Issue 60, August 2008
Order Management Systems
A Good Fit For Hedge Funds?
Hedge Funds can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any financial instrument where they see opportunity. Managing trades for hedge funds has created unique complexities that have challenged the capabilities of traditional order management systems (OMS). It is not news that OMS are deeply entrenched inside traditional asset management firms. What is not so obvious is how successful the traditional OMS have been, and will be, at meeting the demands of hedge funds. What are the challenges of supporting hedge fund trading and how effective are the OMS vendors in meeting the unique complexities of hedge funds?
When selecting an OMS, it is important to consider the differences between the various hedge fund strategies and their impact on workflows and trade processing. One determining factor is that hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options - they can use short selling, leverage, derivatives such as puts, calls, options, futures, and swaps. However, many vendor OMS solutions lack full support for derivatives, complex bonds, or leverage.
Below is a high-level analysis of some of the unique needs of hedge funds and how the major OMS vendors are loading up to deliver on those requirements:
Frequently Hedge funds must be able to associate a strategy with an order or group of orders and follow that link through the trading life cycle. OMS vendors typically support the ability to tag orders by strategy and report on them at an aggregate level. However, the ability to model and rebalance within a strategy or between strategies is not as well supported.
OMS vendors have always provided a "snapshot view" of current positions, typically loaded from an accounting system as of the previous day's close. However, some are now providing functionality for storing and retrieving archived or "as of" position records within the OMS.
Hedge fund managers are looking for functionality to restrict short sales as needed, identify and track borrow locate details, and have controls for trading through zero cases. Typically, the OMS vendors do an adequate job of tracking short positions and transactions, but this is an area to look at closely to ensure the OMS does not simply net short and long positions for reporting purposes.
Derivatives and complex assets
While some of the OMS vendors have made significant progress toward support of OTC derivatives, they still fall short of the specialty systems in several areas - valuation models, analytics, multi-legged deal entry, tracking deal terms, and look-through for composite securities. All of the OMS vendors are grappling with OTC derivatives support, and this will continue to be a major area of focus for them.
Profit and loss processing
The OMS products readily support intra-day P&L tracking for held positions. However, if the position is zeroed out during the day, the systems fall down. Also, the vendors lack sophistication when it comes to breaking down the components of P&L calculations - price movement, currency fluctuation, and cost of carry.
High volume, low latency trading
The OMS systems have suffered performance-related issues in the past but now most are running on re-architected platforms that support high volume trading and multiple allocations. In addition, they are offering their own execution management tools as well as integration with third party applications for direct market access, algorithmic trading, and transaction cost analysis.
The good news for the hedge fund manager looking to evaluate the current OMS space is that today's options are much improved over those available just a couple of years ago. Vendors are working diligently to meet the unique requirements of hedge funds and indeed, they have already made great strides. The bad news is that they have not completely met their mark. And as you might expect, some are better than others when it comes to delivering promised capabilities.