“Whilst we do use some vendor systems, a lot of what we do that give us a competitive advantage and differentiates us are the platforms and systems that we build in-house,” says Man Group’s CTO of Alpha Man Technology, Gary Collier.
Blueshift Asset Management, a New Jersey-based hedge fund with around $2.6bn AUM which specialises in using algorithmic and high frequency trading techniques are in a quest for “pure alpha”, says head of portfolio construction, Tom Fazio.
“We’ve built all of our infrastructure in-house, we’ve created an ultra-high performance, ultra-low latency technology architecture that allows us to do R&D as well as directly push those signals to production and through our own execution algorithm,” says Fazio.
“We’ve spent a lot of time on the technology and that’s really core to our DNA. At the end of the day, we’re all engineers at heart.”
In 2019, quant funds overtook human-managed funds across the US stock market with 35.1 percent of market capitalisation of the $31trn market compared to 24.3 percent for human-managed funds, according to a report by Toptal. As Collier explains, the advantage for these highly technical funds comes in being able to differentiate in the market, making any “out of the box” vendor solution inherently flawed.
“We're looking to distinguish ourselves from our competitors and we're looking to generate alpha for our clients. And if you could do that by just buying a vendor system, the competitive advantage would by its nature disappear because everybody else would be able to buy the same system and exploit the same market features,” Collier says.
“We differentiate ourselves by building and employing clever technology in-house, and that is part of why our tech is so important to us.”
Mark Higgins, co-founder and chief analytics officer at tech vendor Beacon, says Collier’s approach is becoming increasingly commonplace.
“Hedge funds are investing a lot more in internal technology these days than they used to. They used to mostly just buy vendor solutions, but part of the issue is that markets are getting more complex and more electronic. There’s a lot more quant strategy that’s going on now,” he says.
A report by The Alternative Investment Management Association (AIMA) and Big Four accountancy firm KPMG found that while hedge funds are increasingly likely to outsource their back-office functions, less than 10 percent would outsource their trading systems. The report adds that 80 percent of hedge funds are now investing more into improving their businesses digital infrastructure and IT capabilities.
Traditionally, Higgins says, hedge funds didn’t allocate much resource to their tech stack, while it also takes time to develop them before they are ready to take to market. As a result, out the box vendor packages were a cheap and fast solution.
“But the downside of the vendor solution, the black box vendor solution, is that they’re pretty rigid,” says Higgins.
“They’re good at what they do inside the box, but if what you need to do next isn’t in the box? You’re stuck.”
What’s more, Higgins says a lot of tech providers are running the risk of becoming outdated, with many of the foundations for the platforms based around technology available in the 1990s and early 2000s.
“It’s hard for their clients to extend them and build their own ‘special sauce’,” he says.
Changing world of tech solutions
By reaction, vendors must be much more adaptable, and offer more bespoke solutions.
“A lot of bespoke development right now is dependent on which clever building blocks you might take and assemble into higher order applications or tools for people. We’re doing a lot of work with the big cloud vendors building out data science environments,” adds Collier.
Reflecting this change in operations, Beacon provides users with a development platform and full access to its server, allowing hedge funds to build on top of the pre-made solutions.
Collier says it’s not a case of the tech vendor dying out, but rather repurposing how they serve their clients.
“There’s definitely a space for vendors to provide building blocks and libraries that do substantial low level heavy lifting which can then, with the injection of further in-house technical expertise and combined with knowledge of markets and investment, be used and woven together to bring solutions to a business more quickly.”
Breaking the silo culture
The ability of large funds like Man Group to invest heavily in research and development gives rise to an image of a two-tier system in asset management, in which the biggest funds have budget to explore increasingly complex financial technologies in a quest for alpha, while smaller firms make do with increasingly outdated software.
According to a report by Truss Edge smaller hedge funds are at a distinct disadvantage when it comes to tech as they often don’t have the budget for investment. But for Higgins, there is more to it than merely smaller funds having smaller budgets.
“Some funds are set up where every portfolio manager’s business is like a start-up that’s kind of funded by the parents, and the parents are pretty hands off.
“Others try to have more of a consistent technology framework between all the different portfolio managers,” Higgins adds.
But while it’s not as simple as labelling all large firms as collaborative and all small firms as siloed, there is still a problematic silo culture within the industry, according to Northern Trust’s head of investment data science, Paul Fahey.
“I think there's been a lot of development in the investment process over the past 40 years, but the problem has been it's been developed in silos,” he says.
A siloed culture becomes an acute pain point for asset managers when dealing with vast amounts of data, as is now commonplace, and when using the rigid vendor solutions. Higgins says this often pushes asset managers into setting up spreadsheets to quickly solve issues that arise with the vendor solution.
The Truss Edge report adds that small funds in particular faced constrained budgets and a resistance to spend on their digital infrastructure which meant many were turning to outdated technology services like spreadsheets.
“The problem with that is it works for the first few months when you’ve got a little spreadsheet solving some little problem. But spreadsheets aren’t really designed to be enterprise technology. So, over a year you end up with tons of these little spreadsheets,” Higgins says.
Peter Sleep, portfolio manager at long-only fund, 7im agrees that asset managers can run the risk of getting caught in a “tyranny of spreadsheets” despite the work not being that complex. Very quickly an asset manager could be forced to manage reams and reams of data or be left scuppered when a manager decides to leave the company, he says.
Higgins sees many hedge funds falling into what he calls the “spreadsheet trap”, optimising only for short-term gain. For Collier, the spreadsheet trap is prevented through culture.
“Man Group does not operate like that. It's not a silo culture, it's very much one where collaboration and openness is championed. It's a good thing that people are free to share ideas, and to talk about the things that they're working on,” he says.
“We are more sophisticated and want to build a sustainable long-term business and technology platform, and don’t want to be slowing things down or be turning systems off just because the one individual managing it has left.”