Peter Lankford runs a high-tech drag strip on Wall Street. As director of the Securities Technology Analysis Center, Lankford oversees a testing lab where technicians spend their days revving up the latest computer hardware aimed at the financial industry.
From the top floor of a building near the New York Stock Exchange, snaking cables link stacks of computer gear and STAC specialists run the newest hardware at top speeds in trading simulations. From computer chips to network switches, each device is clocked to see if it can deliver on performance claims. The goal: to give hedge funds, brokerage houses and other financial operations an independent analysis of the latest gear being hawked by vendors.
“There is tremendous pressure on banks and hedge funds to reduce latency, while handling much higher volumes,” says Lankford, referring to the elapsed time from the moment new information is sent by an exchange to the moment the trading firm is able to execute a trade in response. “There is also a lot of technology innovation. No one has time to test it all.”
The roster of companies pitching hardware to hedge funds ranges from marquee brand names like IBM Corp., Hewlett-Packard Co. and Intel Corp. to niche companies like Voltaire and Exegy. Hedge fund managers, particularly those running quantitative shops with billions in assets and high-volume trading strategies, are a prime target — and with good reason. Some large hedge fund firms now rely on as many as 100 computer servers to manage their operations. And with innovation ongoing, firms find themselves upgrading or replacing equipment as often as every 18 months.
Though profit-making opportunities for old-fashioned money managers who pattern themselves after the famously tech-challenged Warren Buffett still exist, operating without the latest hardware and software is becoming increasingly difficult. As exchanges have gone electronic, the amount of data they transmit has mushroomed, pressuring hedge funds to invest in technology to absorb and analyze all the new information. TABB Group, a Westborough, Massachusetts–based research firm, estimates that the global equities and options markets now generate more than 7 billion messages a day. TABB expects that number to rise more than 18-fold, to 128 billion, by the end of 2008, making it difficult for fund managers to accurately and effectively monitor basic price quotes without extremely fast servers, chips and network switches.
Increased speed and computing efficiency are the primary advantages of the newest hardware. A hedge fund can buy itself a few milliseconds in processing data — an edge that can translate to millions of dollars in additional profits.
“For a traditional asset manager, saving a millisecond is not worth spending a million dollars a month,” says Kevin McPartland, a senior research analyst at TABB. “But for a quant fund looking for a small arbitrage, saving a millisecond could well be worth the extra cost.”
Andrew Lo, a finance professor at the Massachusetts Institute of Technology who serves as director of the school’s Laboratory for Financial Engineering, notes that hedge funds aren’t the largest potential customer group for companies like Intel that manufacture millions of chips. But, he says, with hedge fund firms’ deep pockets and insatiable appetite for the newest technology, they are an attractive client base, and it is not surprising that technology companies have been tailoring products to their needs.
“This is an arms race,” says Lo, who also manages $550 million hedge fund AlphaSimplex Group. “If hardware costs $100,000 or $1 million, that’s irrelevant to hedge funds. What they care about is reliability. They will pay a lot to improve performance by even a small amount.”
Lo estimates that the tech-at-any-cost players represent only 5 to 10 percent of the estimated 8,000 hedge funds operating today. They include some of the biggest and best-known managers — sophisticated firms like Citadel Investment Group, D.E. Shaw Group and Renaissance Technologies Corp.
Still, smaller, less tech-oriented managers are also focusing more on improving their performance and operations by upgrading hardware. Systems can be made to run faster, deal with a higher volume of data and use less electricity — an important factor in a financial center like New York, where sufficient power availability is a concern.
Hedge funds guard the information on how they are using hardware and the specific products they rely on as closely as they do their trading strategies. Although the technology they buy is readily available to anyone willing to spend the money, hedge funds have been known to hide the front of server stacks placed in co-location data centers near exchanges to prevent competitors from determining the brands and types of machines they are running.
Jerry Levine, head of information technology at Greenwich, Connecticut–based AQR Capital Management, says the level of secrecy can be downright ridiculous. Levine was recently working on a new data center for AQR and trying to determine how to string communication cables under the floor. While pondering an underfloor tray system offered by a vendor, he learned of another Connecticut-based hedge fund that uses the system and contacted them to find out more about how their cables were set up. But he was told there was no way that they would let him near their data center, even to examine something as innocent as cable trays.
Such furtiveness is what spawned testing outfits like STAC, which is headquartered in Chicago. Though hedge funds won’t talk about the advantages of a particular piece of hardware, companies like STAC will. “The ones who are making tons of money on it aren’t telling anybody,” says Lankford, who founded the company in 2006 after a career in banking, software and information technology. “That is one of the reasons for our business. When vendors come to us to test their equipment, we are all about publicizing their technology breakthroughs.”
The results of a typical STAC test can be confounding. In December, the lab ran high-volume market data through HP blade servers — a collection of electronic circuits and processors on a thin, modular chassis that can be inserted into a larger rack — first on a common Ethernet network and then on a newer, potentially faster network technology called Infiniband, manufactured by Voltaire. The result: Voltaire’s product was faster.
Most hardware innovations these days focus on three areas: servers (the central processing units of computer operations), the computer chips that run those servers and the network technology that moves data. Computing work done on these systems includes various back-office accounting functions, as well as trading and market data analysis. Change is rapid in all three areas, and hedge funds are usually among the early adopters of any advances.
Patrick Guay, senior vice president of marketing for Voltaire, says financial firms have been using his company’s newer and faster network devices to improve back-office accounting functions and client services. But the application that draws the most interest is electronic trading and analysis, where added efficiency and speed can translate into profits that rapidly offset the cost of buying new equipment. “The return on investment on these solutions is incredibly short,” says Guay. “Recovery is not years or months; it is down to weeks and days.”
Kevin Pleiter, global finance section director for IBM, oversees the tech giant’s products and services aimed at hedge funds and financial companies. He says hedge funds represent a very diverse market when it comes to hardware. “There is a vast separation between firms,” he notes. Tech-savvy hedge funds doing high-volume trading are important customers for IBM’s latest servers, which promise faster computing capability.
“It gives you an opportunity to do things four or five times faster than the competition,” says Pleiter. “In theory, if you are really good and have a great algorithm, you can make your technology investment back in a second.” Of course, he notes, even the best technology can’t compensate for faulty financial judgment or operations: “If you have bad algorithms and poor execution, faster hardware could mean you actually lose money quicker.”
Hedge funds’ need for speed has led technology specialists to begin embedding heavily used software in the hardware, instead of running it separately — effectively eliminating a tiny step where information has to move from one location to another. A program that prices options can be encoded onto a computer chip to run automatically instead of as a separate software application. “You put it on a chip, and the information doesn’t have to go anywhere,” says TABB’s McPartland.
Advanced hardware can also be used to deal with extreme market gyrations that can swamp existing systems. This past summer’s market mayhem, and the record trading volumes that resulted, overloaded some brokers’ systems and caused backups in orders and trade executions. McPartland says some funds have since decided to build more capacity and faster systems to deal with volume spikes.
“The big concern is, Can these systems continue in worst-market conditions?” he adds. “That is what a lot of these newer solutions are promising. These new technologies have found ways to avoid and eliminate queuing.”
For fund managers, the trick to staying on top of the financial information explosion is being able to upgrade hardware as fast as technology companies turn out new products.
AQR’s Levine says his firm replaces its servers every two to three years to make sure it doesn’t fall behind, adding that the need for new hardware is not limited to its trading desks. Until recently, AQR’s accounting system was running on a system that took 20 hours to complete one particular series of updates. But new hardware Levine purchased included chips so fast that the same task now takes only 20 minutes. “It has made a huge difference in people’s lives,” he says.
With new hardware so complex and specialized and being developed so rapidly Lankford says there is no end in sight for STAC’s role as a testing center. In September, he established the STAC Benchmark Council, an industry group designed to define standard ways of measuring the performance of trading technologies. The group, which began with eight of STAC’s customers — primarily global brokerages — has quickly gained popularity. “In November we opened it up to technology vendors, and in about a month we went from zero to 21 vendors on the council,” Lankford says.
