Unique Boutiques: Smaller Funds Demand Bespoke Tech
Boutique hedge funds are prime targets for third-party technology providers, but they have also become more complicated to win and to service, in part because their back-stories—and clients’ demands—are more diverse than ever. Tim Bourgaize Murray speaks with a quartet of recent fund founders and C-level executives about what they’ve needed, found, and didn’t find, in the process of building out.
When two of every animal was loaded onto Noah’s Ark, the hedge funds must have been left on shore. Not for lack of choices. If a hedge fund isn’t a mountain or tree or Greco-Roman god, it is probably an exotic beast of some kind. No, instead the reason is, even if they could somehow be identically monikered, no two funds are quite the same.
This is especially applicable to 2014. Beyond the diversity of trading strategies, asset classes pursued and geography among today’s new funds, there is the incredibly varied matter of their origin. Spin-offs and splits, mergers and novel distribution channels are becoming more common with regulations like the Volcker Rule and, indeed, “in-a-box” legal and technology services making it both necessary and easier to venture out on one’s own. That’s to say nothing of the fact that, despite many larger, established firms returning less-than-superior performance since the financial crisis, more institutional money continues to flow into the hedge funds, as this once-mysterious industry becomes more mainstream.
Where technology was once an afterthought, ignore it now at your own peril. More than regulators and their desire for operational transparency, and more even than the traders and portfolio managers who might be used to investment-bank grade technical tools and support on spec, a small hedge fund founder has someone else to be most worried about: potential investors’ due-diligence teams.
So, small is beautiful—and for technology providers, packed with profit potential. But small is also hard. To find out why, Waters spoke with executives at four boutique buy-side firms, each managing around $1 billion or less. One of them was born from two family offices; two others, meanwhile, come from the same parent firm: one, a commodity trading advisor (CTA), the other, a long–short equity shop. Two of the four are based in Texas. And yes, one of them is an animal.
While all four have very different ideas and priorities, their shared bottom line is simple: Where technology was once an afterthought, ignore it now at your own peril. More than regulators and their desire for operational transparency, and more even than the traders and portfolio managers who might be used to investment-bank grade technical tools and support on spec, a small hedge fund founder has someone else to be most worried about: potential investors’ due-diligence teams.
And what do those investors want? That depends on who you ask.
Make It Smart
It’s a measure of how far the hedge fund industry has come that firms like Israel Englander’s famed multi-asset giant Millennium Management have, in the past few years, produced numerous independent spinoffs, just as Julian Robertson’s famed Tiger Management led to several successful “Tiger Cubs” in the period after its closing in 2000. Millennium, of course, hasn’t shuttered in the process. Far from it.
One of those spin-offs, Adam Hoffman’s Houston-based Mada Group launched this year, is a CTA intensively focused on energy, agriculture, and metals futures. With that complex emphasis and a preference for separately managed accounts (SMAs), Hoffman says the question of managing technology to an effective level from the start was an easy one to answer, although less easy to implement.
“It was a very important question, especially for people who do not come from a technology background,” Hoffman says. “Since I started in the business building pricing, risk, and reporting models years ago, our team was able to lean on the refined risk and reporting models that were created and that have evolved over the years. Even at Millennium, we ran a parallel process to ensure that there were no errors, as one significant error in this game can put you out of business. Before we even thought about trading any instrument, we had to have the infrastructure in place to ensure that each position could be quickly accounted for with respect to not only static risk calculations such as value-at-risk, but also our own active and dynamic risk slide, which shocks the portfolio through a multi-variable process and gives our team a clearer picture of the real risk in our portfolio.”
To that end, the IT focus was on bringing over the management team’s unique position and profit-and-loss framework, and the firm tapped order/execution management system (OEMS) provider Liquid Holdings to help handle this and many of its middle-office capabilities. “Without disturbing our process, they were able to take our proprietary reports and use them as a template, so the transition was less cumbersome and time-consuming for everyone involved. When you are used to looking at a suite of reports for years, which display all relevant metrics of your trades, positions, and portfolios, switching to a different format while you are in the middle of building a business is not optimal,” Hoffman says.
Just as at Millennium, Mada additionally sought from day one to rely on multiple sets of “the truth,” but not simply because that is good industry practice. The firm checks its proprietary reports to ensure its positions and profit and loss (P&L) correspond with the reports generated from the Liquid platform. It’s a part of the process Hoffman insists upon.
“Those extra few minutes spent checking and rechecking could very well be the difference between life and death,” he says. “Because we’re a CTA, we have accounts across many futures commission merchants (FCMs). Trade allocation, risk and position reporting for each account are as important as the view from a global risk perspective for our team. That being said, from a due-diligence perspective, I think investors also, and should, demand that an independent third party is verifying position, P&L, and related metrics. Ten years ago, the costs of doing that were probably two to three times as much as they are now, so there is not much of an excuse to omit this function now.”
Make It Distributive
A little deeper into central Texas, friendly history, complementary talent and an alignment of mutual interests led two small shops, Austin’s Meritage Capital and Memphis’ Centennial Partners, to merge into one, which now manages approximately $1.1 billion.
The new iteration of Meritage, formed at the end of 2012 and originally founded in 2003 by former Dell CFO Tom Meredith and Dell Treasurer and Ventures head Alex Smith, has big aspirations, including a foray into liquid alternatives—which, for a firm its size, is almost unheard of—as well as continued funding of boutique long-short equity, credit and global macro strategies that have traditionally been the two firms’ separate strengths. Their first liquid alternative mutual fund strategy targets discretionary global macro and CTA managers. In constructing ‘liquid alts’, as they’re better known, Meritage president John McColskey says the firm has sought to outsource its distribution to bolster internal efforts. They have successfully been added to platforms like Schwab, Pershing, and SEI, with others in process – platforms that are important to independent registered investment advisors (RIAs). They will soon select a specialist external firm to assist with broader distribution to the RIA and independent broker-dealer community.
“Before the merger, Centennial was looking at this for a year,” McColskey says. “At a recent conference on liquid alternatives, I was seated in between BlackRock on my right and AllianceBernstein on my left; I was the gnat between two elephants. We believe larger firms create products for every conceivable market strategy. By contrast, our core focus allows us to create a great solution for the RIA community.”
Of course, to make a liquid alt product attractive, the performance must be there underneath, and that is where Smith says new approaches are also coming into play to compliment decades of investment experience.
“Firms like us are very aware of ‘group think’: just because you’ve allocated to ten different managers doesn’t mean you’re diversified,” he stresses. “So we pay a lot of attention to that, frankly less to what they say so much and more on what they do, through quantitative work and examining and understanding their portfolios.
"What we’re really looking at is developments in quantitative analysis beyond the traditional methods used in the investment field and the ability to efficiently analyze huge amounts of data," the CEO continues. "We use some traditional tools like Zephyr for allocation analytics as well as our own modeling to apply quantitative methods to our work to screen and monitor managers; the better screening we can do up front, the more efficient we’ll be. We are exploring quantitative capabilities further to even better inform our extensive qualitative methods. One example is advanced techniques to assist in our portfolio construction process—optimizing manager combinations, allocation size, and identifying factor sensitivities.”
Make It Efficient
Like Mada Group, Tiburon Capital Management—Tiburon is Spanish for shark—was born following chief investment officer Peter Lupoff’s brief stint as a portfolio manager at Millennium, in 2009. But unlike Mada, the event-driven specialist with about $40 million under management, hails allegiance to a single, specific trading paradigm—its Brace methodology, and has designed its technology relationships to match. That’s why even though Tiburon, too, uses Liquid, Lupoff’s perspective is somewhat different.
“Tiburon, as an RIA, has a best-execution obligation to clients, and as such our technological interfaces and trading and risk systems are essential in order to assure the most efficient execution, and adherence and pro-ration of securities among client accounts,” Lupoff explains. “Brace, Tiburon’s proprietary investment approach, requires that securities are cheap on an intrinsic basis if long, or rich if short. Effective trading technology with myriad means of expression and access to markets affords us the tools to express the view propounded by our investment world, utilizing that methodology.”
Although Lupoff says sound technology decisions can be a “narrowing factor” for potential investors, count him among the contrarian crowd arguing that technology can’t serve as a glossy substitute for hands-on experience. Building out from a box, in other words, has its limits—even for small firms.
“Investor due diligence is increasingly attentive to these areas, and prospective investors, particularly those making more influential allocations, pay much closer attention to technology, its efficiencies and its protections, than compliance and regulatory bodies do,” Lupoff says. “While technology can camouflage a shortcoming in operational and administrative experience, though, it is still a flaw. If there is one ‘benefit’ of maturity, it is that having been around hedge funds since 1990 and having helped influence the growth of other firms—most notably Third Avenue Funds—we are conversant in those aspects of investing. To this end, we are able to glean the benefits of technological enhancements, and not just use them as an artifice to hide a lack of experience or capability.”
Make It Secure
Indeed, hidden uncertainties are something funds and their providers would both like to disassociate from the process. With investors seeking more information about protection of infrastructure and data stewardship, even small shops are becoming more invested in understanding and scrutinizing the technology providers they work with. Marshall Terry, COO/CCO at South Ferry Capital Management, which “co-sources” most of its technology operations with Abacus, received that message earlier this year.
To that end, Terry has taken up a several months-long review of technology risk at the firm, choosing to do so with specialist consultancy Aponix, rather than considering other options like hiring an in-house CTO. “When we started using Abacus, the first year was about making sure we understood the flows and bugs in the system, tweaking it, and strengthening the working relationship. But after the Securities and Exchange Commission’s alert on cyber security in the spring, I’ve realized that my job now is to become aware of what our technology risk is, and become accountable for it,” he says.
South Ferry, launched in 2010, sits at about $200 million under management and therefore just qualifies for more extensive SEC oversight. Terry says it’s always been a “Catch 22” for small firms, which seek to grow their assets, but in order to do so must show institutional wherewithal. The difference is that this level has, in a few short years, been reset.
“We just needed to up our game, as we’ve become more cognizant of the magnitude of this,” Terry says. “Obviously, I trust Abacus and our other providers, but more than ever I need to know where their offering ends, where we begin, and any backfill we have to do. That can mean very small details, everything from USB ports—whether to disable or enable those—on vendors’ desktops to managing two levels of authentication for password resets and RSA token authentication, and processes for data deletion and decommissioning servers. What’s interesting is that in the age of cyber, a lot of these issues simply get put in that bucket, but the potential for technology risk spans well beyond that. Cyber has introduced more attention to those.”
It’s a challenge all four firms agree on—not only because of the well-understood nature of the threat, but because of the challenge and cost involved for a small shop to constantly test and retest its providers. Terry admits as much when he says the early work with Aponix, currently being undertaken, will likely prove the easiest.
“As we bring on new providers, tech risk has become a far more critical discussion up front,” he says. “They may have the best widget, but if I can’t understand what they’re doing with our data, it’s difficult to work with them. That’s going to be part of the final equation with Aponix, developing those standards. Can I be sure all our current vendors will fall on the right side of that equation? I can’t. In fact, what’s more likely to happen is finding some weaknesses both internal and external, and working with those vendors to figure out how to solve those. Building to that is a better story, and ultimately that’s what we need most as evidence for our investors. A clean story.”
Salient Points
New pushes by global regulators to separate proprietary trading from universal banks, as well as broader apprehension over traditional investments, have seen more boutique hedge funds launch and flourish in recent years, and with them has come increased diversity of operational requirements and priorities.
Just as these firms have sought to grow their assets or even new channels for distribution, potentially influential allocations from institutional investors have seen external due diligence standards and scrutiny rise across the board, from smarter trading tools to post-trade processing and infrastructural security.
As a result, small funds, which tend to rely heavily on outsourced technology, have come to expect more from their providers and are doing greater due diligence of their own, with particular focus on allocation and account management, the ability to expand to multi-asset trading, and technology risk assessment.
When two of every animal was loaded onto Noah’s Ark, the hedge funds must have been left on shore. Not for lack of choices. If a hedge fund isn’t a mountain or tree or Greco-Roman god, it is probably an exotic beast of some kind. No, instead the reason is, even if they could somehow be identically monikered, no two funds are quite the same.
This is especially applicable to 2014. Beyond the diversity of trading strategies, asset classes pursued and geography among today’s new funds, there is the incredibly varied matter of their origin. Spin-offs and splits, mergers and novel distribution channels are becoming more common with regulations like the Volcker Rule and, indeed, “in-a-box” legal and technology services making it both necessary and easier to venture out on one’s own. That’s to say nothing of the fact that, despite many larger, established firms returning less-than-superior performance since the financial crisis, more institutional money continues to flow into the hedge funds, as this once-mysterious industry becomes more mainstream.
Where technology was once an afterthought, ignore it now at your own peril. More than regulators and their desire for operational transparency, and more even than the traders and portfolio managers who might be used to investment-bank grade technical tools and support on spec, a small hedge fund founder has someone else to be most worried about: potential investors’ due-diligence teams.
So, small is beautiful—and for technology providers, packed with profit potential. But small is also hard. To find out why, Waters spoke with executives at four boutique buy-side firms, each managing around $1 billion or less. One of them was born from two family offices; two others, meanwhile, come from the same parent firm: one, a commodity trading advisor (CTA), the other, a long–short equity shop. Two of the four are based in Texas. And yes, one of them is an animal.
While all four have very different ideas and priorities, their shared bottom line is simple: Where technology was once an afterthought, ignore it now at your own peril. More than regulators and their desire for operational transparency, and more even than the traders and portfolio managers who might be used to investment-bank grade technical tools and support on spec, a small hedge fund founder has someone else to be most worried about: potential investors’ due-diligence teams.
And what do those investors want? That depends on who you ask.
Make It Smart
It’s a measure of how far the hedge fund industry has come that firms like Israel Englander’s famed multi-asset giant Millennium Management have, in the past few years, produced numerous independent spinoffs, just as Julian Robertson’s famed Tiger Management led to several successful “Tiger Cubs” in the period after its closing in 2000. Millennium, of course, hasn’t shuttered in the process. Far from it.
One of those spin-offs, Adam Hoffman’s Houston-based Mada Group launched this year, is a CTA intensively focused on energy, agriculture, and metals futures. With that complex emphasis and a preference for separately managed accounts (SMAs), Hoffman says the question of managing technology to an effective level from the start was an easy one to answer, although less easy to implement.
“It was a very important question, especially for people who do not come from a technology background,” Hoffman says. “Since I started in the business building pricing, risk, and reporting models years ago, our team was able to lean on the refined risk and reporting models that were created and that have evolved over the years. Even at Millennium, we ran a parallel process to ensure that there were no errors, as one significant error in this game can put you out of business. Before we even thought about trading any instrument, we had to have the infrastructure in place to ensure that each position could be quickly accounted for with respect to not only static risk calculations such as value-at-risk, but also our own active and dynamic risk slide, which shocks the portfolio through a multi-variable process and gives our team a clearer picture of the real risk in our portfolio.”
To that end, the IT focus was on bringing over the management team’s unique position and profit-and-loss framework, and the firm tapped order/execution management system (OEMS) provider Liquid Holdings to help handle this and many of its middle-office capabilities. “Without disturbing our process, they were able to take our proprietary reports and use them as a template, so the transition was less cumbersome and time-consuming for everyone involved. When you are used to looking at a suite of reports for years, which display all relevant metrics of your trades, positions, and portfolios, switching to a different format while you are in the middle of building a business is not optimal,” Hoffman says.
Just as at Millennium, Mada additionally sought from day one to rely on multiple sets of “the truth,” but not simply because that is good industry practice. The firm checks its proprietary reports to ensure its positions and profit and loss (P&L) correspond with the reports generated from the Liquid platform. It’s a part of the process Hoffman insists upon.
“Those extra few minutes spent checking and rechecking could very well be the difference between life and death,” he says. “Because we’re a CTA, we have accounts across many futures commission merchants (FCMs). Trade allocation, risk and position reporting for each account are as important as the view from a global risk perspective for our team. That being said, from a due-diligence perspective, I think investors also, and should, demand that an independent third party is verifying position, P&L, and related metrics. Ten years ago, the costs of doing that were probably two to three times as much as they are now, so there is not much of an excuse to omit this function now.”
Make It Distributive
A little deeper into central Texas, friendly history, complementary talent and an alignment of mutual interests led two small shops, Austin’s Meritage Capital and Memphis’ Centennial Partners, to merge into one, which now manages approximately $1.1 billion.
The new iteration of Meritage, formed at the end of 2012 and originally founded in 2003 by former Dell CFO Tom Meredith and Dell Treasurer and Ventures head Alex Smith, has big aspirations, including a foray into liquid alternatives—which, for a firm its size, is almost unheard of—as well as continued funding of boutique long-short equity, credit and global macro strategies that have traditionally been the two firms’ separate strengths. Their first liquid alternative mutual fund strategy targets discretionary global macro and CTA managers. In constructing ‘liquid alts’, as they’re better known, Meritage president John McColskey says the firm has sought to outsource its distribution to bolster internal efforts. They have successfully been added to platforms like Schwab, Pershing, and SEI, with others in process – platforms that are important to independent registered investment advisors (RIAs). They will soon select a specialist external firm to assist with broader distribution to the RIA and independent broker-dealer community.
“Before the merger, Centennial was looking at this for a year,” McColskey says. “At a recent conference on liquid alternatives, I was seated in between BlackRock on my right and AllianceBernstein on my left; I was the gnat between two elephants. We believe larger firms create products for every conceivable market strategy. By contrast, our core focus allows us to create a great solution for the RIA community.”
Of course, to make a liquid alt product attractive, the performance must be there underneath, and that is where Smith says new approaches are also coming into play to compliment decades of investment experience.
“Firms like us are very aware of ‘group think’: just because you’ve allocated to ten different managers doesn’t mean you’re diversified,” he stresses. “So we pay a lot of attention to that, frankly less to what they say so much and more on what they do, through quantitative work and examining and understanding their portfolios.
"What we’re really looking at is developments in quantitative analysis beyond the traditional methods used in the investment field and the ability to efficiently analyze huge amounts of data," the CEO continues. "We use some traditional tools like Zephyr for allocation analytics as well as our own modeling to apply quantitative methods to our work to screen and monitor managers; the better screening we can do up front, the more efficient we’ll be. We are exploring quantitative capabilities further to even better inform our extensive qualitative methods. One example is advanced techniques to assist in our portfolio construction process—optimizing manager combinations, allocation size, and identifying factor sensitivities.”
Make It Efficient
Like Mada Group, Tiburon Capital Management—Tiburon is Spanish for shark—was born following chief investment officer Peter Lupoff’s brief stint as a portfolio manager at Millennium, in 2009. But unlike Mada, the event-driven specialist with about $40 million under management, hails allegiance to a single, specific trading paradigm—its Brace methodology, and has designed its technology relationships to match. That’s why even though Tiburon, too, uses Liquid, Lupoff’s perspective is somewhat different.
“Tiburon, as an RIA, has a best-execution obligation to clients, and as such our technological interfaces and trading and risk systems are essential in order to assure the most efficient execution, and adherence and pro-ration of securities among client accounts,” Lupoff explains. “Brace, Tiburon’s proprietary investment approach, requires that securities are cheap on an intrinsic basis if long, or rich if short. Effective trading technology with myriad means of expression and access to markets affords us the tools to express the view propounded by our investment world, utilizing that methodology.”
Although Lupoff says sound technology decisions can be a “narrowing factor” for potential investors, count him among the contrarian crowd arguing that technology can’t serve as a glossy substitute for hands-on experience. Building out from a box, in other words, has its limits—even for small firms.
“Investor due diligence is increasingly attentive to these areas, and prospective investors, particularly those making more influential allocations, pay much closer attention to technology, its efficiencies and its protections, than compliance and regulatory bodies do,” Lupoff says. “While technology can camouflage a shortcoming in operational and administrative experience, though, it is still a flaw. If there is one ‘benefit’ of maturity, it is that having been around hedge funds since 1990 and having helped influence the growth of other firms—most notably Third Avenue Funds—we are conversant in those aspects of investing. To this end, we are able to glean the benefits of technological enhancements, and not just use them as an artifice to hide a lack of experience or capability.”
Make It Secure
Indeed, hidden uncertainties are something funds and their providers would both like to disassociate from the process. With investors seeking more information about protection of infrastructure and data stewardship, even small shops are becoming more invested in understanding and scrutinizing the technology providers they work with. Marshall Terry, COO/CCO at South Ferry Capital Management, which “co-sources” most of its technology operations with Abacus, received that message earlier this year.
To that end, Terry has taken up a several months-long review of technology risk at the firm, choosing to do so with specialist consultancy Aponix, rather than considering other options like hiring an in-house CTO. “When we started using Abacus, the first year was about making sure we understood the flows and bugs in the system, tweaking it, and strengthening the working relationship. But after the Securities and Exchange Commission’s alert on cyber security in the spring, I’ve realized that my job now is to become aware of what our technology risk is, and become accountable for it,” he says.
South Ferry, launched in 2010, sits at about $200 million under management and therefore just qualifies for more extensive SEC oversight. Terry says it’s always been a “Catch 22” for small firms, which seek to grow their assets, but in order to do so must show institutional wherewithal. The difference is that this level has, in a few short years, been reset.
“We just needed to up our game, as we’ve become more cognizant of the magnitude of this,” Terry says. “Obviously, I trust Abacus and our other providers, but more than ever I need to know where their offering ends, where we begin, and any backfill we have to do. That can mean very small details, everything from USB ports—whether to disable or enable those—on vendors’ desktops to managing two levels of authentication for password resets and RSA token authentication, and processes for data deletion and decommissioning servers. What’s interesting is that in the age of cyber, a lot of these issues simply get put in that bucket, but the potential for technology risk spans well beyond that. Cyber has introduced more attention to those.”
It’s a challenge all four firms agree on—not only because of the well-understood nature of the threat, but because of the challenge and cost involved for a small shop to constantly test and retest its providers. Terry admits as much when he says the early work with Aponix, currently being undertaken, will likely prove the easiest.
“As we bring on new providers, tech risk has become a far more critical discussion up front,” he says. “They may have the best widget, but if I can’t understand what they’re doing with our data, it’s difficult to work with them. That’s going to be part of the final equation with Aponix, developing those standards. Can I be sure all our current vendors will fall on the right side of that equation? I can’t. In fact, what’s more likely to happen is finding some weaknesses both internal and external, and working with those vendors to figure out how to solve those. Building to that is a better story, and ultimately that’s what we need most as evidence for our investors. A clean story.”
Salient Points
New pushes by global regulators to separate proprietary trading from universal banks, as well as broader apprehension over traditional investments, have seen more boutique hedge funds launch and flourish in recent years, and with them has come increased diversity of operational requirements and priorities.
Just as these firms have sought to grow their assets or even new channels for distribution, potentially influential allocations from institutional investors have seen external due diligence standards and scrutiny rise across the board, from smarter trading tools to post-trade processing and infrastructural security.
As a result, small funds, which tend to rely heavily on outsourced technology, have come to expect more from their providers and are doing greater due diligence of their own, with particular focus on allocation and account management, the ability to expand to multi-asset trading, and technology risk assessment.
comments powered by Disqus