New York — Hedge fund spending on information technology will fall 20.5% this year—$1.35 billion compared to $1.7 billion in 2008, according to research firm Celent and reported by Chris Kentouris, Securities Industry News.

Due to deleveraging, losses caused by redemptions and pressure on fee structures, the “overarching theme of IT strategies in 2009 will be a focus on realizing efficiency wins from existing applications infrastructure while lowering maintenance costs, or at least keeping the status quo,” said Boston-based Celent in a new report. “Spending on new technology will take a back seat. Unless faced with a collapsing platform, large-scale system acquisitions or replacements are expected to be postponed.”

“Approaches to thinking about and using technology will be transformed,” said Isabel Schauerte, an analyst in Celent’s securities and investments group and author of the study. “Many of these changes will be transitory, some permanent. For the time being, cost-minimization and operational efficiency are at the top of the operational agenda.”

That approach differs from recent years, when hedge funds opted to replace systems to foster growth. The report, titled “Hedge Fund IT Spending: The Inevitable Contraction,” predicts that the cuts will be larger in Europe and Asia, given the poor performance of the funds in those regions.

The combination of high volatility, weakness in the credit and equity markets and liquidity problems has had disastrous effects on the hedge fund industry, said Celent. The HFRI Fund-Weighted Corporate Index declined 8.85% in the third quarter and 5.5% in September--the industry’s second-worst month on record.

While the worst may still be ahead, returns will eventually stabilize and investors will come back, according to the report. “Retrenchment is certain to be followed by reinvigorated spending,” said Schauerte. Though Celent doesn’t see spending turning around until the end of the year, “beginning in 2011, new investment spending is expected to accelerate as hedge funds embark on fresh IT projects related to business growth. By 2012, budgets will have returned to a solid growth pattern,” said the research firm, which projects that spending will hit $2 billion that year.

In the meantime, fund managers will continue to allocate money to risk analytics, risk monitoring and control, legal and compliance risk reporting, pricing and valuation, collateral management, liquidity risk management, performance measurement and attribution, and multi-prime broker platforms, said Celent. “Some of these priorities will be driven by investor demands, others by ‘de-risking’ efforts, an evolutionary regulatory environment, or the instruments/strategies used to generate alpha.”

According to Celent, risk management technology expenditures will likely be higher in Europe and Asia than the U.S., where increased institutionalization has already spurred hedge funds to make significant investments. In Europe, the need to quantify and manage key risks is also being driven by the implementation of the Basel II capital accords.

Liquidity management software will be an area of emphasis this year, according to the report. “One potential route to address liquidity risk is stress-testing,” said Celent. “Due to a lack of historical data, however, the use of historical value at risk for stress-testing should be complemented by [forward-looking] Monte Carlo testing. We believe that liquidity risk management systems incorporating such stress-testing tools will show particular traction with hedge fund firms.”

In the front office, spending on order management and execution management systems will be secondary, noted the eport, as firms struggle to survive. However, with the surge in volatility, hedge funds will look to improve execution capability through algorithmic trading and smart-order routing technology. In Europe in particular the introduction of the Markets in Financial Instruments Directive will continue to “drive demand for both algorithmic trading modules that enable traders to seek the best matches for order and smart-order routing, which enables traders to send orders to the best execution venue,” said Celent.

Source: Securities Industry News

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