Prop Shop Question: Buy vs. Build?
Startups Struggle to Decide What Technology Must Be In-House
Traders Magazine Online News, June 15, 2012
When traders start their own firms, one of the first decisions they have to make about technology is what they want to build themselves and what they would rather buy from a vendor. That decision is becoming more common as the number of startups continues to rise, partly due to the Volcker Rule, which will require banks to cease proprietary trading.
The number of U.S. hedge funds increased 2.1 percent in 2010 and 3.1 percent in 2011, according to numbers from hedge fund tracker HFR. More than a thousand new funds launched last year, and industry watchers report a healthy number of launches for the beginning of 2012.
James Pinnington, head of hedge funds at the financial software company Misys, said some traders look for one central solution that can handle multiple operations, including trading, risk management and calculating profit and loss. Others pick and choose different systems, building some and going outside for others, and then plug them all together.
Regardless of which method a firm chooses, certain systems will always be proprietary, so even the technology they buy from vendors will generally have to be customized.
We find that when were going with a prop trading team, there is always an element of customization that we need to do in and around the product that enables them to mirror the competitive edge that they had when they were in the institution, Pinnington said.
It can take time to get used to managing all that technology, however, without institutional support. Once they start their own firms, prop traders generally cant just pick up a phone and have a world-class IT professional on call around the clock. Big banks have staff available to fix things that go wrong. A support staff isnt always available for small firms that build their own systems, which can be an argument in favor of hiring a vendor.
If you have a solution off the shelf, then you know that there are teams there to support them, and the managers are allowing themselves to focus on doing their job, trading, Pinnington said.
The trade-off with outsourcing, however, is that firms lose control. Most former prop traders want to make sure they have precisely what they need, which is why their inclination is usually to build rather than buy.
Dan Hubscher, industry marketing manager at Progress Software, said prop traders are wary of using the same technology their competitors are using. They want something better.
You can always go out and buy very quickly a packaged application with commodity algorithms, but theyre going to be the same as everybody elses, Hubscher said.
He added that some firms like to handle hardware installations in-house so they can put the physical technology where they want it to be from a latency perspective. Such do-it-yourself ingenuity can be a good thing, but traders should also be aware of their own limitations.
Steven Smith, co-founder of the financial software firm 4th Story, said former prop traders sometimes dont realize the extent of support they enjoyed when they were back at bulge bracket firms.
We run across a lot of folks who come out and want to do things themselves and think that they can quickly recreate all the depth of functionality that they had in the systems at the big banks, Smith said. Those banks had teams working over years to produce this for them. Theyre used to a certain level of support in the large firms, and sometimes they may not even realize how much support theyre getting.
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