The Technology Gamble: Hedge Funds, Place Your Bets

Hedge funds are at a crossroad and must make a decision about investing in technology.

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Annie Morris

Annie Morris

The hedge fund industry is going through some massive changes right now. Despite the fact that the sector’s performance has been relatively strong in the last year, few other businesses have taken such a severe hit.

The Bernie Madoff scandal, as well as the current market climate, are behind a growing push for hedge funds to boost transparency and disclosure. On one side, regulators and investors want hedge funds to be more transparent. On the other, the funds themselves, faced with rising redemptions, are looking to reduce costs.

Somewhere in the middle lies an uncertain investment environment that’s on the cusp of recovery, which is making it hard for hedge funds to determine if, and how much, they should spend on technology upgrades. The technology capable of helping hedge funds meet some of their challenges is available, but many managers consider these tools suited to the more staid and highly regulated mutual fund industry.

Despite these challenges, many managers realize they must respond; the push for regulation of hedge funds is not going away. In addition, more of the so-called boring questions are coming up in investor meetings – questions about operations, risk, responsiveness and controls.

As disclosure and prudence take center stage in our post-Madoff world, operational infrastructure can make the difference between success and failure for a fund that is seeking capital. Savvy investors want to see how a fund generates and manages its returns. They also want to confirm that skill, not luck, is driving a fund’s performance.

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While robust operational infrastructure and efficiency improvements were always considered by hedge funds to be “nice to have,” technology has really started to matter.

So, what are investors and regulators looking for?

• Transparency, including auditable infrastructure, use of multi-prime brokers, and the ability to track exposures and positions in real-time.

• Regulatory responsiveness, together with the ability to demonstrate a robust compliance infrastructure, and to adapt quickly to upcoming regulatory change.

• Increased efficiency, including straight-through processing and the use of hosted solutions and “hot” (24/7/365) disaster recovery.

Hedge funds can bet in one of two ways: They can spend the money on infrastructure now, hoping to differentiate themselves with investors and take the lead when the market recovers; or, they can hang onto spreadsheets for another year, hoping for delays in government regulation.

I don’t believe the current push for transparency and disclosure by investors and regulators is a fad, nor do I predict that we will all return to the days when the back-office remained in the background.

Hedge funds now recognize regulator and investor concerns, and improved technology is the only clear choice for addressing them. So, it is a little surprising that many uber-traders and strategists have decided not to make that choice, delaying their investment in strong operational infrastructure.

The investment managers who refuse to ante up may be paying a higher price than they realize, as funds with strong technological controls stand to benefit most from the recovery in the months ahead, with improved access to capital and increased profitability.

Annie Morris is Managing Director of Linedata Services Asset Management in North America.

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