Physical vs Cloud

Having investigated the security and regulatory implications of using either a third-party data storage provider or keeping data in-house, the report’s second section covers physical and cloud-based uptake as it stands within the hedge fund industry. We investigate the combinations of cloud and physical data centre solutions that managers are using, the various merits of each type, and the factors managers consider when making business decisions around data storage.
October 2017

Report Overview

Which models are managers using?

There was general agreement among interviewees that quantitative managers would have a much greater need for ‘compute’ than purely discretionary shops. This was borne out by the data. As seen in Exhibit 2.1, our survey of hedge fund technology professionals found that quantitative firms were far more likely to use both on-site and off-site physical data centres (75%) than discretionary managers (30%). In addition, they were more likely to use all three types (on-site, off-site and the cloud) at once (35%) than discretionary firms (17%), also suggesting a greater need for a range of functionality among the former. Discretionary managers, meanwhile, were more likely to use only the cloud for their data storage needs (17%) than quantitative managers (5%).

The most common combination of the three types among quantitative managers was on-site and off-site centre without the cloud (40%), and the most common among discretionary was on-site racks and the cloud without an off-site centre (27%). However, the proportions of discretionary managers using all combinations of storage solutions were fairly consistent (with the exception of ‘just on-site’).

Emerging managers seek the cloud

Additional insights were gleaned by slicing the data by the date the respondent’s management firm was formed. The survey results showed a pattern of greater cloud adoption among more recently established managers, with 26% of hedge funds firms founded since the 2008 financial crisis utilising only a cloud-based solution, versus 3% of those established prior to 2008. Whilst this may simply be a case of firms founded prior to the crash employing legacy IT systems, a recent report by HSBC Private Bank found that younger entrepreneurs were more likely to invest in technology than the over-50’s and had higher turnover in their businesses to boot. In this respect, older executives currently re-evaluating their firm’s data storage requirements, should be mindful of a potential bias against adopting new technology such as the cloud to ensure they remain ahead of the game.

Key considerations – a cultural shift

The combination of physical and cloud-based storage solutions depends, in part, on a firm’s longevity, trading style and the age of its principals. But ultimately, a cultural shift has ensured that managers generally have grown more comfortable with third-party data storage solutions. Indeed, the results of our survey suggest managers now view physical data centres and cloud solutions in much the same way. The top three considerations among respondents when a cloud or physical data centre were identical: 1) security features, 2) reputation of provider, and 3) total cost (Exhibits 2.2 and 2.3).

Security features

The security of the cloud as a concept is a well-worn topic and concerns have been largely assuaged. The COO of one medium-sized manager, that stores all data in the cloud, said that when the firm started out it was the “received wisdom” that the cloud was less secure, whereas now investors and managers are more comfortable with the notion of storing data there. The security of third-party data centres, however, has been less widely covered. The following are three tips from and for managers regarding due diligence of physical data centres:

i) Check the centre’s claims

Verify all claims made by data centre providers in relation to their security and infrastructure. As one US-based CTO said, assessing a new vendor, including a cloud provider, should be a thorough process, documenting everything, including “reasons and the references”. The head of IT at one manager with more than $1bn in AuM spent over 30 hours in a single weekend inspecting their data centre. Another CTO said that upon visiting various data centres many of their claims did not stack up, with one centre purporting to be a ‘Faraday cage’, an enclosure protecting against electromagnetic fields, while running power cables out the main door to the facility, nullifying the protective effect.

ii) Check the centre’s heritage

Look into the heritage of an estate housing a data centre. Many have not been purpose built to house servers and instead have been retrofitted after serving other functions, including as television studios, mines and nuclear fall-out shelters among others. Several interviewees lauded the exceptional communication links and infrastructure of these centres and indicated that they were often better value for money than purpose built facilities. Others indicated the structures of such buildings are sometimes ill-suited to the needs of a modern data centre and occasionally suffer from legacy issues, making careful inspection essential.

iii) Check the centre’s clients

Where possible, learn the identities of other firms and organisations housing their servers in a particular data centre. One CTO interviewed indicated that if a public body, such as the National Health Service (NHS) in the United Kingdom, was in a particular location one could be fairly confident in its security, as the NHS would not risk patient data. This may also offer an insight into the type of clientele the centre is trying to attract, creating potential negotiating opportunities at centres focusing on financial services (this will be discussed further later in this section).

Provider reputation

Many CTOs and COOs interviewed emphasised the importance of firm reputation when choosing a data storage provider. One CTO interviewed by the team said: “You can consume anything as a service when you have a good partner.” Several interviewees admitted that using a recognised brand for data storage helped smooth conversations with their internal compliance team and investors.

Rise of the public cloud

Among survey respondents, the top three providers for data storage solutions were Amazon Web Services, 25%, Microsoft Azure, 23% and Equinix, 18% (Exhibit 2.4). The concerns managers used to have about the public cloud are starting to dissipate and more managers – smaller firms typically – are using them for their ‘pay-as-you-go’ cost benefits and comforting brand names.

One concern managers did raise, however, was the reduced service levels that come with a cheaper, public cloud service – service level was the fourth most important consideration for survey respondents when choosing a cloud provider. One public cloud provider quotes $200 per calendar month for a response time of up to 48 hours to any technical issues – if a manager wants to reduce that lag to 15 minutes the price rises to $15k per month; $180k per year. For this price, a manager could employ another engineer on his team (although the cloud service would never be late or call in sick). Private clouds, meanwhile, can prove even more costly, but offer managers a bespoke service tailored to their needs and may prove more suitable for some managers as they scale up.

Total cost

For managers wishing to avoid a large one-off capital expense, a cloud-based solution seems the obvious choice. One London-based CTO described the cloud as “pay as you drink, as opposed to buying ten pints in one go.” A recent report from RightScale and Enterprise Management Associates found various means of bringing down the cost of a cloud solution, with ‘collaboration within a firm’ coming top. Other suggestions included: the automation of application deployment and the implementation of containers; the installation of a “centralised cost analytics dashboard”; monitoring access to various cloud services based on roles within the firm; and using internal data to analyse where efficiencies could be made.

Physical centres – a buyer’s market

But there is good news for managers looking to add capacity physically: the third-party data centre market is currently a buyer’s one. Of those survey respondents who utilised physical data centres the majority, almost 70%, employed two physical data centres, including their disaster recovery facility (Exhibit 2.5), with most firms finding it more cost efficient to add extra capacity in existing locations rather than expanding elsewhere. And it’s not hard to see why. As one data storage consultant interviewed explained, many data centres are looking to gain a toehold in certain markets, such as the financial services industry, by bringing on board a marquee client. Managers can use the other firms in a data centre to gauge the opportunity to use their own brand to barter. Concessions managers could win from data centre firms currently include:

i) Removal of penalty clauses – managers may be able to negotiate the terms of their contract depending on the amount of business they are bringing in or the prestige of their brand

ii) ‘Hands and eyes’ – having a dedicated point of contact and member of staff looking after one’s server

iii) Price reductions – in a buyer’s market managers may be able to negotiate good old-fashioned price discounts for their rack space.

The consultant also said that prices vary widely, particularly at the lower end of the market where firms are only taking a small amount of rack space. It is here that data centres are making the big margins and CTOs should be cognisant of this in their dealings with the providers.

Other considerations

Location – too much drama?

Location was the fourth most important consideration for managers choosing a physical data centre provider, as cited by 34% of respondents to our survey (Exhibit 2.2). As was noted in the previous chapter, in London many CTOs abide by the so-called ‘M25 rule’, maintaining a presence in at least one data centre outside the motorway encircling the British capital. US-based CTOs follow a similar unwritten rule, with those firms headquartered in New York City often choosing locations such as New Jersey for their disaster recovery.

Many cited the ‘dirty bomb scenario’ as a key driver behind having a back-up facility located at a reasonable distance from one’s primary data centre. Yet others dismissed the idea, saying that if half of central London were taken out there would be bigger things to worry about than accessing one’s data centre. When this was put to one CTO he cautioned that even after 9/11 the markets were open and it was crucial to have access to all IT systems in order to be able to trade. As macabre as this may seem, it remains prudent to take into consideration even such extreme scenarios.

Expertise – who provides it?

A firm’s lack of resources and/or expertise was identified as a significant ‘cloud challenge’ by respondents to RightScale surveys in both 2016 and 2017, albeit with a reduction in the proportion of those concerned between the two (Exhibit 2.6). Just over 60% of our survey respondents had a designated CTO or head of IT, with larger firms (those with assets greater than $1bn) more likely to have a designated in-house IT lead than smaller firms, 87% versus 32%. Having a dedicated IT function in-house will not be an option for some smaller firms, making careful consideration of the various options a prudent step.

But external expertise is not cheap. Several managers complained about fees charged by ‘data centre brokerages’, typically close to 10% of first-year rental cost or 5% of the overall contract. Managers also claimed they found little value in the service provided by these firms, but the brokerages themselves insisted they could help clients achieve significant cost savings, find the optimum solution for their circumstances and advise on a range of issues, such as migration or service issues. A seasoned CTO who has been through the process of procuring space in a data centre will have little use for said services, but a COO at a small shop inexperienced in matters IT might do well to seek their advice.

Timely benefits ease old concerns

RightScale also asked respondents the greatest benefits they had derived from the cloud, with firms citing ‘faster access to infrastructure’ (62%), ‘greater scalability’ (61%) and ‘higher availability’ (51%) as the top three. Scalability was raised again and again during our interviews, with several interviewees lauding the flexibility of the ‘container’ system when building a cloud-based infrastructure.

The availability of bolt-on applications and tools within the cloud was the fifth most important consideration (23%). The ability to utilise said tools and integrate them seamlessly at a later stage seems a clear advantage of the cloud over physical data centres and the development of an online user community, with forums and other areas for discussion, enhances this aspect yet further. Number eight among the top ten benefits was the aforementioned move from capital expenditure to operational expenditure.

Shifting to the cloud

As noted, there has been a paradigm shift in recent years away from building in-house physical data centres towards outsourcing one’s storage requirements to third-party physical data centres and cloud-based systems. It seems this change is irrevocable, with one CTO interviewed telling us that it had been ten years since he had heard of anyone building anything in-house from scratch.

Given the huge improvements in security and accessibility and wider acceptance among investors, employing a cloud-based solution from the get go appears the obvious choice for any shop just starting out, while it seems highly likely that those not already doing so will look to transition to the cloud in the coming years. In the report’s third and final section we look at the principal challenges involved for firms moving across and what they can do to mitigate them.