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Hedge Funds Review
January 2001, Issue 4
Brian Sentance, managing director of Xenomorph, and Neural Net Designer software from developer CQG.
The tools of the trade
by Andy Webb
An increasing number of software solutions are being designed specifically for hedge fund managers - rather than being cut-down versions of applications designed for bank trading desks
When it comes to technology, there's never been a better time to be a hedge fund manager. Mobile order entry, artificial intelligence, sophisticated statistical modelling, data visualisation - all the applications that either didn't exist five years ago or usually required a Pentagon-sized IT budget are now within the grasp of even the smallest hedge fund start-up.
A further bonus is that an increasing number of solutions are now being designed specifically for hedge fund managers - rather than the cut-down versions of applications designed for bank trading desks that they had to make do with in the past. One of the veterans in this field is Xenomorph Software, which provides a range of products suited to hedge funds, including position keeping, risk management, yield-curve analytics, data-base and data analysis.
According to Brian Sentance, managing director of Xenomorph, hedge funds are looking for a number of very specific features when it comes to buying technology. “One increasingly important area is risk management,” he says. “Apart from regulatory changes that are pushing hedge funds into doing more about risk management, managers are also starting to make extensive use of it as a client marketing tool.
“Elsewhere, flexibility and extensibility are also deemed essential, as managers often need to extend the range of instruments that they trade. For instance, we're currently seeing an increasing interest from long/short equity managers in moving into equity derivatives for hedging purposes.”
Vladimijr Attard, of hedge fund and Xenomorph client Lydian Capital, agrees about the importance of flexibility. “We wanted a system flexible enough to allow us to plug in third-party analytics and to cope with a range of instruments, including swaptions and equity options that we use for hedging our convertible arbitrage trades,” he says. “We were also looking for a solution with a flexible database structure that we could manipulate ourselves and create additional fields that we might want.
“At the same time, the application had to be able to integrate interest-rate modelling with everything else, so that one database and one model implementation system could handle all product types and cross-reference between them.” Those hedge fund managers who have previously worked on the trading desks of major banks often tend to have a propensity for more complex and exotic instruments.
Though these requirements can often be met by third-party pricing models plugged into the fund's main trading and risk-management system, some vendors have started to add this sort of functionality themselves. A case in point is eGAR Technology, developer of the Focus trading and risk management system, which is aimed at hedge funds and smaller banks.
The company has recently beefed up Focus's instrument coverage to include weather and emission derivatives. The latest release covers swaps and options on HDD (heating degree days) and CDD (cooling degree days), NOx/SOx (spot, forwards, swaps and options relating to oxides of nitrogen and sulphur), emission exotics, and exchange-traded weather futures and options.
Rather less typically for a hedge fund oriented product, Focus also extends its functionality into the back office to provide comprehensive transaction management, including trade tickets, confirms, Swift interface, cashflow management and a global swap resetter. Like Xenomorph's Sentance, eGAR chief executive Ravi Jain has noticed an increasing demand for risk management tools from hedge funds that is being driven by their clients.
“This isn't just for marketing purposes,” he says. “Investors are becoming far more demanding and actually want to see the risk management and reporting systems in place before they part with any capital. They are no longer prepared to take this on trust or on the basis of the manager's reputation. Nor are they prepared to accept the basic risk analysis traditionally provided by hedge fund administrators.”
Tighter systems integration is another popular theme among hedge fund managers when technology shopping. Those managers who have come from a major trading floor have been used to having the services of a fulltime IT support team. However, once they set up on their own, technology “snafus” that were once somebody else's problem become their's, so keeping the number of separate vendors the fund deals with to a minimum becomes a priority.
“Resilience is vital, and the more individual layers and systems you have, the greater the risk that something will go wrong,” says Anthony Todd, manager of hedge fund Aspect Capital's Diversified Fund.
Visual Insight's SeeIT software (above) can handle very large data sets,
while Macalla Softwave's Mobility product is available on the iPac (middle)
and other PDAs, and Communicating's XLConnect software has been
optimised for the Clio CE far right).
This fact hasn't been lost on vendors who have not traditionally specialised in the hedge fund space. For example, data vendor CQG has been rapidly adding extra features into its core data and technical analysis system that are likely to have considerable appeal for hedge funds. While electronic order entry systems are hardly rare these days, most of them tend to run as separate applications that have to be hooked up to other packages and have a trader to click the “buy” and “sell” buttons. CQG's new Otto trading interface is therefore unusual in being an integral part of its CQG for Windows product and also fully automatic.
Trading strategies can be programmed into CQG for Windows using its trading system builder and any orders generated can (if desired) be automatically executed by Otto, without any human intervention. In the first release, Otto will allow funds to trade on major futures and options markets, such as the CME and Eurex, with equities and cash FX being added in future releases.
CQG has also released three very sophisticated analysis tools, built by the head of its Moscow office, Dmitry Bourtov, who is also the manager of hedge fund Solaris. The CQG Cluster Analyser is used to detect interdependence within groups of securities and to predict the future movement of one security in the group by analysing the behaviour of the others.
The CQG Spectrum Analyser can detect periodic behaviour in markets and uses this to build predictions of future direction, while the Neural Network Designer allows the user to build, train and test sophisticated neural networks in real time. The next major release of the Otto trading interface will be able to execute trading signals generated by any of these three applications automatically.
Because of their client demographic, hedge fund managers often spend a fair amount of time on the move making presentations to clients. Handheld devices that provide real-time prices and allow order entry are consequently of considerable interest. A front-runner here is Macalla Software, which has recently announced a major launch of its Mobility product for Dresdner Kleinwort Benson. DKB's clients will have a range of pre- and post-trade services available to them via a selection of portable devices, including PDAs and Wap phones.
Services include the bank's Globeweb Equity Research, FX order entry, indications of interest, equity order entry and order book browsing, as well as trade settlement and account back office information. These services are available to clients via whatever mobile technology is available in their region - for example, i-mode in Japan and GSM or GPRS in Europe. Ultimately, Mobility will allow clients direct access to their transactions within DKB's back office system, in order to make any corrections necessary to prevent trades from failing.
One of Mobility's most practical features is that it isn't tied to any particular device - a transaction started on one device can be continued or completed on another. “Given the still less than perfect ergonomics of most Wap phones, you may not care to set up a securities watch list using the keypad,” says Ian Rosarius, managing director of Macalla's UK operations. “Instead, you can set your watch list up using a browser on your desktop PC, watch it on your Wap phone and perhaps trades securities on it using your PDA.”
For those hedge fund managers who would like a mobile trading and analysis tool that has room to display a little more information, but who don't wish to lug around a laptop, financial IT company Communicating has an alternative. The company has released a Windows CE version of its desktop XLConnect product that links directly into Liffe's LiffeConnect electronic trading system. (Interfaces to other electronic exchanges, such as Eurex and OM are currently under development.)
The Windows CE version of XLConnect was originally developed for Hewlett Packard's Jornada 680, but is now also available in a version optimised for Vadem's rather desirable Clio CE device. Since this has a huge screen that can be folded over the keyboard, it is possible to have a good-sized price chart and the actual trading interface on view simultaneously and control both applications with a stylus.
Though the availability of good-quality historical data has proved a boon when developing strategies, managers increasingly find themselves having to sift ever-larger databases to find profitable trading opportuni-ties. One technique that has become increasingly popular in this environment for getting a quick and intuitive grasp of data relationships is data visualisation.
One of the leading vendors in this field is Visual Insights, whose SeeIT application allows users to display very large and complex data sets, both static and real time, in a format that can be easily assimilated.
SeeIT shows information on 3000-plus companies, including market capitalisation, market sector, yield, sensitivity to interest rates and sensitivity to financial market volatility.