and the “trading” camp, where sophisticat- ogy, is sometimes no longer financially feasi- ed proprietary traders try to capture small ble. Outsourcing, once taboo in hedge fund profits from large volumes of trading. circles, has become a viable option for funds “The traders don’t really care what the looking to scale down their in-house opera- underlying names are; they are more inter- tions, while at the same time improving risk ested in being able to capture spreads and management and transparency—the new be able to profit from short-term blips in the buzz words in the hedge fund industry. market trading patters,” Simon says. But the question of whether or not to Addison Tsai, managing director at Old outsource certain middle- and back-office Greenwich, Conn.-based hedge fund shop functions is a big one, and there is no SDS Capital Group, is seeing tremendous blanket answer. Matt Simon, an analyst growth in this area first-hand. at independent research firm Tabb Group, “A lot of trading strategies are converg- explains that a fund’s size, strategy and ing to higher frequencies,” says Tsai. philosophy all contribute to whether or not And while the number of money man- a firm decides to utilize third-party vendors. agement firms utilizing so-called high- “One thing that hedge funds have learned frequency trading strategies is miniscule over the years is that building technology compared to the overall universe of asset can be time-consuming and is not their core managers, according to Simon, those trad- business. They are there to manage mon- ers are responsible for 73% of the equities ey, not to build technology,” he says. “But, trading volume on U.S. exchanges, and he for some of these high-frequency/stat-arb- expects them to consume an even bigger type players, the building of technology is piece of the pie in the future. ► FINalternatives 2 Hedge Fund Technology & Trading 2009
  5. 5. In Shift, Investors Hold The Cards think you are going to see going forward is Once upon a time, an investor counted a better alignment between the time hori- himself lucky to be able to gain access to zon of investors and the management style a top-tier hedge fund. Managers such as of the hedge fund.” SAC Capital Advisors’ Steve Cohen and And how will this be achieved? Trans- Renaissance Technologies’ Jim Simmons parency. could write the rules, imposing hefty mini- “Some of that will be solved by look- mum investment requirements, long lock- through reporting, so the fund investors up periods and high performance fees, with will see their underlying investments in the smaller, less pedigreed managers following fund,” he says. suit. Investors smiled and handed over their Transparency rules the roost in 2009. money, satisfied that they were getting the According to Tabb’s Simon, “transparency best possible returns on their investments. of positions, transparency of balances, Then, in 2008, the sky fell. Lehman transparency of pricing—anything to do Brothers collapsed, Bear Stearns went with transparency,” is foremost on both in- the way of the dodo, liquidity and credit vestors’ and managers’ minds. dried up, arch-fraudsters Bernard Madoff One firm that has always insisted on full and Marc Dreier revealed that supposedly transparency is New York-based hedge fund sophisticated hedge funds and funds-of- incubator SkyBridge Capital. Co-founder hedge-funds were some of their biggest and managing partner Anthony Scaramucci patsies, and hedge fund managers lost the explains that all of the funds that his firm biggest bargaining chip they had over their seeds must be completely transparent. investors—solid returns. “We want to have an interface with a “This fall was a key pivot point in the fund manager’s prime broker. It’s like a industry, where for a long time investors Reagan ‘trust but verify’ relationship,” he didn’t have a lot of power—hedge funds says. “What we do is have a feed from one did things their way,” says Chris Momsen, of the software providers where everything senior vice president and general manager gets uploaded into that system, and we of global accounts at Advent, a financial have a global macro portfolio report that software firm that specializes in portfolio gets generated by that software.” management and accounting platforms for The data feed not only provides Sky- asset managers. “I think hedge funds had Bridge with piece of mind that everything is inappropriately structured their fees in re- on the up and up and the trades are being gards to their investment strategy.” He ex- cleared and reconciled correctly, but it also plains that managers who were investing in serves as a risk management tool. The illiquid securities that became even more il- system SkyBridge utilizes, GlobeOp Risk liquid were facing off against investors who Services’ GoRisk, can be used for back wanted to redeem. testing and stress testing strategies, and “Managers had to give them their mon- also to independently confirm to investors ey within 30 days or put up gates, which that agreed investment style, risk profiles caused problems,” he says. “So what I and limits are being adhered to. ► FINalternatives 3 Hedge Fund Technology & Trading 2009
  6. 6. “It has proven to be a good way to sell stress tests to properly inform the portfo- these managers because when we go out lio manager’s macroeconomic views takes to market them to institutions and high net- time and must be customized. It’s not the worth individuals, us being able to say that complexity of the technological screens we have transparency and that we have a that will impact an investor portfolio. It’s the great, solid risk management team working hedge fund manager’s proper interpreta- alongside the manager adds credibility to tion of the information that far surmounts the manager,” he says. the aesthetics. All said, consistency and content outweigh all else.” Transparency Is Key, But Accuracy Is King The Prime Focus While transparency is important, accuracy In the past year, the wisdom of the prov- is critical. If managers don’t have proper erb warning not to keep one’s eggs in just data, all the analysis and transparency in one basket proved true once again. When the world won’t help them make good in- Lehman’s basket had the table knocked vestment decisions. out from under it, the hedge funds that “The Advent view of the world is that used its prime brokerage services were left everything is based on accurate account- with egg on their face. The result? Hedge ing information,” Momsen says. “If people funds are now using more than one prime have data in spreadsheets, and the infor- broker. This, of course, comes with its own mation in someone’s hand is not accurate, set of operational issues. then the firm can make erroneous deci- “Most systems out there were either sions, and that can allow them to be un- built by broker-dealers or bought by bro- dermargined or overmargined; it can cause ker-dealers. As a result, there was a lack trading errors.” of willingness to work with other broker- Rachel Minard, president of San Fran- dealers,” says Bo Vastine, director of sales cisco-based hedge fund Cogo Wolf Asset at Advanced Financial Applications, a tech- Management, agrees that the most impor- nology company that provides a platform tant thing for her is to get accurate data so to help traders manage their workflow in a that her fund managers can make informed multi-prime environment. “When you be- decisions. gan to see not just the large hedge funds, “New technologies and the costs asso- but the medium and small hedge funds ciated [with them] are not the biggest chal- moving toward a multi-prime scenario, the lenge, but rather procuring the relevant in- system that they may have been using for formation to inform the investment team’s their single prime could no longer facilitate top-down views,” says Minard, whose firm the workflow for their second prime. That employs a combination of both in-house meant a lot of manual processing, even and outsourced technology and software. cutting and pasting.” “Almost all hedge fund data is historical. Vastine says that what hedge funds are Constructing the appropriate optimiza- looking for is a system to tie these multiple tion model and programming the relevant primes together, with some important ► FINalternatives 4 Hedge Fund Technology & Trading 2009
  7. 7. considerations to take into account, such Rathgeber says that no matter what as ease of use, ease of integration and the software or type of technology a fund connectivity. is thinking of using, the managers should “A system like ours that is agnostic al- make a list of exactly what they want or lows them to generate those end-of-day need from a system, and then give that files to multiple prime brokers and custodi- list to the service provider well in advance ans,” he says. of the presentation. That way, the service Advanced Financial Applications cur- provider will have time to put together a rently works with 23 different prime bro- presentation to show the manager exactly kers, and its open architecture allows it to how the system or software can perform be fully customized to the users’ needs. those stated tasks. “If you look at a hedge fund, the amount Picking Your Providers of operational effort that is spent recreat- While there are a multitude of factors for ing the world that they wanted all along but hedge funds to consider when selecting never really communicated effectively is service providers, one long-time industry staggering,” he says. expert says that hedge funds aren’t, in fact, actively selecting their service providers, The Road Ahead Could Be Rosy which can be a costly mistake. While some hedge fund investors may use “The due diligence that hedge funds do the tough economic environment as an when picking their service providers is hor- excuse to sit on the sidelines, some see a rible,” says Jeffrey Rathgeber, co-founder reason for optimism. In fact, according to of hedge fund consultancy Pelorus Advi- one investor and manager, there may nev- sors. “If you go to those meetings where er be a better time to make money. hedge funds are picking a fund administra- “In an environment like this there has tor or a prime broker, the [fund managers] never been greater opportunity,” says let the prime broker run the show.” Scaramucci, who will be rolling out the He also says that hedge fund firms of- third SkyBridge fund of hedge funds later ten let pre-existing relationships influence this summer. “First, there is a tremendous which providers they use, even if that amount of talent still looking for homes provider is not the best one for the given in the musical chairs of Wall Street and task. He points to a case where one of his hedge funds. Second, there is a shortage former hedge fund clients traded bonds of capital. People are fearful to put money through Goldman Sachs and traded equi- out. And third, you add to that distressed ties through Lehman Brothers. prices, and that sets up pretty well for good “The managing partners had their investment opportunities.” minds set on it because those were their But to profit from those opportunities, existing relationships,” adding that at the hedge fund managers need to adapt to the time, “Goldman was the king of equities changing needs and requirements of in- and Lehman was the king of fixed-income. vestors and regulators, as well as those of They had it backwards.” a changing marketplace. FINalternatives 5 Hedge Fund Technology & Trading 2009
  8. 8. Wherever your firm fits into the investment industry, the software and services available from PerTrac Financial Solutions can help you • PerTrac Analytical Platform: the world’s leading in- reach your goals. Since launching in 1996, we’ve vestment analysis and asset allocation software, with grown from a small business with one product to access to a wide range of investment databases, plus an industry leader with a full suite of applications over 900 statistics and professional-quality reports and thousands of clients around the world. Let us help your firm grow too. • PerTrac P-Card: a revolutionary new tool for distribut- ing and collecting performance numbers, portfolio infor- PerTrac’s integrated suite of products gives mation and other fund data our clients the tools to organize, analyze, under- stand, and act upon the information central to • PerTrac CMS: the alternative investment industry’s pre- their businesses. The end results: maximized op- miere workflow solution for investment management, portunities, better decisions, and accelerated capital raising, investor relations, and regulatory compli- growth. ance For an introduction to our major software ap- • PerTrac Portfolio Manager: the command center for plications, keep reading. And to learn more about your fund of funds or other multi-manager portfolio, cov- how PerTrac products can help your firm reach its ering processes from due diligence to trade entry and growth potential, visit us online at cash management to risk assessment © 2009 PerTrac Financial Solutions. All rights reserved.
  9. 9. From CRM To Compliance: The Madoff Effect Drives Demand For A Data Trail By Hung Tran & Jonathan Shazar Bernard Madoff has gone up the river, un- Erol Dusi of Imagineer Technology, likely to ever return. But the specter of his which provides software and tools to help $65 billion Ponzi scheme continues to hang hedge funds and other investors run their over the alternative investments industry. businesses more efficiently, has also seen For many investors, especially those of his firm benefit from growing demand for the all-important institutional variety, the only transparency. He says hedge funds that way to combat Madoff’s dark cloud is to shine previously did not report their numbers to a bright light on what have long been the databases are now rushing to get their in- more secretive corners of the industry. One- formation out. page monthly statements from hedge fund “We’re seeing a tremendous [move- managers are no longer enough; their clients ment] in that direction, and it’s all a result are demanding transparency, due diligence of what has happened within the last six and risk management previously anathema months,” he says. to many in the industry. They want detailed Baseball fans spend countless hours reports on everything from how managers debating a player’s “intangibles,” the things are selected and who their prime brokers that don’t show up in box scores or statis- are to how those managers reconcile their tics but that can be the difference between trades and balance their books. winning and losing. There is a similar focus “Since the Madoff scandal, we’ve been today from investors—spooked, no doubt, dealing with multi-billion dollar endowments by the shadiness of Madoff’s operations— and pension funds that are looking to auto- on the things that don’t have a metric rep- mate and create an [audit trail] around their resented by a letter of the Greek alphabet. research and diligence process,” says Jer- “The fact is, you’re investing in the man- emy Bacon, a Goldman Sachs veteran and agers’ ability to manage during tough mar- founder of Backstop Solutions, which offers kets, and you’re investing in his integrity customer relationship management, sales, and personality,” Dusi says. “Those things marketing and accounting services. Chicago- are not going to be captured in returns. based Backstop has a total of 185 custom- Rather, they are going to be calculated ers on its platform, 105 of them being hedge from your meetings with them and data funds. Bacon says the firm has continued to from background checks.” grow, despite the recent trials and travails of In fact, it is those intangible details that the alternative investment industry. are often the deciding factor in whether a “We’ve obviously had clients fold, but fund manager wins a mandate, according we’ve continued to add more clients than to one consultant from Cambridge Associ- we’ve lost,” he says. ates, who asked not to be named. ► FINalternatives 7 Hedge Fund Technology & Trading 2009
  10. 10. “I take detailed notes on every manager “Regulation is sure to place greater bur- I meet, from whether they seem fidgety to dens on the middle- and back-office func- what they order at lunch,” said the consul- tions of hedge funds,” says Schauerte, a tant. “If the guy I’m meeting with has whisky capital markets analyst at Celent. “Here, on his breath and bags under his eyes, you the last years have seen great progress can bet that I’m not going to recommend in terms of technological sophistication. In him to my client, even if his numbers are many cases, funds have grown to a size out of the park.” and scope that forces managers to run their business more formally. This has spurred Specter Of Regulation technology adoption rates.” Looms Large Schauerte also credits the increase in Fear of being taken in by the next Bernard institutional investors’ allocations to hedge Madoff is not the only factor driving the de- funds for the push to adopt better technology. mand for a paper trail. New regulation of “The growth in assets from this breed the alternative investment industry looming of investors comes with requirements on both in the U.S. and in Europe has man- operations and risk management that have agers rushing to anticipate what will be re- forced hedge funds to embrace IT to a quired of them by authorities. greater extent,” says Schauerte. While it’s still unclear what form new “Going forward, regulatory compliance regulations will take—that there will be new is also going to be a greater issue for hedge regulations is a certainty. It seems equally fund administrators.” clear that new regulations will, at a mini- But despite the inevitability of stricter mum, force hedge fund and private equity regulation, many firms have not accorded managers to offer greater transparency and improved compliance systems the priority impose stricter compliance requirements. they deserve, according to Bill Mulligan of Research and advisory firm Celent ex- New York-based HedgeOp Compliance, pects that global information technology which provides compliance, operational spending associated with governance, op- and due diligence reporting to the alterna- erational risk and compliance activities will tive investment industry. increase from $1.4 billion in 2008 to $1.7 “When we get involved, we make sure billion in 2011. that there are not other priorities that are “There is now a ‘get big or get out’ going to push compliance issues to the theme at play,” says Cubillas Ding, a se- back of the line,” he says. nior analyst at Celent. “Firms and vendors And according to Backstop Solutions’ need to position themselves accordingly Bacon, the time to prepare for the looming in terms of purchasing or developing solu- regulations is now. tions. Significant investments are required “Each vendor out there has had to make in an end-user market which is increasingly sure that their systems can help to buoy the sophisticated in its demands.” compliance and regulatory requirements Ding’s colleague, Isabel Schauerte, as related to the products that they’re offer- concurs. ing,” he says. FINalternatives 8 Hedge Fund Technology & Trading 2009
  11. 11. Risk Management: The Pros And Cons Of Building Your Own System By Aleksey Matiychenko, Risk-AI, and Alexander Makeyenkov, DataArt Risk Management is in vogue these days. The crisis of 2007-2008 has in many ways been blamed on the failure of risk managers to predict the stress that we have all now lived through. With global markets rebounding and hedge funds posting positive results, the discussions about improving risk management policies and systems are taking place at many hedge funds. Effective risk management requires that the firms establish culture, policies and pro- cedures that are specific to their operating model. However, at its core risk manage- ment is a quantitative discipline that requires significant investment in data, systems and people. In this article we discuss what it takes to develop internal risk management architecture. Necessary Tools The exact set of tools depends on a hedge Since risk management is a quantitative fund’s strategy, range of securities traded, discipline, the first step in developing risk liquidity and other factors. There are, how- management infrastructure is the develop- ever, some tools that are likely to be used ment of a repository to house four types of across all hedge funds. data: ● Value at Risk (VaR) – Perhaps no other 1. Holding and trade level data tool received as much criticism and blame 2. Historical pricing data for securities trad- for the current crisis as VaR. While VaR ed by the fund has many well documented shortcom- 3. Historical data for risk factors used in ings, it’s likely to remain an important part various analyses of a risk manager’s toolbox. VaR provides 4. Results of risk management analyses risk managers (and their bosses) with a It’s been a long term practice in the financial quick read of the hedge fund’s risks. services to use Microsoft Excel as a tool for ● Stress Tests – Scenario analysis based both storing data and performing analysis. on either historical stress events or theo- The growing complexity of financial products retical scenarios can be used to comple- and the need to have robust systems make ment VaR analysis. Excel spreadsheets a less than ideal envi- ● Greeks – Various sensitivity measures ronment to store data. To be truly reliable, such as Option Delta, Gamma and others the data used in risk management analysis provide important information about the should be housed in a relational database fund’s exposure to different market factors. such as a MS SQL Server or Oracle. ● Factor Analysis – Factor analysis can be Once the data repository is built, tools used to uncover potential hidden tilts in to analyze the data need to be put in place. the fund’s portfolio. ► FINalternatives 10 Hedge Fund Technology & Trading 2009
  12. 12. Risk management systems should be able developing risk management architecture, to perform the above analysis and provide but it shouldn’t be the only step. clear and consistent reporting mecha- Ultimately, all commercial packages are nisms so the output of the analysis can made to be able to satisfy the largest num- be used by risk managers, traders and a ber of customers. Some packages can be fund’s investors. customized to each client’s needs, but the customization effort may be complex, limit- Build vs. Buy ed in scope and expensive. We have seen Whenever new systems need to be put in such implementation at a number of hedge place, the usual question of build versus funds. The usual architecture involves a buy arises. There may be many factors vendor risk management package such as that affect the ultimate decision to build Risk Metrics, MeasureRisk or others. Any or buy a system. Though price is often risk management system (vendor or in- an important criterion, it should not be house) needs to be integrated with trade the deciding factor. There are many in- capture, portfolio management, and back stances when a hedge fund should opt for office systems. a buy decision and avoid spending time Depending on the complexity of the and resources on internal development. fund’s portfolio, the vendor system may not The buy decision is usually justified when be capable of handling certain instruments. implementing systems that aren’t specific In such situations, the solution may involve or critical to the hedge fund’s core strate- either building an internal system to handle gy. Such systems usually include: contact these instruments or purchasing an addi- management, accounting, trade capture tional vendor system(s). We, in fact, have and others. seen multi-strategy hedge funds purchase The decision to buy or build a risk man- one system to handle equity products, a agement system depends on the complex- second system to handle fixed income, ity of the hedge fund’s strategy and the and a third system to handle exotic prod- variety of products traded. Most commer- ucts. Ultimately, all these systems need to cially available systems may be sufficient work together. to analyze a certain range of products. Few While ensuring seamless dataflow and systems are able to produce meaningful building custom reporting that integrates analysis of a diversified and complex port- all the systems is a big task in itself, there folio. Even fewer do it well. is an even a bigger issue. At the end of If anything can be learned from the the day, a risk manager needs to have a current crisis it is that risk management complete picture of portfolio exposures. needs to be part of a core strategy of any Such a picture needs to incorporate cor- investment firm. What this means is that risk relations among various products that ex- management systems need to be part of the ist in disparate systems. Building a tool to core strength of any hedge fund that wants bring all these exposures together is akin to stand out. For such hedge funds, buying to developing a complete risk system from an off-the-shelf product may be a first step in scratch. ► FINalternatives 11 Hedge Fund Technology & Trading 2009
  13. 13. A typical risk management infrastructure at a multi-strategy hedge fund Trade Capture Fixed Income Risk System Central Market Data Data Equity Risk System Repository Portfolio Management Other Risk System Integration System Custom Reporting Risk Aggregation Straight Through Process Equity Risk FI Risk Reports Other Risk Portfolio Level Reports Reports Reports For a fund that has decided to dedicate time tionally, a proper enterprise-level devel- and resources to develop its own risk man- opment effort will require investment into agement system, the decision of whether project management, quality assurance to hire full-time personnel or to outsource and maintenance practices, all of which the development needs to be made. will call for extra hires. The solution to this Developing a risk management sys- may lie in outsourcing a significant part of tem is not a trivial process and is likely to such development to a firm specializing in take significant time and money. Human such projects. resources required to implement such a The in-house vs. outsource decision project typically require at least two, and does not need to (and perhaps shouldn’t) likely more, highly-skilled professionals be mutually exclusive. In order to extract with graduate or post-graduate degrees the full benefit from the custom developed and extensive software skills. Even in the system, the fund should employ at least stressed employment markets that we are one of those highly-skilled risk profession- experiencing right now, such individuals als capable of modifying and maintaining carry an expensive price tag. Hiring sev- the system. Having an outside vendor per- eral such individuals may not justify the form most of the development would en- value added by the development. Addi- sure faster implementation. ► FINalternatives 12 Hedge Fund Technology & Trading 2009
  14. 14. Cost Comparison It’s impossible to estimate costs of implementing a robust risk management system with- out detailed analysis of the fund’s strategy and operations. However, some basic indica- tions may be provided. Vendor Package Cost Time To Total Cost of From To Implement Ownership (5 Years) Vendor System 80,000 250,000 3-6 Month $1,000,000 Integration & Mainte- 200,000 400,000 3-6 Month $1,000,000 nance (2-4 developers) Total 200,000 400,000 6-12 Month $2,000,000 Custom - Cost Time To Total Cost of In House From To Implement Ownership (5 Years) Development & 400,000 600,000 9-12 Month $3,000,000 Ongoing Maintenance Custom - Cost Time To Total Cost of Outsourced From To Implement Ownership (5 Years) Development 400,000 600,000 6-9 Month Annual Maintenance 50,000 150,000 $1,000,000 Developing a custom risk management system is a perilous undertaking indeed. A lot of things can go wrong in such a complex project. If done right, though, it provides important the benefit of a custom-tailored solution at a price level comparable to, and often better, than many commercial products. Aleksey Matiychenko is a Senior Partner and Chief Executive Officer at Risk-AI, LLC Alexander Makeyenkov is a Senior Vice President of Capital Markets at DataArt FINalternatives 13 Hedge Fund Technology & Trading 2009
  15. 15. The Great Investor’s Mentality Quiz do you have it? Take the quiz and remember that great investing is a mindset, not a skill-set. Unfortunately, mindsets are harder to change than skill-sets. But just like other great investors, you can put systems and discipline in place to help foster a culture with the “great investor” mentality. 1. a blackjack player has 19, takes a hit and gets a 2 for 21. Was the decsion to take a hit a: a. Good decision b. Bad decision 2. a $20 stock has $15 in net cash and a volatility of 50%. the risk of this stock should be measured by: a. Downside potential - $15 net cash b. Volatility - $10 (based on 50% volatility on $20 stock price) 3. Letting “winners run” should enhance portfolio returns: a. True b. False 4. you buy a house for $1 million that subsequently declines in value to $500,000. someone offers you $800,000 for the house. do you: IneffIcIent a. Take the deal b. Pass posItIon sIzIng 5. human instincts are well-designed for portfolio management: a. True Is the bIggest b. False 6. risk-adjusted return should be the highest rIsk funds weighted factor in determining position size: a. True b. False take toda . y 7. the best time to buy is when: a. Fear in the market is low b. Fear in the market is high 8. economic forecasts are an easy way to Alpha Theory fixes the improve an investment thesis: problem and provides a. True b. False true risk management for 9. two stocks trading at $20 have the same fundamental investors. potential upside to $40 and downside to $10. you have greater confidence in the upside being achieved for stock one. assuming all else equal you would: a. Have a greater exposure to Stock 1 b. Have equal exposure to both assets 10. Modern portfolio theory is the optimal method to manage a portfolio: a. True b. False To find these answers visit Alpha Theory’s website at: ALPHA THEORY (212) 461-4757 | |
  16. 16. FINalternatives Survey: High-Frequency Trading Has a Bright Future By Irene Aldridge High-frequency trading has grown expo- arena. At present, many financial indus- nentially in the past several years, and, try participants understand the business according to the FINalternatives 2009 of HFT, yet few understand the details Technology and High-Frequency Trading and implementation involved. Some 39% Survey, that growth is here to stay. of hedge fund managers, investment ad- A whopping 90% of respondents think visers, executing brokers and proprietary that HFT has a bright future. In compari- traders have just “a little” understanding son, only half believe that the investment of the high-frequency business, accord- management industry has favorable pros- ing to the FINalternatives survey, with pects, and only 42% have a positive out- 52% reporting a solid understanding. By look when it comes to the U.S. economy. contrast, only 40% of the respondents Given that dose of pessimism, it should be report that they had a solid grip on the noted that HFT tends to work particularly implementation of HFT, with 19% report- well in volatile range-bound markets like ing no understanding of implementation the current economic environment. tactics whatsoever. The optimism for HFT—which research The outlook for HFT is largely driven by firm Tabb Group estimates accounts for the high profitability potential of well imple- 73% of equities trading volume on U.S. mented HFT systems. While traditional exchanges—is bound to bring additional buy-side trading strategies hold positions skill and capital to the high-frequency for weeks or even months, HFT is ► Need For Speed Drives Interest In Technology There’s a major technology shift happening in the financial markets, one that isn’t go- ing unnoticed by the alternative investment industry. New exchanges and electronic communication networks have come online, frag- menting the market and increasing the potential number of trades. All of these innova- tions require efficient data transmission: messaging involved in order transmission, confirmation of order placement and the like. Technology has enabled these changes, especially the efficiency and speed of execution, most notably, increasing the number of daily trades while simultaneously decreasing the average trade size. Given the changes, it’s no surprise that over 60% of the respondents to the FINal- ternatives 2009 Technology and High-Frequency Trading Survey said their ability to execute electronic trades is “extremely important.” ► FINalternatives 15 Hedge Fund Technology & Trading 2009
  17. 17. characterized by fast turnover of capital. riods of time. An overwhelming 86% be- Instead of capturing large price changes lieve that the term “high-frequency trading” over extended periods of time, HFT aims referred strictly to holding periods of only to book multiple small gains over short pe- one day or less. ► Distribution of responses to the question “What position holding time qualifies as HFT?” 70.0% Source: July 2009 FINalternatives Hedge Fund Technology & Trading Survey 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% < 1 second 1 second - 10 minutes 1 hour - 4 hours 4 hours - 1 day 1 day - 5 days 5 days - 1 month 1 month - 3 month Over 3 month 10 minutes - 1 hour According to Jim Wang of the Stevens Institute of Technology, the six global equity top exchanges combined send and receive 200,000 messages each second during trading hours, with an average message taking just 0.115 seconds to reach its destina- tion. Robust technology enables this kind of information throughput. One way to speed up the transmission of messages between exchanges and their clients is locating order-sending servers in close proximity to the exchange, a practice known as co-location. Co-location reduces the distance the trading message needs to travel to and from the exchange. Still, only 15% of the survey respondents rated co- location as an “extremely important” capability, with 60% of the survey respondents rating co-location as “not important.” Despite its perceived lack of importance, most respondents (58%) also outsource at least part of their co-location capabilities. Among other highly outsourced techno- logical capabilities were Internet-wide information gathering (57% outsource this capa- bility) and trading software (outsourced by 64% of the respondents). ► FINalternatives 16 Hedge Fund Technology & Trading 2009
  18. 18. Intra-day position management is impor- itself refers to fast entry and exit of trad- tant for two reasons: savings from the over- ing positions, the process best executed night position carry costs and elimination by algorithms and dedicated computer pro- of the overnight risk. The carry is the cost grams employing artificial intelligence. of holding a margined position through the Only 51% of the respondents report us- night; it is usually computed on the margin ing HFT at present, but 60% of the respon- portion of account holdings after the close dents indicate that they intend to use HFT of the North American trading sessions. in the future. Overnight carry charges can substantially The FINalternatives survey garnered cut into the trading bottom line in periods of 202 responses, of which half worked for tight lending or high interest rates. a hedge fund, 26% for an investment ad- Second, closing down positions at the visory or consulting firm, 12% for a fund end of each trading day also reduces the of hedge funds, and smaller numbers for risk exposure from the passive overnight executing brokers, proprietary traders, mu- positions. Smaller risk exposure again re- tual funds, research providers, technology sults in considerable risk-adjusted savings. firms and family offices. Some 59% said In addition to high capital turnover and that portfolio management is their primary intraday entry and exit of positions, the responsibility. FINalternatives survey respondents further identified the following key distinctions of Irene Aldridge is an expert in algorithmic and HFT: Trading decisions made upon tick-by- high-frequency trading. Ms. Aldridge’s new tick data analyses and Algorithmic trading. book “High-Frequency Trading: A Practical Tick-by-tick data processing and high Guide to Algorithmic Strategies and Trad- capital turnover do indeed define much of ing Systems” (Wiley Trading, ISBN: 978- HFT. Identifying small changes in the quote 0470563762) is available for pre-order on stream sends rapid fire signals to open and Ms. Aldridge can be reached close positions. The term “high-frequency” at The two least-outsourced areas proved to be computer-aided number-crunching and computerized generation of trading signals: 62% and 58% of the survey participants, re- spectively, indicated that they prefer to perform these functions internally in their entirety. Other functions for which the participants showed strong preference to develop and run in-house were backtest engines and investment allocation modeling software. Still, survey participants reported interest in buying selected off-the-shelf software. In particular, 55% of the respondents reported having bought electronic execution soft- ware and trading software; 50% noted buying Internet-wide information gathering soft- ware and real-time third-party research. It seems that trading technology still has long ways to go to meet the rising interest and demand. FINalternatives 17 Hedge Fund Technology & Trading 2009
  19. 19. We make you feel like a BIG fish in a small pond. MERIDIAN EQUITY PARTNERS is an independently owned Wall Street broker dealer with a global reach and a local feel. We provide customized, best-of-breed strategic solutions to the investment management community. Products include: equities, options, futures, fixed income and forex. Prime Brokerage Services Analytics, Research & Corporate Access • Start-Up Services • Risk Management Advisory • Administrative & Operational Support • Option Analytics • Technology & Infrastructure Support • Technical Analysis • e-Trading Solutions & Outsourced Trading • C-Level Corporate Access Institutional Brokerage Capital Placement & Advisory Services • Meridian ProTrade – Electronic Trading • Asset Gathering • NYSE Floor Operations • Marketing & Consulting Services • Sales & Trading • Manager Due Diligence Our goals are simple: • Allow clients to operate on a variable cost basis, without sacrificing performance • Provide customized solutions that are creative, flexible and cost-effective • Develop client trust through consistent performance 5 Hanover Square, 21st Fl. New York, NY 10004 T: 212.500.6650 F: 212.742.2737 Member NYSE, FINRA, NFA & SIPC
  20. 20. Q&A: PerTrac Execs Say Hedge Funds Need To Step Up Transparency, Risk Management To Lure Investors When it comes to analytic and workflow solutions for investment profession- als, PerTrac is the undisputed 800-pound gorilla of the asset management industry. The firm boasts more than 2,000 clients in 50 countries, including institutional investors, family offices, private banks, service providers and money managers. While the firm is best known in the hedge fund industry for its PerTrac Analytical software, which tackles the quantitative side of investment man- agement by helping money managers track and analyze investments, that is only one spoke in the wheel. Two other software systems complete the firm’s PerTrac suite: PerTrac CMS—which helps managers keep track of commu- nications with their investors and service providers—and PerTrac Portfolio Manager, which helps funds of funds and institutional investors manage in- formation relevant to their portfolios. And while growth in the money management industry has slowed, PerTrac has continued to roll out innovate new products, such the snappy sounding P-Card, which promises to help smooth communications between managers and investors. FINalternatives recently sat down with PerTrac’s president and CEO, Ger- ald Mintz, and his colleague, managing director Meredith Jones, to discuss how the hedge fund industry is changing, and more specifically, how new pressures on the industry are forcing managers to increase transparency, strengthen due diligence and invest in technology. ► FINalternatives 19 Hedge Fund Technology & Trading 2009
  21. 21. How did last year’s tough market condi- ‘Don’t redeem; hold on.’ So, I think all of tions and high-profile scandals affect the those shifts are going to cause people to alternative investment industry? want to track each of those things more carefully going forward. Mintz: The industry has really gone through a severe shock—some people have fallen What changes are happening in the indus- out and other people will likely still fall out. I try now, and how are they driving demand would say that all of the trends in the indus- for technology? try argue toward people having more au- tomated, third-party systems. There’s less Jones: I’ve been in the industry since be- confidence in a marketing report that is fore Long-Term Capital Management blew produced by a manager’s own Excel tem- up, and I’ve watched the progression of how plate and own calculations than one pro- the industry has matured following each cri- duced by something like PerTrac that has sis. After LTCM, after the tech wreck, and a known name. There is a strong desire for now, clearly, after the market meltdown people to have tools to track and document and Bernie Madoff, there’s been a period of due diligence. Also, traditionally managers were reluc- tant to share informa- “You can’t see a survey these days where tion with investors, but investors are now de- they don’t rank transparency and manding that they get risk-management right behind performance.” more information about the underlying risk. In- vestors want things like sector exposure or strategy exposure or re- rapid maturation in the markets and in the gional exposure, and they want to be able alternatives space. What we’re beginning to aggregate that information and make to see right now is an accelerated process decisions. focusing on transparency. You can’t see a Liquidity mismatches are also a big survey these days where they don’t rank deal for people—making sure that the transparency and risk-management right promised liquidity of, say, a fund-of-funds behind performance, whereas before, per- product actually matches the liquidity of formance was far and away the most im- the underlying investments. For example, portant thing that investors were looking for. if an institutional investor is co-mingled in a fund with high net-worth investors, that How is the looming potential for increased may not be such a great thing. Some of regulation affecting funds? the high net-worth investors may want to cash out and that would force redemp- Jones: In terms of internal systems, cer- tions, while the institutions might say, tainly regulation could have a large ► FINalternatives 20 Hedge Fund Technology & Trading 2009
  22. 22. impact on that as well. What’s required by tors are looking for proper risk systems and various governments will drive to a large transparency, at least in terms of where the extent how the industry has to evolve with assets are, and making sure you’re not de- respect to technology. The way they do pendent on one prime broker. business, who they talk to, who they don’t The Lehman situation certainly scared a talk to; all of those kinds of things. A lot of lot of people with the assets kind of held in things are up in the air right now. Clearly, limbo. And then on the fund of funds side, with the whole regulation issue, there have people are looking to see what’s your val- been some proposals on the table, but ue-add. If it’s due diligence, prove to me nothing concrete. I think all of those things that you have a really rigorous due dili- are going to push toward transparency as gence process and systems around that. well. We’re moving further down the trans- If it’s portfolio construction, show me that parency line and we’re also moving toward you’ve got a good handle on risk and you daily and weekly estimates so that people can give me a portfolio that’s going to per- have a better view as to what’s going on in form well and not give me as much kind of their portfolio. a dispersion that I might get if I just picked a set of funds. Are you seeing any new hedge fund So, in each case, managers are going launches? to have to put in systems and procedures to show investors that it’s worth invest- Jones: I did a prime broker event and, ing in them. That, of course, will raise the of the 25 groups that were there, four of cost of a launch. So, it argues that funds them were new funds that were just start- have to be a little bit larger to be able to ing out. But they’re taking a more cau- afford those kinds of systems. I think the tious approach, and they’re also taking bar has been raised for what you need to the time to get some systems in place. It’s run a fund. not just two guys in a townhouse running a fund anymore. We’re probably looking What is the future of the industry? toward the late third or fourth quarter for the number of new funds to starting ramp- Mintz: I think you’ll see more outside ad- ing up again. ministration, and I think more focus on custody of the assets. We may see more Mintz: I think what Meredith said that is a in managed accounts, which is one way really important point to emphasize is that to address some of the custody and li- barriers to entry are higher because inves- quidity issues. FINalternatives 21 Hedge Fund Technology & Trading 2009
  23. 23. When every millisecond counts, you can count on this book. Written by industry expert Irene Aldridge, High- Frequency Trading offers innovative insights into this dynamic discipline. Covering all aspects of high- frequency trading—from the formulation of ideas and the development of trading systems to application of capital and subsequent performance evaluation— this reliable resource will put you in a better position to excel in today’s turbulent markets. Pre order your copy TODAY! Available January 2010.
  24. 24. Hedge Funds Slash Overhead, Vendors Reap The Rewards By Hung Tran As assets under management dwindle and Jayesh Punater, founder of New York- performance fees fall, hedge funds are in- based Gravitas Technology, which special- creasingly looking for ways to cut costs. izes in providing technology and software But choosing whether or not to outsource integration services to the alternative in- certain operations—especially those that vestment community, says he is seeing a have traditionally been done in-house, surge in hedge fund firms choosing to out- such as risk management—is a big deci- source in order to save money and stream- sion. Managers must not only look at the line operations. potential cost savings, but must also con- “This is the era of hedge fund 3.0,” Pu- sider the quality, reliability and security of nater says. “These hedge funds are smart- their vendors. Despite the caveats, hedge er, rather than larger. They’re reducing funds are increasingly taking the leap. overhead by using outsourced data cen- “It used to be a black mark to have out- ters and their focus has shifted from invest- side risk managers,” says Kenneth Grant, ing to running a real business.” who has served as head of risk manage- Punater says that pressure from inves- ment for some of the world’s most promi- tors and regulators is forcing hedge funds nent hedge funds, including SAC Capi- to expand their definition of risk, and hence, tal Advisors, Tudor Investment Corp. and to find ways to manage it. Cheyne Capital. In 2005, Grant set up his “No longer are firms just focused on own shop, but he didn’t go the hedge fund P&L and trading risks; now they’re focus- route. Instead, he opted to focus on what ing on regulatory risks and the needs of he knows best—creating customized risk investors,” he says. “What we’re seeing management reports for hedge funds. is increased demand for customized risk His firm, Risk Resources, employs 20 dashboards.” people and works 24 hours a day analyzing everything from volatility and portfolio expo- Outsourcing the IT Guy sures to value at risk and scenario analysis. Another way hedge funds are reducing While Grant says there are many firms that costs is by cutting personnel. Whereas provide some sort of risk management ser- funds once flush with cash could afford a vices software, it is the qualitative side of full-time information technology staff, tough the analysis that is often lacking. times call for tougher decisions. “Managers need someone to interpret “We recently saw a fund that was $6 bil- all the data that they are given and tell them lion before 2008,” says Alexander Kouper- what it means,” he says. “It isn’t enough to man, president of InfoHedge, a four-year- just crunch the numbers.” old technology firm. “We met with ► FINalternatives 23 Hedge Fund Technology & Trading 2009
  25. 25. the CFO and the chief technology officer, A managed service provider also has the and the CFO pointed a finger at the CTO knowledge of the technology options and and said, ‘This guy is my old friend and our possibilities since they provide support to wives are friends, but I have to fire him now multiple businesses and are able to bring because we don’t have the money to pay this value to the fund.” his salary.’” Kouperman says his InfoHedge, which Protecting The Secret Sauce counts more than 90 hedge funds among But not all hedge fund executives are sold its clients, is seeing a boom in demand, es- on the prospects of outsourcing every- pecially from firms that are being forced to thing but the trading to vendors. Brian Kim, downsize their operations due to decreas- founder of New York-based hedge fund ing assets under management. Liquid Capital Management, says outside “The outsourcing space is definitely in technology is a double-edged sword. good shape, given what is currently hap- “If everybody was buying the same pening in the market,” he says. risk management platform, frankly, I don’t Warren Finkel, president of Network feel like it could be any good,” he says. Doctor, which special- izes in providing IT ser- vices to the financial community, says he, “These hedge funds are smarter, too, is seeing an in- rather than larger. They’re reducing crease in business from the hedge fund sector. overhead by using outsourced data “We are seeing a centers and their focus has shifted from strong move towards complete managed ser- investing to running a real business.” vice offerings where IT consultants are being hired to handle all technology and not just “If [third-party vendors] were so good at relying on break/fix work,” Finkel says. “This managing risk, then they should be doing allows the hedge fund owners to plan their my job.” spending and also allows them to focus Dmitri Sogoloff, founder of New York- their efforts on managing funds rather than based Horton Point, a quantitative hedge worrying about day-to-day IT problems.” fund, echoes Kim’s sentiments. Sogoloff, He adds that another advantage of us- whose firm uses InfoHedge’s technology, ing an outside IT provider is that “a man- says while he’s satisfied with the vendor’s aged service provider can offer 24/7 sup- capabilities, there are just some functions port, monitoring and maintenance and that hedge funds should not outsource. provide technicians who are certified “We’re a technology-heavy shop and and proficient in each technology includ- we have a lot of stuff that we develop in- ing networking, phones and computers. house,” he said. ► FINalternatives 24 Hedge Fund Technology & Trading 2009
  26. 26. Indeed, despite the growing clamor generic infrastructure that every hedge for outsourcing solutions, Kim says ven- fund firm must have, such as computer dors have more work to do. He has been hardware and backup services that pro- searching for a way to ease the burden of vide business continuity in case of a di- labor-intensive back-office functions, but saster. has found the solutions available wanting. “We don’t need to spend the time or the “Back-office and mid-office support is money internally to do this,” he says. something I feel is a little lacking in the indus- New York-based technology provider try,” he said. “Everybody wants to sell you Richard Fleischman Associates is benefit- the latest trade management and execution ing from clients like Sogoloff—who in es- platforms, but if I could get some more help sence use a combination of in-house and in the back office, that would alleviate my outsourced technology. The firm boasts burden from an administrative standpoint.” more than 400 hedge funds, private equity firms and broker/dealers as clients and is The Nuts & Bolts: growing at a rapid clip. Servers, Hardware, “We probably do about 100 startups a Telephones & IT Experts year, and one of the things we’ve seen, While some hedge funds—especially post-Madoff, is a spread of outsource and those dealing in high-frequency trading in-source solutions, whether it’s with equip- strategies like Horton Point—may be loath ment offsite or with in-house facilities,” firm to use outside risk management systems, founder and namesake Richard Fleis- many of those same hedge funds prefer chman said. “For folks starting new busi- to employ third-party hardware vendors to nesses, there is a lot of trepidation about manage servers, telephones, data recov- building new offices, and they come to us ery systems and the like. for hosted solutions where they can get In fact, Horton’s Point’s Sogoloff says off the ground pretty quickly with minimum he is comfortable with outsourcing the out-of-pocket expense.” FINalternatives 25 Hedge Fund Technology & Trading 2009
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  28. 28. Hedge Fund Software & Technology Providers Premium Service Providers ® Advent For 25 years, Advent has been providing portfolio management and accounting, straight through processing and trade order management software, services and data to the world’s leading financial profession- als. Advent is the industry standard investment management software for asset managers, hedge funds, fund administrators, prime brokers, family offices and wealth managers and private client service providers. Phone: (800) 685-7688 Web: Alpha Theory Alpha Theory, the investment industry’s leading Fundamental Portfo- lio Optimization tool, is the premier solution used by hedge and mu- tual fund portfolio managers to develop an efficient portfolio using the concept of risk-adjusted return. Alpha Theory leverages research and instinct to build a repeatable system for optimally sizing positions. Phone: (212) 461-4757 Web: BackStop Solutions Group Backstop Solutions Group, LLC is a Chicago-based provider of award-winning software services to alternative asset managers, in- cluding funds of funds, hedge funds, family offices, pension funds and endowments of all sizes. BSG’s core platform includes tools for client relationship management, investor accounting, partnership al- location, web reporting, and funds of funds research & portfolio man- agement software. Phone: (312) 277-7700 Web: InfoReach InfoReach is an innovative company focused on providing leading software solutions for the trading of financial securities. INFOREACH TMS combines order entry, rule-based portfolio trading, order man- agement and FIX connectivity in a single broker-neutral trading plat- form. Product features include global assets traded either manually or algorithmically, high-frequency, analytics, charting, etc. Phone: (212) 269-2722 Web: FINalternatives 27 Hedge Fund Technology & Trading 2009
  29. 29. Meridian Equity Partners Meridian Equity Partners is an independently owned Wall Street bro- ker dealer with a global reach and a local feel. We provide custom- ized, best-of-breed strategic solutions to the investment management community. Products include: equities, options, futures, fixed income and forex. Member NYSE, FINRA, NFA & SIPC. Phone: (212) 500-6650 Web: PerTrac Financial Solutions PerTrac Financial Solutions was founded in 1996 with the goal of creating a comprehensive suite of software solutions for investment professionals. Now an industry standard, PerTrac software is used by more than 2,000 clients in 50 countries, including banks, brokerage firms, consultants, plan sponsors, family offices, investment manag- ers and funds of funds. The company’s foundation product, the Per- Trac Analytical Platform, is now the world’s leading asset allocation and investment analysis software. Phone: (212) 661-6050 Web: Client Relationship Management Actuate Advent Software Backstop Solutions Code Red Digiterre EZ Data Fidelity National Info. Services FundCount Imagineer Technology Group Netage Solutions PerTrac ProTrak International RiskMetrics Group Satuit Technologies UNAPEN Viveo FINalternatives 28 Hedge Fund Technology & Trading 2009
  30. 30. Compliance Software Global Relay Communications HedgeOp Compliance MyComplianceOffice Smarsh Electronic Trading / Trade Execution Aegisoft Baxter Financial Chi-Tech Fidessa First Advantage First Derivatives Flextrade Inforeach Investment Technology Group Lightspeed Trading Market Technologies Marketcetera Meridian Equity Partners Omego OptionsHouse Orc Trading smartTrade Streambase Thesys Technologies thinkorswim Traderserve Trading Metrics XELink FINalternatives 29 Hedge Fund Technology & Trading 2009
  31. 31. Hardware & IT Alden Technology Partners Eze Castle Integration Generic Network Systems Gravitas Technology Indus Valley Partners Investment Technology Partners MTM Technologies Network Doctor Vichara Technologies Portfolio Analytics, Accounting & Risk Management Advent Algorithmics Alpha Theory AlternativeSoft Appian Analytics APT Archway Technology Axioma Bravura Solutions Calypso Charles River Development Cogency Software Cognizant DataArt DST Global Solutions Eagle Investment Systems Fermat Fidessa FinAnalytica FinLab Fiserv FINalternatives 30 Hedge Fund Technology & Trading 2009
  32. 32. Fi-Tek FundCount GlobeOp Financial Services Horizon Software Imagine Software Imagineer Technology Group Isis Financial Systems Linedata Services Murex Nirvana Solutions Northfield Information Services Odyssey Financial Technologies Omego OpenLink Paladyne PartnersAdmin Patni Penny IT Works PerTrac PNC Global Investment Servicing Richard Fleischman & Associates Risk-AI Riskdata RiskMetrics SimCorp SmartStream Sophis SS&C Technologies Sungard Sybase RAP TKS Solutions Twenty-First Century Note: This list is not all inclusive. Viteos Large banks, hedge fund adminis- trators and prime brokers also offer many of these services. Xenomorph FINalternatives 31 Hedge Fund Technology & Trading 2009