Institutional Investor's Alpha Magazine - December 2007/January 2008 - (Page 62)

“If you are really good and have a great algorithm, you can make your technology investment back in a second,” says Kevin Pleiter, IBM’s global ﬁnance section director. the moment new information is sent by an exchange to the moment the trading ﬁrm is able to execute a trade in response. “There is also a lot of technology innovation. No one has time to test it all.” The roster of companies pitching hardware to hedge funds ranges from marquee brand names like IBM Corp., Hewlett-Packard Co. and Intel Corp. to niche companies like Voltaire and Exegy. Hedge fund managers, particularly those running quantitative shops with billions in assets and high-volume trading strategies, are a prime target — and with good reason. Some large hedge fund ﬁ rms now rely on as many as 100 computer servers to manage their operations. And with innovation ongoing, ﬁrms ﬁnd themselves upgrading or replacing equipment as often as every 18 months. Though proﬁt-making opportunities for old-fashioned money managers who pattern themselves after the famously tech-challenged Warren Buffett still exist, operating without the latest hardware and software is becoming increasingly difﬁcult. As exchanges have gone electronic, the amount of data they transmit has mushroomed, pressuring hedge funds to invest in technology to absorb and analyze all the new information. TABB Group, a Westborough, Massachusetts–based research ﬁrm, estimates that the global equities and options mar- kets now generate more than 7 billion messages a day. TABB expects that number to rise more than 18-fold, to 128 billion, by the end of 2008, making it difﬁcult for fund managers to accurately and effectively monitor basic price quotes without extremely fast servers, chips and network switches. Increased speed and computing efﬁ ciency are the primary advantages of the newest hardware. A hedge fund can buy itself a few milliseconds in processing data — an edge that can translate to millions of dollars in additional proﬁts. “For a traditional asset manager, saving a millisecond is not worth spending a million dollars a month,” says Kevin McPartland, a senior research analyst at TABB. “But for a quant fund looking for a small arbitrage, saving a millisecond could well be worth the extra cost.” Andrew Lo, a ﬁnance professor at the Massachusetts Institute of Technology who serves as director of the school’s Laboratory for Financial Engineering, notes that hedge funds aren’t the largest potential customer group for companies like Intel that manufacture millions of chips. But, he says, with hedge fund ﬁrms’ deep pockets and insatiable appetite for the newest technology, they are an attractive client base, and it is not surprising that technology companies have been tailoring products to their needs. “This is an arms race,” says Lo, who also manages $550 million hedge fund AlphaSimplex Group. “If hardware costs $100,000 or $1 million, that’s irrelevant to hedge funds. What they care about is reliability. They will pay a lot to improve performance by even a small amount.” Lo estimates that the tech-at-any-cost players represent only 5 to 10 percent of the estimated 8,000 hedge funds operating today. They include some of the biggest and best-known managers — sophisticated firms like Citadel Investment Group, D.E. Shaw Group and Renaissance Technologies Corp. Still, smaller, less tech-oriented managers are also focusing more on improving their performance and operations by upgrading hardware. Systems can be made to run faster, deal with a higher volume of data and use less electricity — an important factor in a ﬁnancial center like New York, where sufﬁcient power availability is a concern. Hedge funds guard the information on how they are using hardware and the speciﬁc products they rely on as closely as they do their trading strategies. Although the technology they buy is readily available to anyone willing to spend the money, hedge funds have been known to hide the front of server stacks placed in co-location data centers near exchanges to prevent competitors from determining the brands and types of machines they are running. Jerry Levine, head of information technology at Greenwich, Connecticut–based AQR Capital Management, says the level of secrecy can be downright ridiculous. Levine was recently working on a new data center for AQR and trying to determine how to string com- 62 • INSTITUTIONAL INVESTOR’S ALPHA • DECEMBER 2007/JANUARY 2008 PHOTOGRAPH COURTESY OF IBM

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - December 2007/January 2008

Institutional Investor's Alpha Magazine - December 2007/January 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Liberal Returns The Good Guy: Inner-city MVP Cover Story: Marathon Men Interview: Rizk Management Profile: Living on Hostile Ground Profile: Buy and Hold In Theory: The Fallacy of Portable Alpha Strategies: Changing Course Alpha Bytes: Behind the Scenes Unhedged: Commentary: An Activist Alternative

Institutional Investor's Alpha Magazine - December 2007/January 2008

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