Hedge Funds to Prime Brokers: Fintech, Please

Terry Flanagan


Hedge funds need to access securities markets quickly, reliably and efficiently. The technology of their prime brokers is a key ingredient in making that happen.

“Folks are latency-sensitive, and beyond that they’re seeking other pools of liquidity and other execution sources, while trying to manage risk,” said Sean Trager, senior vice president at Wedbush Securities. “It’s the fintech tools that allow them to do so in a more competitive way.”

Prime brokers handle a lot of behind-the-scenes work for hedge funds: global custody, securities lending, financing, portfolio reporting and operational support. There are more than 10,000 hedge funds, each of which has its  own unique investing strategies, trading protocols, and technology needs.

Dellwood Capital is a long-short hedge fund that trades equities, options and exchange-traded funds. Peter Milman, portfolio manager, describes the firm as a high-volume shop with holding periods ranging from about 15 minutes to one week.

“Today’s market has evolved so much that if you’re not positioned to get fills and executions from the best routes and algos, you’re a step behind,” Milman said. “We’ve invested, and we’re willing to pay more in commission dollars for specialized custom routes that allow us to get the executions we need, as opposed to getting our orders front-run and not being able to get the execution quality that’s so important these days.”

“On top of that, it’s important to be able to assess your risk at all times, to be able to toggle and see all your positions in real time and stress-test your portfolio,” Milman added. “For example, if SPDRs were to do this or if interest rates were to do that, how would that affect my portfolio? This macro-type technology puts us in a good position to succeed.”

Peter Milman, Dellwood Capital

Peter Milman, Dellwood Capital

There is a price component to the value proposition of technology, especially in the currently challenged market environment where cost containment is mission-critical. A technology product can be ultra cutting-edge, but if it’s not affordable, it doesn’t add value because it will be like a car that sits in the showroom.

Equities Global Analytics, a proprietary trading shop with managed accounts, trades about 2 million shares per day. “What’s important for us is the price of direct market access, data and smart order routing, and the reliability of the connection,” said Michael Aksman, president.

Specifically, the New York-based firm looks for the best algorithms and analytics for routing orders, plus transaction cost analysis, at a reasonable price.

For registered investment advisor ArbitrOption Capital Management, connectivity is the prime consideration. “The most important thing to us is a wide range of different order management software solutions,” said Heath Winter, managing partner of the seven-year-old firm. “Ideally, we want (brokers) to have connections with everybody.”

“If we need to trade futures, for example, but the broker doesn’t have an OMS that can handle futures, then there’s no way for us to work together,” Winter said. “When it comes to financial technology and prime brokers, the OMS is my first concern.”

Winter noted that some prime brokers differentiate themselves via customized, high-quality trade reporting and risk management, but ArbitrOption generally builds rather than buys such products.

“Our approach is to rely on internally generated solutions for things like portfolio management, risk monitoring, return assessment, and identifying opportunities,” he said. “Technology from the broker comes in when we need to interact with the outside world, for example when we need to place orders, record executed orders, and keep track of orders that have not yet filled.”

Ultimately, fintech allows hedge funds to focus on their raison d’etre: generating investment returns with little correlation to the broader market.

“If you’re a hedge fund manager, you’re looking to save money and you’re looking to make money,” said Trager of Wedbush. “Having the proper technology in place allows you to do that.”

Previously in this series:

Featured image by bruno135_406/Adobe Stock

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