Omgeo last week published the results of a round table in hosted on London on 7 July. It says the main conclusion from the event was that the continuing growth of the hedge fund industry is dependent on the development of a “robust operational infrastructure that tackles trade failure, instrument complexity and risk control.”
The roundtable participants were Michael Azlen, Managing Director of hedge fund of funds, Asset Alliance International; Sven Jones of hedge fund Marshall Wace LLP, Gary Plummer, Head of Operations of start-up hedge fund, Callidus Capital Partners LLP; Neville Atha, Executive Director from Morgan Stanley Prime Brokerage; Pradeep Menon of risk management software vendor RiskMetrics; Jonathan Clark, Executive Director of investment management consultancy, Citisoft; Richard Hughes, Managing Director and Dominic Rieb-Smith, Business Development Manager EMEA, of Omgeo.
The context for the roundtable event, entitled “Hedge Funds in the Mainstream: Addressing Cost, Risk and Compliance through Technology” and hosted by Omgeo, the leading provider of global trade management services, was the continued growth in allocations to hedge funds from large investment houses seeking to diversify portfolios.
“Given the rapid growth of the hedge fund market, and the growing interest from the industry on the issue of increasing transparency and efficiency, we felt it important to facilitate some industry discussion on the topic,” explains Richard Hughes.
The roundtable participants were invited to debate the importance of operational issues to hedge funds in both meeting the strict due diligence requirements of institutional investors and achieving sustainable growth as the number of managers pursuing hedging strategies in the market increases.
Omgeo says other key conclusions were:
Sophisticated technology is required to meet institutional demands: Hedge funds are undergoing a significant change in structure in order to attract institutional investment. “Two traders in a room with a Bloomberg will not attract institutional-quality capital” commented Michael Azlen. “Institutions need to see more than one person managing the money, a dedicated person in risk management and transparency from top to bottom.”
Omgeo says the participants agreed that hedge fund managers will develop new investment strategies to accommodate institutional investment and they will need sophisticated technology to support the execution of those strategies. Richard Hughes observed: “Historically the demand for technology such as trade management systems has come from the larger, traditional fund managers. Today however, the hedge fund and prime broker industries increasingly see these types of systems as fundamental to the validity of their business models”
Operational risk reduction was another key concern. All participants agreed that institutions will not invest in hedge funds that cannot meet their due diligence requirements. Operational risk in particular was considered to be a serious threat to trading activity. Sven Jones emphasised that a “lack of operational control and repeated manual errors could be very damaging to a hedge fund’s reputation”.
The introduction of a greater degree of straight-through-processing (STP) to the investment process was seen to offer many benefits. Jonathan Clark felt that, in the main, hedge funds would concentrate on bringing front-office products in-house, but would look to prime brokers to provide back office solutions such as trade matching. Dominic Rieb-Smith maintained that “STP is critical for firms’ competitive edge – when margins are tight and the market is competitive, you can actually lower your overall costs and increase your profits through operational efficiency. The value of automation is magnified in the hedge fund industry, particularly with start-up operations, where there is a need for scalability from day one in order to cope with volatility in trading volumes without incurring increased cost and headcount requirements.” Participants felt that hedge funds were better placed than most financial institutions to take advantage of the latest technology, as they are not held back by legacy systems.
Central matching is the inevitable next step to truly increase efficiency and reduce risk: Participants agreed that trade matching and confirmation systems were essential. Gary Plummer said: “I come from a bank where in 3 years of using Omgeo’s services we had had virtually no failed trades, so when it came to starting Callidus it wasn’t a question of “Can we afford to have Omgeo Central Trade Manager1?” but “Can we afford not to have it?” However some of the speakers felt that many start up hedge funds were not particularly aware of the significance of technology, and Neville Atha stated that he “spent a lot of time explaining the importance of automating the trade cycle with new funds.”
The roundtable participants concluded that the future for the hedge fund industry is bright, says Omgeo. “Institutional investment in hedge funds will continue to grow rapidly. Keeping up with demand is going to be a challenge, as capacity comes under pressure,” commented Azlen. “Technology is key to creating scalable, efficient hedge fund operations that can adapt to this unprecedented growth in the market.”
Omgeo says a full report of the roundtable discussion will be available at the end of July.