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Hedge Funds Turn to Technology (September 8, 2006)

Location: New York
Author: Ellen J. Silverman
Date: Friday, September 8, 2006

Increasing exposure and regulation are forcing hedge funds to look to technology to increase operational efficiency. This is increasing opportunities for IT vendors for not only hedge funds but to service providers such as prime brokers and fund administrators.

Hedge funds globally will look to use technology to improve execution capability in the front office. In addition, service providers need to raise the bar too by offering enhanced reporting functionality and superior connectivity to clients.

Despite having a relatively poor year in 2004, the global hedge fund industry has rebounded strongly. The global market is expected to reach approximately $1.9 trillion in assets under management by 2009. Hedge funds are beginning to resemble traditional asset managers by placing cost control and efficiency higher in their priorities, as, there have also been numerous instances of funds collapsing due to the competitive pressures in the industry.

Moreover, the industry is facing increased levels of regulation. In the past, high net worth individuals dominated the investor base, pension funds and insurance companies have now begun to invest in hedge funds. In addition, new investment vehicles such as the emergence of fund of hedge funds provide a greater level of access to the hedge fund sector. Even though the US courts recently threw out the SEC's mandatory rule for hedge funds to register, regulation of the industry to protect investors is still expected to grow and to be determined on a country level.

In addition, the shift of the hedge fund industry into the retail space has prompted an increased focus on execution capability. The availability of real-time data to enhance the investment decision making process, direct market access and algorithms are all key areas hedge funds are beginning to focus on as they search for new trading opportunities.

Firms servicing the industry such as prime brokers and fund administrators are also beginning to suffer from competitive pressures. While traditionally offering custody, clearing and reporting functionality, prime brokers in particular are finding hedge funds demanding more in terms of supporting complex strategies from both a connectivity and operational aspect.

IT spending by prime brokers will be focused on the European and Asian regions in the next few years and it is estimated to reach $414 million and $194 million, respectively, by 2009. Brokers will attempt to enhance their margin and stock lending systems as well as upgrading settlement systems to process higher volume, more complex instruments being traded by hedge funds. Technology solutions will continue to be driven by the need to retain and capture client order flow. Fund administrators too will have to update their offerings and will be looking to technology to do this.

The technology in demand is a step on from solutions for the mutual fund industry by focusing more on how to provide a consolidated view to cater for the demands of each kind of investor. As the market develops, fund administrators will be pushed to offer customizable real-time reporting with web based user interfaces.

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