A chat with Jason Topaz about the role of tech in hedge funds

Jason Topaz, the former CTO at hedge fund Horizon Asset International in Tokyo, talks to HFC boss Stefan Nilsson about the role of technology in the hedge fund industry. Prior to joining Horizon in 2009, Jason was Head of Technology at JD Capital and has previously worked at Azimuth Trust, Intelligent Markets and Long-Term Capital Management. The Harvard-educated Jason started his career at Goldman Sachs in 1993.

In your many years as CTO and tech/IT/programming roles at hedge funds, investment management firms and financial institutions, what has been the biggest technology-driven change you have seen in the industry?

It’s always tempting to point to specific technical changes, e.g. the increasing affordability of storage and fast computing resources, mobile technology, or the public cloud. These all truly are game-changers. However, I think they all contribute to a bigger theme that’s changed the fund industry, which is the democratisation of technology and data. It’s happening at two different levels. At an industry level, the playing field’s been levelled quite a bit between large firms with massive resources, going all the way down to startups. You see way more “hedge fund quality” third party software solutions provided by vendors, and that means small guys can benefit from economies of scale, sharing the R&D costs of some pretty fancy stuff with other firms. As another example, the public cloud’s “rental” model means that both small and large firms can be way more agile than before, avoiding long buildouts and capital expenditures. I helped out on a speculative project recently in which I estimated purchasing the equipment was likely in the hundred-thousand-dollar range, with at least a month needed for acquisition and setup. Instead, we threw it into the cloud with one of the big providers and had it running the same day. We managed to rack up a bill of only a few thousand dollars before we concluded the experimental system was not a fit for us and shut it down with very few tears shed! At a staff level, what’s happened is that really everybody has become technologists, to a degree. We’ve moved into a self-service world, with staff on just about any team you can imagine – trading, legal, middle office, HR – able to harness proprietary and market data and do some really snazzy analysis ranging from old-fashioned spreadsheets up to fancy interactive visualisations. With no help from the friendly neighbourhood IT guy needed. The technology team’s role, in many cases, is to “liberate” the data so the rest of the business can apply their analytical skills to it. This change is happening not just because of better tech tools, but also because of far better tech skill sets among professionals who are not full-time techies.

What are the big tech threats to fund managers’ operations? Is it cyber attacks or less sexy things such as systems going down and firms not being prepared for business continuity?

Stefan, it’s way less sexy than you even imagined! I think the biggest tech-related threat is becoming the compliance and legal implications of the way systems are run. The dizzying array of regulations, licensing and IP concerns, and other contractual issues – especially for a fund in multiple regulatory jurisdictions – is just starting to be recognised, I think. I don’t think there’s any such thing as a fund – despite their best intentions – that’s not at least accidentally in violation of something tech-related that could lead to serious financial, legal, or reputational risk. Staying on top of these issues is a cross-disciplinary problem. Technology leaders need to form great relationships across business units and departments, particularly compliance and legal, to achieve enough information sharing and mutual education to avoid pitfalls. Are your traders storing market data in a way that risks a million dollar fine by the exchange when they audit your systems? Has somebody on your IT infrastructure team pushed a button and moved backups of the firm’s books and records to a part of the cloud, without realising this needed a filing with a regulator? Or that it violates personal data handling regulations? There’s a growing minefield of risks that needs to be navigated.

Where is tech in the fund management industry heading? Will hedge funds become automated businesses driven by artificial intelligence and robo advisory services? Will humans still have a place in the investment process?

I think you’re spot on about the increased use of those tools. Still, humans still have a place for a long time. Let’s look at AI as an example, focusing on the subset that’s playing a bigger role in investment management: machine learning. I think people have realised that yes, part of what a great portfolio manager does is “pattern recognition”. They find something in the market that may be hard to spot for most people, they assume the outcome will be similar to the past, and they trade on that idea. Machine learning can be a great tool to help automate some of this. But it’s quite telling that a complete amateur like me, starting from scratch, can probably have a pretty useful machine learning environment up and running in the cloud within a few hours. The basic building blocks are getting commoditised. If you think machine learning gives you an edge, you’re going to increasingly find that edge only comes from how you apply it, not your mere ability to access the tech. And if this tech gets more pervasive and the IP arsenal of many firms grows, who knows – we may find crowding leads to shrinking profit opportunities to those focused on historical patterns. People who can generate new trading ideas, which is still – I believe – way beyond the reach of current AI technology, still will stay busy and don’t have to worry about computers taking away their jobs yet! Taking a slightly wider view – the point I mentioned earlier about democratisation means that technologists are going to find themselves spending a lot less time building very generic tools from the ground up. Instead, they’ll be learning to become experts on industry-standard solutions, focusing their time on customisations that differentiate their fund.

Is the CTO or CIO more important in a hedge fund today?

I’m going to answer based on my experience working in funds more on the discretionary side rather than the systematic side. And I’m also going to answer by looking at a fund as a product, built for customers. I’m going to have to give the prize to the Chief Investment Officer – but qualify that by saying that more than ever, the CIO’s own tech skills, and ability to work with the CTO to leverage technology, is critical. Look, in the end, a fund’s health mostly stems from its pattern of returns and the pool of capital it manages. I feel the CIO continues to be the “face” of the fund as seen by customers, and truly has the primary responsibility for the final decisions that lead to those returns, and retaining or growing that capital. But increasingly, it’s harder to harness opportunities without strong tech supporting the data and research, trading, and portfolio management needs. When the CIO assesses a new trading opportunity, the viability and profitability can sometimes actually hinge on the CTO’s ability to deliver the right tech, cost-efficiently, reliably, and quickly. And don’t forget the CTO’s own “portfolio”, so to speak, encompasses way more than just the alpha generation side of the business. There’s general office technology, back and middle office technology, cybersecurity, and a lot more. I’d argue the CTO may have a harder job than the CIO because of the sheer breadth, and the burden of managing not just part of the portfolio risk, but also the firm’s operational risk.