Institutional Investor's Alpha Magazine - March 2008 - (Page 58) Outsourcing hardware or high-speed data communications networks. More-ambitious firms can develop highly customized outsourcing for their entire IT infrastructure, and algorithmic traders can easily dovetail with execution management systems at prime brokers. One of the most popular new strategies, though, is to use third-party vendors to host and maintain crucial trading-software applications. Part of the appeal of such an arrangement is that firms can cost-effectively exploit a technology, even it if means sacrificing any competitive advantage in that particular technology. That leaves fund managers, however, in the position of having to develop a systems-and-technology edge elsewhere. They may also have to consider developing systems that are better suited to their unique business needs than off-theshelf solutions. AM Investment Partners, a New York–based hedge fund with 22 employees and $900 million under management, is no stranger to this balancing act. When it opened shop in 2001, the firm lacked the resources — both staff and hardware — for a conventional deployment of the Imagine Software risk management system, which serves as a centralized screening process for the firm’s trades. “We started like a lot of hedge funds do: with three people in a room,” says Mark Friedman, a principal with the firm. AM Investment’s initial focus was on growing its two main funds — one devoted to convertible arbitrage, the other to volatility arbitrage. The fi rm also decided not to commit its limited technology prowess entirely to proprietary trading models. “We never tried to rebuild the Black-Scholes [option pricing] model to see if we could squeeze pennies out of it, because that’s not an efficient use of our time,” Friedman says. So for seven years, AM Investment has been using the Web-hosted version of Imagine’s risk management application and services, which is what much of the competition has been doing. But as the fi rm has grown, so has its IT staff, and AM Investment has developed its own order management applications, says John-Peter Lee, the fi rm’s chief technology officer. Internally crafted applications built by local freelance developers have helped the firm better manage transaction information — all of which flows to the Imagine platform, Lee explains. He says the homegrown applications also do a good job of splitting investment allocations according to the fi rm’s preferences. Part of striking the right balance is knowing when enough is enough. Lee says that AM Investment has been careful not to overdo its internal effort: “I think you can blow your cash on building these products and not have enough to go around for the rest of the operations of the hedge fund.” Lee adds that the opposite is also true. “To get your competitive edge, you have to at least build some of it — but not all of it,” he says. According to Lee, the firm has racked up $1 million in employee cost savings by outsourcing part of its order management applications. Photo by Chad Batka for Alpha “You can blow your cash on building these products and not have enough to go around for the rest of the operation,” says John-Peter Lee, chief technology officer for AM Investment Partners. ing company based in Beijing. The arrangement requires iSoftStone to assign what Lavelle calls its “most astute” developers to the Credaris account; in turn, Credaris teaches the iSoftStone team about credit markets. Hodges spent six months last year in China schooling seven developers on Credaris’s business and orchestrating efforts between iSoftStone and the in-house development team at Credaris. The diversion created a short-term dip in productivity whose brevity served as proof to Lavelle that hedge funds can benefit by taking a more active role in managing outsourcers to avoid the turnover and burnout that are often drawbacks of the process, which is pursued not only to save money but also because it can give a company expertise it wouldn’t otherwise have. He decided to take the common challenge of outsourcing to a foreign company — the time zone difference — and turn it into an opportunity by viewing the lag in hours as an extension of the workday. Credaris’s experience reflects the more aggressive approach that hedge funds are taking to outsourcing. Some of the new attitude can be attributed to funds’ typically being peopled by investment bank veterans who have high expectations of information technology. It’s also bolstered by Internet technologies and by vendor competition in a wider array of services and solutions than was available in the late 1980s and early ’90s, when outsourcing required a long-term commitment to a wholesale, one-size-fits-all agreement. In those days outsourcing often meant settling for work that wasn’t much better than what hedge funds could do in-house. Customization is the trend now. Today funds can pick and choose to suit their needs. They can start small and piecemeal, for example, by outsourcing just their telephone systems, data-center 58 • INSTITUTIONAL INVESTOR’S ALPHA • MARCH 2008
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