Buy side to reduce reliance on proprietary algos

Buy-side organisations are re-assessing the tools that have traditionally provided them with their competitive advantage as the front-end trading options available to them continue to grow. According to a new Tabb Group report, the development of trading algorithms is one such function that is fast becoming more cost effective to outsource than to manage in-house. By Stewart Eisenhart

NEW YORK – Buy-side and hedge fund managers deploying their own trading algorithms are reconsidering their approach, as these tools become more commoditised and brokers improve their own algorithmic offerings. A new Tabb Group report, OMS, EMS or DMA? The future of the buy-side desktop, reveals that as managers assess whether to utilise order management, execution management and direct market access products on their trading desks, the cost and maintenance required to develop algorithms in-house have driven a number of firms to consider using more broker-developed algorithms.

The report surveyed 159 traditional asset managers and hedge funds on the current and anticipated status of their trading desks; 36% of large managers and 8% of mid-tier managers report using proprietary algorithms currently, although 40% of these firms say they may utilise more tools provided by their brokers in the face of higher development costs and fewer trading advantages.

Jeromee Johnson, senior analyst at Tabb Group and author of the report, observes that buy-side traders must deal with increasingly overlapping functionality among OMS, EMS and DMA trading technologies, but that this convergence should eventually offer traders the possibility of more integrated, less complex desktops.

However, the analyst emphasises that these product types also comprise significant functional and architectural differences appealing to very different types of traders and strategies.

Choosing to deploy OMS, EMS or DMA technologies, or, as is the case with a lot of buy-side organisations, a combination of the three front-office technologies, depends largely on how well managers perceive their trading needs are being met by their current front-end platforms. Buy-side traders' future expectations of how their desktops will evolve depends largely on how well integrated their current trading tools are, according to the report.

Among respondents already using integrated platforms, 70% reported expectations that their platforms will remain integrated but 'separate' – that is, these traders will continue using multiple, integrated systems as opposed to single, convergent ones.

On the other hand, half of all respondents using systems with little or no integration expect their platforms to converge in the future, Johnson found.

In terms of current infrastructure challenges, respondents identified their most acute need as more desktop integration, followed by OMS technology.

Johnson found that when considering whether to implement any order or execution management system, respondents cited the availability of analytical tools as their number one concern; the report notes that brokers and vendors have responded to this need either by developing analytics themselves or partnering with other providers to do so.

Access to trading algorithms is still the primary driver (37%) among managers opting to implement OMS or EMS platforms, although Tabb Group anticipates this figure will shrink by 2008 as these tools become more 'assumed' features of front-end systems.

Instead, managers are most likely to focus on how easily and quickly their trading platforms can incorporate changes in brokers' algorithmic offerings. Vendors are responding to this concern, according to Johnson, by adding 'algorithm templates' to their platforms allowing clients immediate access to new tools once brokers roll them out.

The report shows that more technologically advanced managers with complex investment styles/strategies typically use a greater number of trading platforms compared with long-only firms, but this differentiator is expected to shrink over the next two years.

In 2004, long-only managers averaged 2.2 platforms compared to 3.6 platforms at multi-strategy managers, a 64% difference. That percentage fell to 25% in 2006, and Tabb Group expects a further drop to less than eight percent by 2008.

Johnson attributes this diminishing statistic to technology advances obviating the need for multiple platforms, as well as asset and hedge fund managers' operations becoming increasingly similar.

In terms of future changes in OMS, EMS and DMA functionality, the Tabb Group sees a greater likelihood for integration rather than convergence in the near term.

Regarding OMS technology, Johnson writes that vendors are struggling to increase uptake of hosted versions of their products. He argues that developers must roll out lighter versions of their ASP offerings to win more small- and mid-tier business, and also address integration challenges with back-end systems and counterparties.

DMA platform providers will focus on developing order types and other functionalities for new market rules and venues in the wake of Reg NMS, Johnson writes.

Finally, EMS developers are expected to enhance their core automation and algorithmic construction features. The Tabb Group anticipates that these vendors will partner with other providers to address buy-side needs for more advanced analytics in the face of higher market data volumes and speed. Johnson expects that through these alliances, EMS vendors should be in a better position to provide more sophisticated predictive analysis and real-time transaction cost analysis.