Zombie Hedge Funds & Tech's Dual Role

Don't get me wrong, I don't have anything against the erstwhile Zombie/Vampire craze that swept through American culture a few years ago. I didn't much buy into it, though. I tried to watch an episode of The Walking Dead once, and that was the extent of my effort. Mercifully, we're beginning to see the end of it. I think.

Sadly, though just as naturally, the same can't be said for zombie hedge funds.

As I began working with one London-based spinoff manager, Kola Capital, on a piece examining their initial technology investment this week, I was surprised to learn in my research that new funds are statistically about as likely to fail in the first three years as new restaurants. The numbers on this issue vary tremendously — but some studies wager as high as 80 to 90 percent don't make it through.

Now, even if those numbers reflect reality, there are a lot of different reasons hedge funds might cease to exist. Not all of them have to do with a misinformed or poorly-timed investment thesis.

The way they're legally structured, their founders' individual interests, and indeed the fund's collective purpose (which could well be temporary) all come into play. I suspect that a meaningful number of funds wind down and disappear off the books for reasons other than performance.

Still, if you want to establish a shop of your own for the long haul, a legacy of sorts, and have a better shot of doing so by opening a Taco Bell franchise than a hedge fund, obviously that's an interesting phenomenon.

When Things Go Wrong

At Waters we're generally interested in understanding how to do things right with technology; in fact, tech is often the replacement for doing something "wrong". But just the same, we should probably do more looking into what happens when good technology intentions go horribly sideways.

For instance, though we rarely hear about it, I'm sure there are cases of hedge fund startups that furnish their entire operations from day one — including trading technology — as if they're Bridgewater Associates or Citadel, and ultimately torpedo themselves as a result with cost centers their fees can't cover or investors refuse to sustain. Maybe not the only factor, but in the least, it's a contributing element in their demise.

This is a relevant question for vendors in the space, too. Almost every buy-side provider will say they would prefer a user who is successful over time, scaling services up and paying less for a lighter system at first, than one that takes on a huge (relative) outlay from the outset and then promptly crashes. Zombies don't make good clients, in other words.

But let's be honest: there's a lot of grey area here, and vendor sales teams are there to lock you into spending money. As I overheard two fund managers saying at a conference once, "you have to be careful" with a certain large tech provider that will remain unnamed. "They'll pull you right in; they're monsters," one said.

There. I knew I could sneak in a vampire reference, too.

Crown Jewel?

So, it seems incredibly important to determine what's appropriate very early on and align technology needs with medium- and long-term objectives rather than jumping the shark.

Kola, which comes from SAC Capital background and set out to be multi-asset from the beginning, went with a beefier system in FinCAD's F3 for good reasons, though even they had trouble finding a sweet-spot solution. For their target level of sophistication, many of the choices were far too expensive.

It's a tricky problem, especially if you're trying to grow assets under management and attract outside capital. Those investors like to see lean operations on one hand, keeping costs of running the shop down. On the other hand, they also like strategy portability, demonstrated potential, and the ability to measure and visualize risk with elegance and pinpoint accuracy.

Stronger technology certainly exudes confidence. I'm sure some startups might even see it as a crown jewel of sorts — a sign of arrival. But it invariably costs a prettier, potentially lethal, penny. All in the life of a young fund, I suppose, where the best advice — just stay alive — is harder to do than it seems.

NATAS Tuesday!

Speaking of staying power (and not zombies), one of our longest-running conference events, the North American Trading Architecture Summit (NATAS), is next Tuesday at the Marriott Marquis on Times Square.

It promises to be a great kickoff to our conference season, as always, and though originally focused on the sell side, the buy side is firmly represented and has elbowed its way into much of the agenda.

For more information on topics and registration, click here.

Look forward to seeing many of you there!