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Prime Brokers exited hoteling services, as it was not core to their business model. Consequently, hedge funds are seeking Managed IT service providers that provide solutions that are reliable, fast, and cost-effective and well supported so they do not need to develop an internal IT staff.
 Electronic trading has created the need for extremely high performance networks, applications and monitoring capabilities. Reliability is critical and demands no single point of failure. A properly designed network is built for scalability and incorporates a real-time business continuity plan. Operations, security, development and help desk support are just a sampling of the expertise required for any hedge fund operation. An IT staff with these broad capabilities is generally too costly and outside the reach of most hedge funds. A cost-effective solution needs to balance shared resources with proprietary solutions that will provide the same level of support that was previously provided in the hoteling space. Finally, the quality of support is measured by how few business interruptions are caused by the technology solution and the quality of help desk support when it is needed.
With this in mind, let’s take a look at this situation with William Adiletta, President of TekFinancial Solutions.
Q: What are hedge funds doing to replace the services formerly provided by the prime broker’s hoteling services?
Hedge funds are looking to outsource some or all of their IT and Telecom services. Outsourcing is a large trend in the financial services market in general, from small to large firms. Some firms target outsourcing up to 80% of their IT functions! Hedge funds benefit from this trend. Hedge funds are founded by experts in the financial markets who typically spin out from larger firms with internal IT resources. This poses serious challenges to new hedge funds or hedge funds that grow quickly, since many did not have to be concerned with technology and when spinning out do not have the infrastructure, IT background, systems, knowledge or desire to support their own infrastructure.
Q: What do the hedge funds want their new technology infrastructures to do for them and how does it differ from what they had with the prime broker?
Generally, they are looking for the same or better level of service that they received from their prior environments. In some cases hedge funds were dissatisfied with the responsiveness of their prior services and are looking for better levels of service to ensure a competitive advantage. Hedge funds now have the opportunity to define their own service levels. In addition, hedge funds typically received a bundle of services for a set fee from prime brokers. Hedge funds can now select what services they want and not pay for the services they do not use. Often times, hedge funds will also seek improved business processes so that they have a more streamlined and efficient trading environment.
Q: Why is outsourcing so important to hedge funds and how is it addressed in the technology solution?
Hedge funds need uninterrupted access to their tools that generate their revenue. The technology solution must support their telephone, email, PDA and data at all times. Downtime of the technology can result in a loss of revenue. Telephone circuits go down, wide area and LAN network designs must be designed to include redundant equipment and diverse routes. Additionally, equipment breaks, software configurations are constantly changing. Security and compliance are critical services all of which demand fast and knowledgeable response from a diverse range of expertise. Sophisticated Managed IT service providers can deliver a “Virtual IT and Telecom” department with all the attendant skills required, including design, deployment, and operations. This delivers all the necessary skill sets of networking, telecommunications, security, design, development, and operations needed.
Q: What are the factors used to determine that the network is properly scaled?
First, it must be prepared to fit the hedge fund’s five-year growth plan. This means that components in the infrastructure must be able to handle or grow to handle the foreseeable demands and be compatible with the rest of the network to achieve these goals. This does not mean that the network is initially built to presently support the size of year-five. It means that it needs to be able to grow to that size with minimum interruption and change in the technology. Second, it must be able to meet the users’ expectations from the technology throughout the five-year plan. If the users become dissatisfied because of transaction delays that are caused from the network’s inability to support the growth in the five-year plan, then it was not properly designed.
Q: Is reliability the same as redundancy?
Redundancy is a subset of reliability. The key is to have no single point of failure for every step of the process. This redundancy will then increase the overall reliability of the solution.
Q: Why is a real time business continuity plan so important to reliability?
Even in the case of disaster, hedge funds still need to conduct business as normally as possible. Staff members need access to email and phones as well as to the trading desk. Access probably would be needed off-site, most likely from staff members’ homes. This does not mean they will have full recovery of data immediately, but they can continue conducting business.
Q: How do security issues affect the technology solution’s reliability?
Adequate security assures that the existing reliability remains. Additionally, the security measures must protect the hedge fund’s client information, its proprietary investment positions and meet Security and Exchange Commission (SEC) requirements.
Q: How does the issue of solution speed differ for hedge funds than other financial services companies?
Because trading transactions are now completed electronically, a hedge fund’s network speed must be as close to real-time as possible. Any delay in completing a transaction may result in the cost of the transaction to increase. Every hedge fund tries to find a way to access information and complete transactions quicker. Financial service companies that do not have to race the electronic trading clock can accept a slower network speed.
Q: How do you determine the right network speed and what are the trade-offs?
The speed of the network is balanced against the level of security that is required, the communication link to the prime broker and the additional cost of enhancing the network to be as close to real time as possible. There is an additional cost to acquiring a bigger communications pipe and increasing the power of your network resources. Ultimately it will be decided by the additional costs incurred by the hedge fund due to delay in completing transactions verses the cost of improving the network resources.
Q: How can a hedge fund, now separately located, obtain the cost benefits of shared resources?
Prime brokers were able to provide cost savings through volume discounts and by offering shared resources. The volume discounts can be obtained and passed on to the hedge fund by the new technology provider assuming they have a large enough customer base. When it comes to volume discounts, purchasing power matters, so pick a vendor that buys a lot of technology and has established relationships with the manufacturers. As to the shared resources savings, many technology resources can be shared even if they are not in the same location. Look to vendors that offer hosting services but be sure to understand how the location of the technology can affect performance.
Q: When does a hedge fund decide not to use a shared resource and, instead, maintain a potentially more costly, proprietary solution?
There are three main reasons why a hedge fund will prefer to maintain a costlier proprietary solution. First, the hedge fund believes that its custom solution provides it with a competitive advantage. Second, it allows the hedge fund to control how and when the technology will evolve. Finally, this helps to reduce potential performance or security concerns.
Q: Is customer support really a significant factor in selecting a hedge fund’s technology provider or is it merely a tie breaker?
Customer support may be the single most important issue in selecting a technology provider. After the infrastructure is built, customer support helps you use and manage that technology over the next two to five years. Hedge funds should seek a vendor whose support personnel has specific knowledge of how the technology is used in the industry and provides the level of support required by the hedge fund (response time, supports all technologies deployed and hours of support) and related technology services (i.e., application development or Web site development) that may be needed. Ideally, a hedge fund wants one number to call for its technology needs.
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