Can Asset Managers and Hedge Funds Converge?
The Short of It
"If asset managers start hedge funds from scratch, the Paladyne Systems, a provider of alternative solutions to hedge funds and prime brokers. "A lot of their systems are long-only systems, and they're just not capable of managing a lot of the long-short requirements." And on the front end, Shalaby adds, hedge funds typically need to reach more execution venues and have a need for real-time P&L, which asset managers typically do not.
Further, hedge funds allocate trades by strategy, prime broker and fund, whereas asset managers are account oriented, explains Shalaby. "[Hedge funds] may create a strategy that has five longs and 10 shorts, and execute that in one shot. And they create baskets that are also multi-asset class," he says. If a hedge fund is long on some bonds, short on some stocks and hedged on some FX, it will need to combine all three into one strategy. "It's a different perspective, and not all the systems [traditional asset managers] have will address that," says Shalaby.
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Hedge Funds vs. Asset Managers: How Are They Different?
The roles played by hedge fund traders and traditional asset management traders is different, says Peter Hess, SVP and general manager of Advent Software's Global Accounts Business based in San Francisco. Hess says the No. 1 difference is that a hedge fund trader manages the P&L of the fund and is more like the portfolio manager. "Whereas in a long-only fund, the trader's responsibility is to get best execution." The second difference is the types of instruments in which hedge funds invest, including OTC derivative-type instruments. They "tend to be higher volume if they are in a stat arb account, which is all computerized and generated off of models," Hess explains. The main difference between long-only shops and hedge funds is that "hedge funds deal with the concept of borrowing stocks, finding locates and selling short as a trade type," says Dave Quinlan, president of Eze Castle Software, a BNY ConvergEx Group company, whose OMS is used by many hedge funds. A second difference is that hedge funds allocate their trades to multiple prime brokers whereas asset managers allocate their shares through a single custodian, he adds. Advent's Hess notes that in the hedge fund world, the OMS is only one piece of the trader's puzzle, whereas in the long-only space, the OMS is a trader's main tool. "In the hedge fund space, risk management and execution management systems are, from the trader's perspective, more critical than the OMS," he contends. Still, the hedge funds need OMSs to record their trades, make allocations for the fund and send notifications to the prime brokers. -I.S.
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The hedge fund also may trade FX, bonds and stock on disparate systems. "One of the common challenges is to combine all three positions and split the allocations between two different prime brokers," Shalaby relates. These hedge fund-centric requirements, he stresses, are "plain vanilla." "If you're an asset manager trying to get into this space, you've got to look at all your systems and make sure they do all that," says Shalaby.
"As traditional money managers get into hedge funds, they need to evaluate their systems and, in some cases, replace them," according to Mike Wyne, head of operations and IT at FFTW. "So many order management systems are fairly old and antiquated, and some money managers have done long-only business that doesn't handle derivatives well," he explains. Asset managers will need order management systems, risk management systems, and compliance and accounting systems that can handle all the new instruments and derivatives off those instruments, such as credit default swaps (CDS) and basket swaps, Wyne notes.
According to David Quinlan, president of OMS vendor Eze Castle Software (a BNY ConvergEx Group company) that is used by many hedge funds, there also are legal and compliance issues when a typical mutual fund or long-only fund decides to go into hedge funds. "They have huge issues with how [they] manage the information flows between the two divisions," he says.
"In terms of the technology platform, there's no question that the technology environment and the connectivity of a long-only platform is different than a hedge fund," says Roger Ehrenberg, the former president and CEO of Deutsche Bank subsidiary DB Advisors, where he led a 130-person team managing more than $6 billion in capital through a 20-strategy hedge fund platform. "If you are a long-only asset manager, you are not dealing with issues of stock borrow. You're not likely to be dealing with issues of high frequency, low-latency trading," says Ehrenberg, who is now CEO of Monitor 110, an Internet search company catering to hedge funds and institutional investors.
"But at the same time, there is still enormous leverage to be gained by centralizing trading and at least having the benefit of combined volume in order to negotiate lower commissions from your providers," Ehrenberg continues. If a firm is able to leverage the aggregate flow from both sides, that could benefit both sets of investors in terms of negotiating lower commissions, he says. "So then the challenge is: How do you maintain the confidentiality of the flow from the hedge fund and the asset manager?" Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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