Smaller Hedge Funds Looking to New Tools to Better Manage Risk

An audience member asked: How do smaller and emerging hedge funds utilize technologies to compete with larger funds that have better risk management, data and people?

While speaking at Waters USA, Apollo Wong, chief risk officer at one of those relatively smaller funds—Verition Fund Management, a Greenwich-based multi-strategy firm that manages $1.2 billion—was quick to respond.

"I do not agree with that question," he said. "I do not know why everyone thinks that a smaller hedge fund would have smaller risk management versus the bigger funds."

He said that while smaller managers have a litany of challenges to overcome, and it's true that small funds fail all the time, from a risk management perspective, advancements in technology have vastly improved risk capabilities for these upstarts.

Katherine Macleod said she agreed with Wong, and that she was representing one of those large hedge funds: Senator Investment Group, which manages $13 billion.

She mentioned that for a firm paying to use Bloomberg Port, the data giant's multi-asset portfolio risk and analytics tool, things like factor-level sensitivities and attribution come included along with a vast amount of other risk measurements.

The real challenge facing firms when it comes to risk is the culture. You can have all the tools and metrics under the sun but if you ignore them or don't wrap them into the investment strategy, those numbers are useless.

"These conversations often come down to the culture of the firm and the willingness to translate the risk analytics into the investment process; that's what really makes the difference," Macleod said. "If I do an analysis the nicest thing my portfolio manager has ever said to me is, ‘It's exactly how it looks in my mind.' That means that what I'm looking at analytically is the same and we're speaking the same language, so we don't have to have difficult discussions about how the portfolio is trading."

Sonny Saksena, principal at Maihar Capital Strategies, which provides capital and advice to firms, noted that his firm has one programmer based in the Ukraine that can outperform 20 programmers based in the US. So you can find talent if you're willing to extend your reach past traditional IT hotbeds.

Additionally, cloud-based technologies have helped bring down the costs of previously expensive tools.

"The cost of computations, the cost of connections, the cost of storage and analysis have come down. There's been a leveling of the playing field," Saksena said. "You can build things today far more cheaply than what the funds that have been in existence for 10 to 20 years would have had to spend. The third-party tools are there; the databases are there; everything exists for a small hedge fund of two guys to knock the socks off of a fund with 50 people."

Still, scale and large budgets will always help the bigger firms. Vlad Khandros, global head of market structure and liquidity strategy at UBS Investment Bank, said that while the prices of some tools have decreased, more data and the ability to analyze that information has created more complexity, noise and false red flags.

He says that smaller firms should consider the number of broker relationships they have in order to create greater focus and efficiency.

"I'm still surprised by how long the broker lists are," Khandros said. "If I was on the buy side, I'd probably be placing my bets with a smaller broker just to try and get better allocation from them, because there's still a fair number of relatively small buy-side firms and they'll have dozens of brokers. Obviously, every broker has its own nuance, but's it's just surprising in general."