Hedge Funds Embrace the Cloud, but Due Diligence is Still Key

Date: Wednesday, November 28, 2012
Author: Ahila Karan, ProHedge.co.uk

Nigel Someck, Director of PROHEDGE, spoke at Monday’s “Tech in the City” event in London about cloud computing and technology outsourcing for hedge funds. Technology providers believe the industry will fully embrace the cloud in time.

Is cloud computing a “no brainer”? The conclusion according to Someck is “yes – in specific situations. However, this does not remove the need for a robust due diligence and selection process for every system tender.”

The theme of sound due diligence was echoed in a subsequent panel discussion on cloud computing. Industry experts agree that  the cloud has many benefits; such as cost, deployment and maintenance, however it should not be adopted blindly without rigorous evaluation of every system.

For years, investor anxiety had stunted cloud adoption. Investor distrust in cloud security had restrained funds from entering the cloud, fearful of alienating potential clients. This stance couldn’t last long. As investor demands have grown, so has the operational burden on hedge fund managers that serve them. Cloud computing has allowed fund managers to bolster their offering and investors have acknowledged the benefits of this approach.

Service providers have been doing their bit as well to ease concerns about the cloud and respond to increased operational due diligence. Sufficient Business Continuity Planning (BCP) helps to consolidate cloud technologies and reinforce investor confidence, Andrew White, CEO of FundApps, warns “as an investor you should demand proof that systems are working. For example, demand for simulations of the data centre going down” and stress-tests. BCP should outline contingencies to potentially circumvent Hurricane Sandy style system collapses. Ambasuthan Jananayagam from Acumen Global Partners agrees: “when a provider goes down, you need an enrichment process to cross over to another system. You need a back-up”.

Although BCP signals credibility, White recommends additional investor pressure and vigilance. “Often managers are one step behind” so checks on stress-testing methodology and due diligence by investors has a knock-on effect of enhancing security. Simply relying on the BCP certification is not enough, “the vendor has to prove that it’s secure; does the service match up to what the BCP says?” The complacency of fund managers is a given, so whether a fund uses a cloud or not is irrelevant; investors themselves will always need to push for security.

Jananayagam, highlights additional investor concerns and points to the lack of data control as the biggest issue; “for many firms, data is more valuable than capital… lose control for one month and you will burn money in your account”. An Eze Castle survey finds 77% of respondents were discouraged by cloud platforms due to risk of unauthorised access. There have been cases where this concern has driven users away from the cloud. Someck provided an example of a large US hedge fund that opted for an in-house CRM solution which was five times more costly than its cloud equivalent. “Even though the chances of data loss are extremely low, the consequences of a security breach were so great that the additional expenditure was justified.”

Service providers have come up with a solution to combat this concern through “Private Clouds”. Nigel Kneafsey, provider of private cloud technology at Options Technology, believes they combine scalability from the cloud, with a control and security model akin to onsite technologies so the user enjoys the “best of both worlds”. “Investors also request data should not be shared in US facilities” in response to Patriot Act, so the “cloud is hosted locally, which gives investors greater comfort”. Companies providing the cloud service are developing a full proof service and giving hedge funds access to technology that would have otherwise been untenable; “it’s infrastructure built on a completely different scale than what hedge funds would have invested in… it’s our core business and we’re better at it”, Kneafsey explains.

The low cost nature of the cloud has appealed to funds facing rising regulatory and investor servicing costs. Fund managers are also avoiding the complexities surrounding integration by encouraging their service providers to work together. Certain processes require both old back office technology and new cloud systems to work together; the costs and complexities of integration discourage many fund managers. White however assures the “cloud is great for outsourcing, they provide APIs to integrate with back office systems. It’s an issue, but not a barrier.” Evidently cloud providers are increasingly on the pulse to provide solutions for emerging issues, and soon these issues will run out.

Kneafsey expects investors to also jump aboard as “more people who use cloud in their personal life are now more open to it”. Ultimately the widespread adoption of the cloud is happening at a very fast rate as service providers rapidly address end user concerns. Most industry commentators accept that it is only a matter of time before the majority of hedge fund technology is cloud-based.