A technology guide for hedge funds by Linedata


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In this document Linedata uses its experience in working with hedge funds of all sizes across the globe to establish the criteria to be used in assessing the suitability of a technology vendor and solution for their business.

Key areas for consideration are:

- Does the product support for alternative strategies, including full asset class coverage, full product lifecycle support, real-time P&L, strategy attribution and trade allocation?

- Does it provide operational control over multi prime workflows, including an understanding of how the system consolidates and presents information and the provision of auditable data trails and consistent views?

- Can the vendor support your business: Are they financially stable? do they have the staff and operational infrastructure to provide a service which truly meets your current and future needs?

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A technology guide for hedge funds by Linedata

  1. 1. KEY TECHNOLOGYCONSIDERATIONS FORHEDGE FUNDSExamining the business and technology issues facing a hedge fund when selectingtheir software solution.
  2. 2. TABLE OF CONTENTSKey technology considerations for hedge funds 1. Take-aways 2. Introduction 3. Supporting alternative asset classes a. Asset Classes b. Interrogating Profit & Loss in Real Time c. Strategy Attribution 4. Achieving operational control in a multi–prime environment 5. Supporting your business 6. Conclusion
  3. 3. KEY TECHNOLOGY CONSIDERATIONS FOR HEDGE FUNDS TAKE-AWAYS In this document Linedata uses its experience in working with hedge funds of all sizes across the globe to establish the criteria to be used in assessing the suitability of a technology vendor and solution for their business. Key areas for consideration are: • Does the product support for alternative strategies, including full asset class coverage, full product lifecycle support, real-time P&L, strategy attribution and trade allocation? • Does it provide operational control over multi prime workflows, including an understanding of how the system consolidates and presents information and the provision of auditable data trails and consistent views? • Can the vendor support your business: Are they financially stable? do they have the staff and operational infrastructure to provide a service which truly meets your current and future needs?INTRODUCTIONSelecting investment management software can be a confusing task and the importance toyour business is often overlooked in the early days. The wrong decision can lead toincreased costs in the medium term and, potentially, levels of operational risk thatinvestors will find hard to swallow. This document aims to highlight the key areas ofconcern and provide a framework for selection due diligence for both start-ups andestablished hedge funds who are reassessing their software requirements.Any selection process should start by mapping the workflow needs of the business; a goodsystem should aid the desired workflow. All too often decision makers will have a particularfocus, be it trading and front office needs or operational considerations. However, abalanced view is preferable to avoid unnecessary oversights which may hinder a business’sability to raise capital in today’s climate.This document considers the technology challenges facing a hedge fund in three differentways: 1. the technology requirements needed to support alternative strategies 2. the technology issues associated with operating in a multi-prime environment 3. the challenge of supporting your business.
  4. 4. SUPPORTING ALTERNATIVE stage, will leave a manager with realSTRATEGIES issues understanding exactly where he stands on a day to day basis.Asset ClassesFor the hedge fund of today, assessing Interrogating Profit & Loss in Real Timethe suitability of a vendor and their Critical to any hedge fund is the flow ofsoftware is more complex than ever information between the front office andbefore. One key area is how well the the back office. Hedge funds willsystem supports alternative strategies. invariably have an eager eye on costs, and will need to understand what goes onRegardless of the strategy with which a in the back office, as it can be afund is labelled, the asset types traded significant source of operational risk. Thiswithin it are many and varied. Long / has to be looked at on a consistent basisshort equity portfolios were once across the business. Disparate systems forstraightforward to support; they would trading and accounting are a real sourcetrade listed equities, some index futures of such risk and platforms whichand options, and perhaps some CFDs or reference a single book of records, forswaps for access to restricted markets or trading, positions and P&L can keep thisfor tax efficiency. Nowadays, credit risk to a minimum. Time consuming,derivatives and CDS are often used as onerous reconciliations between fronthedging tools within long / short equity office reports, and the numbersfunds. Systems need to have a full asset generated for the fund by the back officeclass coverage, as anything less will limit can and should be eliminated to optimiseyour strategies. operational efficiency.The multi prime arrangements Understanding P& L is another key areacommonplace today can lead to securities where technology can help investmentbeing traded or given up to multiple managers to maintain an overview oflocations. The issues of allocations and their activity. Visibility of the full breakfinancing methodologies then arise. There down, in real time, of the factorsis little standardisation amongst contributing to your P&L is essential.derivative or synthetic products and each Whether returns are coming fromprime broker has a proprietary way of intraday price or currency movements,addressing resets, financing terms, associated income, or accruals should alldividends and realised gains / losses. In be visible on the managers desktop fromorder for any system to report accurately the moment they pull the trigger.on cash, counterparty exposure andfinancing costs, each of the available In addition, the high levels of marketmethodologies needs to be supported. volatility we have seen due to recentIncreasingly, portfolio managers need to events has highlighted the need for real-assess the true cost of running strategies, time reporting. Attempting to maintainand net the costs associated, be they control through turbulent trading sessionsstock borrowing charges or swap with outdated views of your portfolio isfinancing or rebate fees back to the P&L simply not good enough and a lack ofof the underlying positions. It should not real-time transparency can no longer bebe underestimated what a challenge this justified. Systems must be able tois for any hedge fund solution; few can support streaming data and the FIXsupport it and those who can have a real protocol to display the impact of tradeedge in today’s market where executions on a fund’s risk and returntransparency is paramount. Systems profile the moment they happen.which are not able to truly support theproduct lifecycle, from initial tradecapture through all the various eventssuch as resets, assignments, partialunwinds and eventual closure, trackingthe impact on cash and collateral at each
  5. 5. Strategy Attribution and Trade ACHIEVING OPERATIONALAllocation CONTROL IN A MULTI–PRIMEAlternative investment strategies aretypically combinations of positions, from ENVIRONMENTthe simple pairs trade to more complex In the not-so-distant past, the typicalstructured positions with various hedge fund would probably have launchedderivatives employed to strip out credit with and sustained a single brokerageand interest rate risk; all have to be relationship. The prime broker providedplaced into buckets in order to monitor safe keeping of the fund’s assets but alsothe net returns. Any hedge fund solution a range of services, including clearing,worth its place in today’s market must settlement and securities lending. Theprovide a flexible business hierarchy for single prime would have completebucketing trades, related cash and oversight of the fund’s trade and positiontherefore risk and returns. Historically, data and therefore serve as the logicalthis was not such a challenge for a fund source for data on cash balances, riskusing the single prime model. The multi- exposures and financing charges againstprime fund, however, complicates which to reconcile.matters considerably. Systems need toprovide multiple views of the same funds. The collapse of Lehmans and Bear StearnsTake, for example, a large short position in 2008 meant that almost overnight,in a specific name; to facilitate the hedge funds could no longer entrust theirborrowing required to cover the short, assets to any one prime broker, no matterseveral primes may have been used and how big or well-established. Multiplethe position constructed from allocations, prime broker relationships became theboth physical and synthetic, held in standard and investors focused theirseveral locations. Once the position has attention firmly on counterparty risk.been established, portfolio managers are Quantifying counterparty risk was madeconcerned with the net portfolio position all the more tricky as many hedge fundsand the resultant returns. The back had their assets re-hypothecated, whereoffice, however, need to reconcile they would be loaned by the prime brokerpositions and P&L on a secondary basis. to other organizations whilst still servingThe “real world” view, or prime broker as the funds collateral. Investors nowaccount level view may vary considerably demand funds diversify their counterpartyfrom the net portfolio view. How systems risk and many gain transparency throughtreat this discrepancy must be separately managed accounts. Theunderstood. Contract-based instruments necessity to have an accurateemploying FIFO accounting methods will understanding of the multipleorder trades differently at account levels relationships funds maintain is the keyto the net portfolio view. Reconciling the issue. There is a need to collect andtwo can be extremely onerous and time- aggregate position data, cash balances,consuming. financing accruals and trades in a timely manner.A further complication is trade allocation.The multi-prime model requires a fund to An alternative source for consolidateddecide how to allocate trades between its information is the third partyprimes. When should it split a trade administrator. They are perfectly set upacross its prime brokers? Which position to consolidate multiple prime broker datashould it unwind first? And on what as they are already required to do so asgrounds? Related borrowing or financing part of the regular end of month Netcosts should be visible to the managers at Asset Value reports. However theall times in order to make decisions in the downside for the hedge fund manager isbest interest of its investors. A platform that these processes are not as quick orwhich cannot offer this functionality as timely as they may require. Asshould be questioned in today’s institutional investors pay ever closerincreasingly transparent market. attention to the operational processes employed by a fund, any lack of timely process in aggregating position data is no
  6. 6. longer acceptable to the due diligence hedge fund, but to continue to invest inexpert and funds needs clear visibility at and release new functionality. Referralsall times. are valuable but decisions should not be based on this alone.In light of these issues, a good hedge fundplatform operating in a multi-prime Over the past three years we have seen aenvironment should perform the rash of acquisitions in the market thatfollowing: have impacted the support and focus of technology providers. You should consider• Trader position look-up for whether your technology provider is likely appropriate allocation of trades to to be in a position to continue to support multiple prime broker accounts. your business and whether they have the• Consolidated reporting tools to financial stability to remain a viable present data from across the multiple solution provider in the years to come. prime brokers.• Prime broker connectivity, a secure Funds need to ensure that their vendor and encrypted process in which to has sufficient support and backing such transmit trade and position data in the that their considerable ongoing format prescribed by each prime investment in the system is secure. The broker. people behind the solution are also• Exception-based reconciliation of the important. When hedge funds buy a fund’s own records of trading activity solution they need to evaluate not only with those kept by its multiple prime the system and its ability to operate brokers and third party administrator. efficiently according to their business Without the use of specialized model, but also the solution providers technology, the process of matching people, their expertise in the hedge fund the fund and prime broker records and market and their ability to deliver. then identifying discrepancies – particularly in the multi-prime This is increasingly important with environment – can become a time- respect to the level of support firms consuming and tedious task. provide. Firms operating in a single Integrated exception processing is geographic region often provide single required. region support. While that may be suitable for some, increasingly we are• Ability to accrue for the various styles seeing demand for 24/6 support by local of product financing employed by the staff, deploying a ‘follow the sun’ prime brokers. Products vary approach. significantly in their lifecycle between prime brokers and as no standard A further consideration in selecting exists, flexibility to cope with the technology is the time available to differences falls upon the technology manage the vendor relations and the in place. Efficiencies can be gained sometimes complex integration of various where financing rates and charges are systems. There are three schools of visible and transparent to the thought in the market space on this issue. manager. One says that you should bring in and manage multiple vendors, each one the best possible fit for that part of yourSUPPORTING YOUR BUSINESS business. This option may deliver goodAssessing the ability of a vendor to solutions but at a price: a large vendorsupport your business is vital as this can management commitment and increasedalso be a source of considerable overheads, repeated each time eachoperational risk. Funds should carefully system is upgraded and interfaces mustconsider who they are buying from and be renewed. The second says it is best towhether the vendor has the core manage this technology providercompetency to not only implement the overhead by leveraging a single vendorsystem and support the needs of the that can provide a full service.
  7. 7. This may offer solutions across all the high on the agenda, some compellingbusiness with hugely reduced vendor reasons for outsourcing now exist.footprint and a relationship that can besustained and built upon. The third option Outsourcing can take several forms, fromis to build in-house, which enables you to the simple IT infrastructure hosting ordesign a system to fit, but implies ASP services available from the specialistreliance on an increased development vendors to a full business process model.and IT resource and a time-lag for Middle office platforms can offer acompletion. variety of business process workflows inWhether selecting for the first time or addition to hosted technology. Many ofreviewing your existing technology, unless the third party fund administratorsyour business has a clear and simple looking to differentiate themselves areworkflow model, whilst you may have a now offering some form of outsourcing,key technology partner in place for most from straight technology hosting throughsystems, it is unlikely any single vendor to full post-trade business management.can meet every one of yourrequirements. Your technology solution A key consideration for any outsourced orneeds to allow easy and logical hosted platform is the security andintegration through an open and standard privacy offered. The physical security ofinterface, particularly as multiple the data centre, 24/7 monitoring, as wellvendors and service providers and in- as CCTV and digital surveillance are allhouse application development may be issues to be covered by both your anddeployed as your business becomes more your investors due diligence. Anysophisticated. complete offering should include full redundancy and high availability of theUntil recently hedge funds have always infrastructure for seamless businessshown a degree of reluctance in adopting continuity and should cover back upoutsourcing solutions, primarily due to power supplies and multiple networkconcerns over privacy and flexibility. providers. Hedge funds whose veryHowever, as solutions have advanced to existence depends on managing risk inmeet the demands of managers using the volatile markets need to know, in themulti-prime model and with transparency event of disruption that it is business as usual.CONCLUSIONIn conclusion, the choices for a hedge fund are endless and often confusing. Taking ananalytical approach to ensure a solution meets the specific needs of your strategies andyour funds will serve you well. The challenge for the vendors, service providers and hedgefunds alike will be ensuring solutions are sufficiently flexible to deliver the functionalityrequired while satisfying the future demands of both investors and the shifting regulatorylandscape. Ad–hoc investor requests, overnight regulatory restrictions have to beconsidered.The key to success is a concise mapping of your current workflow in conjunction with aclear view of your business direction. You will then be in a position to ask the rightquestions to ascertain how technology can best support you on your journey.
  8. 8. About the AuthorRichard Pascoe is a Hedge Fund Product Specialist for Linedata Services, part of the teamresponsible for the formulation of product strategy. Richard has over 12 years experience inthe alternative asset management industry, and as a hedge fund operations specialist, hasspent the past 5 years at Linedata working closely with many of the leading hedge funds inEurope and Asia.About LinedataLinedata is a global solutions provider with 700 clients operating in 50 countries. With morethan 840 employees across the globe, Linedata is dedicated to the investment managementand credit community. Linedata has been at the service of the financial industry from dayone, and applies its market and client insight to provide innovative and tailored mission-critical software and services that help its clients grow. As a pioneer for over 10 years withthe set up of ASP infrastructure for the financial industry, Linedata has preached andspread this model throughout the global financial community, for its full range of products.Headquartered in France, Linedata achieved revenues of EUR 144.5 million in 2009. Thiscompany is listed on Euronext Paris FR0004156297-LIN - Reuters LDSV.LN - BloombergLIN:FP.About Linedata’s Hedge Fund SolutionSince Linedata acquired Beauchamp Financial Technology and its suite of hedge fundsolutions in 2005, we have been committed to the hedge fund market and that commitmentcontinues today. We invest in products and in people to ensure that weboth meet and anticipate the technology demands of this market, working in partnershipwith our customers, industry bodies and other stakeholders to create innovative and costeffective hedge fund solutions.Today, Linedata supports more than 300 hedge funds globally. Linedata’s Hedge FundSolution is a comprehensive offering catering to multi-currency, multi-asset class, multi-prime and multi-strategy investing. It encompasses order and portfolio management,industry-leading pre- and post-trade compliance monitoring and full reporting functionality.It comes with a comprehensive rules library and an intuitive rule-builder, full trade ordermanagement capabilities with portfolio modelling and advanced rebalancing. At the heartof this unique package is our award-winning portfolio management software, enablingsophisticated tracking of product and counterparty financing plus accurate NAV estimationto both reconcile with and monitor third party administrators.