The typical outsourcing drivers are no secret. Faster time-to-market, accelerated revenue generation and reduced IT expense are just a few well-known benefits. When it comes to today's buy-side firms, we can add 'necessity' to the list. As new sources of market data become available or a trading operation expands to support trading hours across the globe, off-the-shelf package vendors are notoriously slow to respond. Buy-side IT managers often have no choice but to build -- and fast.
Not to be outdone on the custom development front, many hedge funds are contracting specialist development shops to build out their own custom applications. Let's look at a leading European hedge fund with more than $8 billion USD in assets under management. (We can't name them -- sorry.) The fund managers needed a custom-built, comprehensive portfolio risk management and scenario analysis system to calculate risk exposure metrics across asset classes, including currencies, commodities and equities. They required a front-to-middle office integrated platform with an adaptive risk mitigation system that could provide model calculations.
To meet this need, the firm enlisted outside help to develop a Web-based application to calculate various portfolio risk measures like VaR (value at risk), as well as exposure for the different types of accounts it manages. The system also provides pre-trade risk modeling and approves recommended trades for each of the client's accounts. It can run back-tests on the current portfolios using an extensive array of historical market data and calculate the tracking error for each portfolio to ensure regulatory and contractual compliance. This functionality is crucial for the hedge fund operation, as per-account risk budgeting is a strict requirement by the firm's larger institutional clients.
The hedge fund is currently using the application to manage assets on behalf of some of the largest European pension funds, major asset management firms, and banking institutions.
While projects will vary based on a firm's specific needs, any custom-developed application must address the firm's immediate needs while also providing a scalable model that is able to grow as the firm and its solutions evolve. Buy-side firms typically look for platforms that can handle multiple functions simultaneously, so the end solution needs to be high-performing, flexible, adaptable and easy to navigate.
Let's look at another example -- again with no names. A prime brokerage recently needed a custom application to address issues they had with operations workflow. They were looking for an application that could handle valuation, cash flow calculations and accounting for equity swaps and TRS, but the program also needed to minimize errors and ensure data consistency.
By building in additional functionality, the brokerage will be able to integrate with swaps engines for cash flow model calculations, and with their order management system to import new long and short positions. It will also provide a detailed audit trail that contains a comprehensive backlog of all data fluctuations, deliver a consistently clear picture of the portfolio status at any moment, and offer the ability to predict future behaviors. This gives the brokerage an application that meets their immediate needs, but is powerful and flexible enough to handle their changing future requirements.
Because the buy side's development needs are so specific and tailored to individual trading strategies, it is vital that custom development shops have detailed market knowledge and a keen understanding of the particular needs and challenges that these firms face. A good development partner is just that -- a partner, rather than a vendor, who understands the business' goals and can make recommendations and suggestions that will ultimately make the final product more useful and enduring.
These sorts of partnerships will help accelerate the buy-side's technology revolution as they continue to leverage the newest and most innovative offerings to keep pace in today's dynamic markets.
Alexander Makeyenkov is senior vice president of capital markets at DataArt, a software development firm for the financial services industry.