Brokers and Vendors Launch More User Products and Services
The boom in program trading has sparked an arms race among the major technology suppliers. Already this year, three of the biggest providers of basket-trading systems have come out with new features and functionality. Spear, Leeds & Kellogg, a broker, has added pre-trade analysis and a sophisticated algorithm. InfoReach, a vendor, has added a pairs trading module. And Portware, also a vendor, announced an alliance with Lava Trading to offer smart routing and connectivity.
The rush to enhance these systems is driven by intense competition in the formerly cozy and arcane world of electronic basket executions. Where once Spear, Leeds and Investment Technology Group held sway, now at least ten firms are battling for market share. The surge comes as more buyside shops look to aggregate order flow, or more efficiently process their existing baskets.
Suppliers of program trading technology are split into two camps: vendors and specialty electronic brokers. The most prominent vendors are FlexTrade, Portware and InfoReach and Aegis Software. The brokers are Spear, Leeds, ITG, UNX, Instinet, Bloomberg, Belzberg and BNP Paribas.
The vendors license systems, installing the hardware and software on users' premises. The brokers act as service bureaus, giving customers access to the technology over telecommunications lines. The software and hardware remain on their premises while they charge per share.
Customers are do-it-yourselfers on both the buyside and the sellside who prefer to trade their own baskets instead of sending them to brokers' program desks. The traditional users are quantitative money managers, indexers, sellside program desks and sellside prop desks.
The growth of the hedge fund industry has introduced a new set of customers. Hedge funds, like the sellside prop desk, engage in such strategies as index arbitrage, merger arbitrage, and statistical arbitrage.
In the past few years, more plain vanilla money managers have turned to program trading to cut transaction costs. The advent of penny ticks made transacting blocks more difficult. The market downturn hurt performance.
Some are working their own orders, but a great many are asking brokers to do it for them. That has brokers of all stripes setting up program trading desks. That, in turn, has provided the technology suppliers with a new sales outlet.
In the race to offer the hottest functionality, ITG is clearly the name to beat, according to some pros. The aging specialty broker has long been known for some of the most sophisticated program trading technology on the Street. Its QuantEx system was considered the gold standard that allowed it to capture the buyside quant market.
Now, however, the rest of the pack has caught up. Much of what ITG offers has been replicated by its competitors. ITG's "client site" division has been hit hard. Last year, the group saw its revenues drop $34 million to $77 million.
Systems suppliers tend to split products into three or four modules, each geared to a different trading style. That way, traders only get the windows they need to conduct their strategies.
Spear, Leeds' TradeFactory, for example, gives users four overarching strategies from which to choose: index trading; spread trading; portfolio trading; and delta/gamma hedging. Portware divides its system into three parts: portfolio trading; prop/index trading and position management.
FlexTrade Flexes
FlexTrade, one of the early thorns in ITG's side, is now coming under pressure of its own. Three other vendors – Portware, InfoReach and Aegis- have sprung up in FlexTrade's wake, promising similar solutions at lower prices.
FlexTrade is not standing still. While some vendors prefer that customers write their own trading rules, FlexTrade realizes that many don't want to. Last fall, the vendor introduced a series of canned execution strategies.
"Firms with in-house programming staffs were [writing the rules] themselves," explained Vijya Kedia, FlexTrade's president, "but now even users who don't have on-staff programmers can simply fill in some parameters and start using it."
The new algorithms complement a set of pre-packaged portfolio strategies already built into the system. At the portfolio level, FlexTrade has strategies for pairs trading; index arb; risk arb and other strategies. The new algorithms deal with the nitty gritty of second-to-second execution strategy.
Traders have the choice of five execution strategies. Which one they use depends on their objectives. Is it to beat a certain benchmark? Is it to avoid market impact? To be aggressive? Passive?
Two strategies allow the trader to set benchmarks, or prices a trader hopes to meet or beat. That could be VWAP, the current price, the midpoint of the high and low or whatever. The time frame can be as short as the next 15 minutes, or the entire trading day.
Another two let the trader shoot his orders into the market, either in a steady flow of same-sized chunks, or randomly in varying-sized bites.
The last algorithm helps the trader avoid market impact and is the opposite of a benchmark strategy. A trader would use a low-impact strategy when his orders are getting filled and the market is not moving away from him. He can be more passive and take it slow. By contrast, he might use a benchmark strategy to be more aggressive if he is not getting filled and the market is moving away from him. "Think of one as liquidity capture,'" said Kedia, "and the other as liquidity provider.'
InfoReach Grabs at Pairs
InfoReach has been around for about eight years, but is relatively new to the business of selling off-the-shelf systems. The vendor, headquartered in Chicago's financial district, got its start building custom systems for such trading houses as Warburg Dillon Read (now UBS) and Credit Lyonnais's G-Trade division (now part of Bank of New York). The firm has 16 customers, both for its canned and custom products.
InfoReach recently added pairs trading to its line-up. Pairs trading involves the simultaneous trading of two stocks whose price movement is correlated in some way. Merger arbitrage is one form. A trader will often buy the shares of the company to be acquired and short those of the acquirer.
A second form is statistical arbitrage. Assuming the shares of Ford and GM trade in lockstep, a trader might buy one and sell the other if the pattern changes. Once the stocks realign themselves, the trader exits the positions.
Merger arb executions are budgeted in shares. Stat arb is often done in dollar terms. To mitigate risk, traders usually trade multiple pairs. That's where basket trading technology comes in.
InfoReach's new module lets users trade the same stock in more than one pair in one portfolio. That's something the other systems don't do, according to InfoReach president Allen Zaydlin. "They allow only one unique name," Zaydlin said. "You can implement a work-around. But there is no straightforward way to trade, for instance, 100 IBMs against 100 other names in the same portfolio."
Spear, Leeds & Kellogg
Courts Buyside
Spear, Leeds' TradeFactory hit the Street in the early 1990s with a clientele of sellside program and prop (index arb) desks. At the time, TradeFactory was owned by TLW Securities. Spear, Leeds bought TLW in 1999 in order to bring the technology to its clearing customers. The move vaulted SLK into the ranks of the top program trading houses among New York Stock Exchange members. SLK's acquisition by Goldman Sachs in 2000 gave the broker a new set of prospects for TradeFactory: the buyside. Since then, SLK has been building functionality into TradeFactory meant to appeal to both traditional money managers and hedge funds. (For more on Spear, Leeds, see Q&A on page 70.)
Portware Now Delivers
None of the four vendors in this space – Portware, FlexTrade, InfoReach or Aegis – is enthusiastic about providing smart order routing or connectivity services. That is in contrast to the brokers which all offer connectivity. Most of the vendors' customers contract with service providers such as TNS or Radianz for connectivity. Some build their own smart order routing.
But some traders are asking for routing. FlexTrade has taken steps to offer a canned version of smart order routing, but does not have a network. Now Portware is adding both.
Earlier this year, Portware entered into an agreement with Lava Trading, a single stock front-end vendor, to provide Portware customers access to Lava's order types and connectivity. Traders get direct access to all listed and Nasdaq execution venues as well as Lava's decision-making functionality. "People like Lava's network," said Portware president Eric Goldberg.
The move by Portware keeps up the pressure on FlexTrade. The functionality is similar. The pricing is not. A trader processing over 250,000 shares per day would be better served using Portware, according to Goldberg. By the same token, a trader should be doing at least 100,000 shares per day to justify buying his product, Goldberg asserts. Otherwise, the system is overkill. Portware has about 100 mostly hedge fund customers.
Instinet Crunches Numbers
Post Trade
As with Portware, Instinet has also decided to outsource functionality. To keep up with the Jones, Instinet last summer signed a deal with analytics provider Quantitative Services Group (QSG). Users of Instinet's Newport basket trading system now get access to QSG's transaction cost measurement system called T-Cost Pro. The product allows traders to research their costs after the trade. It complements Instinet's own pre-trade portfolio analysis and real-time transaction cost analytics that are already a part of Newport. T-Cost Pro looks at the impact of the stock selection style, such as growth or value, as well as trading style.
Instinet has installed Newport at 164 sites worldwide with 277 users, according to the firm. It has actually carved out a second product from Newport called "Instinet Advance" that is geared to buyside desks without trade order management systems.
Instinet Advance contains less of the purely program trading features, according to Instinet President Mike Plunkett. It focuses more on single stock order-driven functionality.
The creation of Instinet Advance is an attempt to please those "order-driven" customers, such as traditional money managers, that don't want to trade unless they have an order. The more feature-rich Newport is geared to hedge funds who prefer to create orders on the fly.
The move also reflects the quandary all the brokers face in trying to serve multiple constituents with diverse needs. Do you incorporate both single stock and basket trading functionality into one system? Or offer two systems? The first route, taken by SLK, potentially burdens traders with more technology than they want. But it cuts the broker's costs as it only needs to maintain one system. The second road, taken by ITG, makes the user's decision more straightforward, but saddles the broker with more cost.
It is a problem, Plunkett says, with which Instinet is currently struggling. So far, the broker has installed Instinet Advance almost entirely in Europe at 19 sites with 30 users.
ITG Integrates Technology
Traders have long had access to transaction cost estimation and analysis technology, but until recently using it has been somewhat inconvenient. Traders have had to take their eyes off the markets to monkey with another system. ITG, in launching its new Triton program trading system, sought to remedy that by integrating its formidable pre-trade ACE and post-trade TCA technology into Triton.
Now, traders simply highlight a row of names, click, and the ACE presents such bits of information as sector decomposition, expected costs and risk exposures. "It will tell you where you should be throughout the day in 30-minute bins if you follow our strategies," explained Scott Harrison, an ITG marketing exec.
Triton can then auto-trade the list or the trader can drill down for a detailed risk analysis. "What are the most risky names in my portfolio?" Harrison asks rhetorically. "Where am I most likely to start bleeding first? Which ones do I want to get out of the way?"
The analysis can be done anytime throughout the trading day. Previously, traders mostly used the tools at the end of the day. "It has been a big transition in how people even think about these tools," Harrison said. "All of a sudden, they are just a click away. It changes their utility."
UNX Battles Fragmentation
Front-end trading systems may aggregate all market centers on one screen, but they do not eliminate fragmentation. A trader must still be careful to pick his spots. Place an order on the wrong ECN and he might miss the trade. The problem is multiplied hundreds or thousands of times when trading baskets.
To reduce the opportunity cost of being in the wrong place at the right time, UNX is coming out with a new order type. Called a scatter' order, it allows a trader to break up a limit order into multiple pieces and post them on multiple venues. Instead of placing a 100,000-share order on Brut, for example, the trader can place four lots of 25,000 shares on each of Brut, ArcaEx, SuperMontage and INET.
In addition to hedging a trader's bet, the order type also delivers valuable intelligence. With executions in one market center often printing on another, traders may not be able to figure out wherein lies the liquidity. Fills accomplished with a scatter order provide the trader with market intelligence he can't get from the tape. UNX reports the venue on which the trade occurred, not just where it printed.
"There was nobody with a limit order in Microsoft on the Boston," UNX president Randy Abernethy offers as an example. "It was on Brut. But Brut printed on Boston."
