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Front offices must evolve to
achieve alpha in the passive era
Ed Gouldstone, COO for Northern Europe at Linedata Asset Management, outlines three areas where active
managers and hedge funds can deploy technology in the front-offices to achieve a market edge.
T
he prevailing narrative is that
active managers are becoming
obsolete amidst the seemingly
inexorable rise of passive investing.
Indeed, this existential threat has
grounds. The record-breaking bull
run and period of low or negative in-
terest rates have meant managers have
struggled to outperform market indi-
ces – stock-focused hedge funds on
average gained 13.7% last year, while
the S&P 500 climbed 29%, according
to Hedge Fund Research.
Signs active managers are losing
their edge have spurred investors to
pile vast sums into passive invest-
ment vehicles, with assets in US
index-based equity mutual funds and
ETFs outstripping active stock funds
for the first time in August last year.
However, active managers are
responding to the overriding pressure
to increase returns and realise that the
front-office must evolve. It’s becoming
ever clearer that deploying technology
in this area will be a decisive factor in
being able to continue to deliver value
to investors.
Beyond pursuing a more data-led
investment strategy, upgrading tech-
nology across front office operations
can deliver greater efficiencies and
unlock new opportunities, helping
managers to wring every last drop of
alpha out of each investment idea.
In my view, there are three key areas
where active managers can deploy
technology in their front-offices to
help achieve a market edge:
100 // TheTRADE // Spring 2020
Trade and compliance automation
Automation is fast becoming an
inextricable strategy for hedge fund
managers and the front office is no
exception. Trade automation through
machine learning enables firms to au-
tomatically match execution strategies
to order conditions and even tweak
orders in mid-flight, if necessary.
Furthermore, monitoring and other
support services are also becoming
increasingly automated. This not only
reduces the burden of reporting but
can also aid risk management and
prevent failures. Last month, the FCA
outlined its concerns that the uptake
in algo trading had led to widespread
market failures and flash crashes,
like the ones seen in 2010 and 2018.
However, this may be a rare instance
where it is possible to fight fire with
fire, and applying AI to compliance
and risk management may help im-
prove the health of financial markets.
Data visualisation
Trade automation, while maximising
potential, has also led to far greater
complexity in the daily lives of active
managers. It has enabled managers to
hold drastically more positions at any
given time and across a wider range
of asset classes. This far outweighs any
single manager’s ability to hold all this
detail in their head and to under-
stand the potential outcomes of each
investment.
Data visualisation tools and soft-
ware will therefore be vital for manag-
ers to continue to operate successfully.
These distil investment data into a
clear and digestible user interface,
giving managers a holistic under-
standing of their portfolios. This
enables managers to make informed
decisions with confidence, quickly
change investment strategy where
necessary and identify untapped
opportunities.
Cloud migration
Many sectors are already experiencing
the benefits and flexibility that comes
from moving to the public cloud.
While financial services in general,
and asset managers in particular, have
been slower to adopt cloud technol-
ogy, the industry is starting to make
the jump in full force.
The front-office of the future needs
to be far more agile and be able to in-
tegrate third-party capabilities which
more often than not are cloud-hosted.
External data inputs, research and
other applications need to be added
or integrated in modular fashion,
often using APIs. By adopting this ap-
proach, the front office can be quickly
adapted to traders’ needs, which may
shift suddenly according to market
developments. Digitalisation will
bring greater customisation and op-
timisation to increasingly tech-savvy
traders, who want to integrate the
best software and data into their
investment decision-making.