Vendors Pioneer Hosting Channels and Open Source Alternatives
Innovations in hedge fund operations are emerging as vendors roll out new hosting channels for key services and an Open Source coding alternative becomes available at a time when investors want firms to get serious about middle and back office support.
Drawing upon their years in the hedge fund industry, the founders of the recently launched Alpha Cooperative see that concerns over operations, workflows and IT infrastructures are on a par with investors’ demands for returns. But hedge funds just starting out are not likely to have the resources to develop an infrastructure, says Sara Malak, chief compliance officer (CCO) and co-founder of the Alpha Cooperative, which is staffed with industry veterans that have worked for many hedge funds. The new service launched on March 1 of this year.
“We found it challenging to build out what investors were looking for and still be able to maintain that structure at a cost that was efficient to our business,” Malak says. “With all the upcoming regulatory changes, we found it became more and more difficult for smaller managers to handle the regulatory requirements and also the increased investor demand for institutional operations.”
To better serve small-to-medium sized firms, the Alpha Cooperative has developed two platforms—one is an outsourced service that offers an all-in-one approach that includes accounting, operations, compliance, investor relations and independent risk management.
“We’ve created a fiduciary platform for managers who are looking for more of an in-source solution,” Malak says. “In that solution, we become the investment manager to the fund and we share co-fiduciary liability to the investor. It really depends on the manager and where it is in its growth phase.”
In the meantime, the Alpha Cooperative has announced this week that it has chosen Linedata to provide infrastructure support via the Beauchamp portfolio management solution and the Mshare investor accounting solution. Linedata will host the software in its data center.
“With all the changes in hedge funds, Linedata understood immediately what it is we are trying to accomplish,” Malak says. “We like the straight through processing that they offer from the Beauchamp system into Mshares, which we’ll be using to shadow the NAVs produced by the administrator.” Firms can use the Beauchamp system to reconcile their clients’ positions, search for trade breaks and reconcile Alpha positions with prime brokers and fund administrators.
The Alpha Cooperative reviewed several vendors although Malak declines to identify them.
“We are definitely settled on Linedata for the portfolio management system but there’s always something new coming up so we of course want to see what’s out there,” Malak adds.
Jack Wiener,
executive vice president,
Linedata
For Linedata, it gets a new client and an indirect channel to customers that will be growing, which increases Linedata’s overall footprint at the Alpha Cooperative, explains Jack Wiener, executive vice president for Linedata in North America. Without systems like Linedata’s, small hedge funds will try to get by via spreadsheets and fund administrators. “But spreadsheets don’t have audit trails or accountability,” Wiener says.
Executives at hedge fund start-ups try to do too much and that wears thin especially when it comes to IT and operations, Malak adds. “I’ve worked at emerging, small hedge funds in the past and no matter how good you are as the trifecta, C-level job—the CFC, CCO and COO— you are all three,” she says. “No matter how good you are, you are still only one person.”
The key problem with squeezing so much into one role is that one individual may not be able to maintain the checks and balances required.
“Though many are good at it, it becomes challenging to attract investor capital, because even though you’re doing everything a larger firm does, you’re still the only one doing it,” Malak says. “I think this will remain a challenge unless there’s an outside-of-the-box thinking about how to get your institutional infrastructure up and running.”
By using a third party arrangement, firms will be able to show investors that they have a support system in place for their middle and back office operations.
“A few years ago, pre-2008, hedge funds, in general, didn’t worry about operations—it got done but it wasn’t a focus as it pertains to getting investors,” Wiener says. “All that mattered was getting returns. Today, that doesn’t cut it.”
Investors’ demands have led to “the institutionalization of the hedge fund space,” Wiener says.
Toward that end, Linedata and the Alpha Cooperative will be “winding down over the next week or two,” the implementation phase of their partnership, Wiener says. “And then the Alpha Cooperative will start bringing clients onto the platform.”
While the Alpha Cooperative has two confirmed clients, approximately 40 firms are waiting in the wings to give the service a try, Malak says.
Another vendor aiming to provide institutional-level services to hedge funds is AcadiaSoft, which offers a hosted approach to margin automation. The vendor hopes to lure hedge funds to its MarginSphere service and has recently secured the support of Barclays, BofA Merrill Lynch, Credit Suisse and Morgan Stanley.
“We found it challenging to build out what investors were looking for and still be able to maintain that structure at a cost that was efficient to our business. With all the upcoming regulatory changes, we found it became more and more difficult for smaller managers to handle the regulatory requirements and also the increased investor demand for institutional operations.”
—Sara Malak, CCO of the Alpha Cooperative
The limitations of manual margining have become acute as regulators reform the over-the-counter (OTC) derivatives market, says Chris Walsh, chief operating officer (COO) at AcadiaSoft, based in Pembroke, Mass.
In general, the manual process for margin calls starts with an email indicating what a firm’s trade exposure is, Walsh says. For instance, a firm could have $190 million of collateral for an exposure of $200 million, which would mean a $10 million shortage. A counterparty such as a large bank would have to send a margin call for $10 million, which would have to be compared against a hedge fund’s understanding of its exposure. If there’s a dispute, a lengthy, error-prone manual process is likely to ensue.
“MarginSphere automates that entire process,” Walsh says.
The hosted service plugs directly into clients’ internal systems so that when exposures are calculated, calls are automatically arranged; exposures can be matched on a real-time basis. Areas of agreement can be found quickly so that both parties can focus on the disputed amounts.
“For these major banks, we’re not talking about hundreds of calls that are being sent out, it’s thousands of calls,” Walsh says. “Those calls are tens of millions of dollars in terms of the amounts of exposure. The amount of capital being managed today without MarginSphere but through email is enormous.”
To connect to MarginSphere, the vendor offers an open API, file-based integration and its portal; MarginSphere can also be integrated with major, third-party collateral management systems.
“We’ve helped clients with our integration service bureau without them having to involve their IT,” Walsh says. “We’re supporting that integration ourselves by using the existing information standards they have in their operations.”
As the OTC reforms take hold, hedge funds will need efficient risk management across their margining and collateral management operations especially as the reforms require them to do so at a higher frequency. The key is to do it without incurring more costs, Walsh says. “MarginSphere is a portal for all margin calls for both cleared and OTC calls,” he says. “All that additional complexity really drives the need for automation and electrification of this process.”
The Open Source movement may be another way firms can achieve cost-effective operational support.
Earlier this week, “the first open-source analytics and risk management platform” for financial services firms was released by OpenGamma, a London-based company founded in 2009. The flagship offering, the OpenGamma Platform, targets front-office traders, quants and risk managers in a bid to unify the calculation of analytics across traditional trading and risk management boundaries.
“A few years ago, pre-2008, hedge funds, in general, didn’t worry about operations—it got done but it wasn’t a focus as it pertains to getting investors. All that mattered was getting returns. Today, that doesn’t cut it.”
— Jack Wiener, EVP for Linedata in North America
The OpenGamma Platform 1.0 offers an open architecture that lets users customize the code, integrate it with legacy systems and applications, and modify source code in real-time. The platform also has a Universal Calculation Engine for real-time and batch risk management computations, a library of analytics and extensive market data support and trade data management capabilities, officials say.
The new platform also provides:
- An Open Source Bloomberg module that enables users with a valid Bloomberg terminal or Server API instance the ability to directly access Bloomberg data from within the OpenGamma Platform. The module loads reference data for exchange-traded securities and includes time series loading and updating capabilities as well as real-time streaming data support
- A Web User Interface (WebUI) that lets firms view market and trade data from multiple live sources and integrate security time series data into security views.
- The R integration module for manipulating market data at a variety of levels for customized securities and portfolios
- Customizable database masters that cover inflation products, equity variance swaps, FX futures and digital FX options. The masters enable users to customize metadata on portfolios, positions, trades and securities.
Using Open Source code has a bottom-line and operational efficiency appeal for the middle office, says Kirk Wylie, founder and CEO of OpenGamma. “What we’ve done is we’ve identified a horizontal technology within a vertical, which is financial services,” he says.
For hedge funds, the platform offers quick access to ad-hoc and pre-trade analysis, live risk and analytics, and batch and overnight risk reporting that’s linked to legacy data sources, financial analytics libraries, trading systems and multiple market data feeds. The new platform lets customers obtain approximately 85% of what they need for common tasks that do not constitute a competitive advantage.
“Ultimately, what OpenGamma does is plumbing,” Wylie says. “It’s very sophisticated plumbing, very state-of-the-art and very domain specific. But, at the end of the day, nobody gets a strategic advantage out of calculating a VAR number or out of a better security master.” Firms are going to build those strategic advantages on their own, he says.
The greater goal is for end-users to replace the silos that have grown up around middle office functions. “Our job is to say that the traditional silos between a risk technology stack and a trading analytics stack are really artificial,” says Wylie, who acknowledges the history that caused these silos.
“If you roll the clock back 10 to 20 years ago, you had traders that wanted specific tools that were often intraday and live, specifically around trade selection and security universe monitoring,” Wylie says. “Separately, you had your risk guys in the middle office that wanted VaR numbers and daily reports.”
This resulted in different budgets and thought processes and thus autonomous technology stacks.
“If you have one tech stack, one platform that is capable of handling both sides simultaneously, now all of a sudden you’re in an ideal world where the number that the trader sees before he executes the trade is guaranteed to be consistent with the number that the risk manager sees the day after,” Wylie says. “That’s a beautiful world from a reconciliation perspective because there’s no more arguing back and forth over whose number is correct.”
Having the same IT stack should ease reconciliation. “You’re in a front-to-middle office reconciliation-free world,” Wylie says. “That’s the exact goal of our early customers.”
Another goal of OpenGamma’s customers is a streamlining of trading tools, Wylie says. One customer had an external service that produced overnight numbers for the middle office risk managers that never matched up and nobody ever trusted the other side’s numbers, he says. “We’re giving them a single infrastructure that cuts out the external service, which is a clear win from an ROI perspective.”
In addition, OpenGamma enlists the domain expertise of its customers via access to comprehensive support services, including public, community-driven forums to confidential support and consulting services.
While sharing is caring in the Open Source world, OpenGamma customers are not required to give back.
“If we never get a source code contribution from one of our commercial customers, that is entirely fine,” Wylie says. “They’re contributing through their domain expertise and through their funding of the company. That’s a very good contribution in its own right.”
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