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Buy-side Traders Seeking Alpha In Asia, Looking For Crossing Networks and Dark Pools

Asset managers and hedge funds are fueling the volumes in Asian equity markets with DMA and algos. Could crossing networks and dark pools be next?

Buoyed by high returns and the hot IPO markets in Hong Kong and China, and the rapid growth in India over the past few years, buy-side traders have increased their flows into Asian equity markets in search of alpha. And with the increased volumes, they are applying electronic trading techniques such as direct market access (DMA) and algorithmic trading to the different rules and structures of the Asian markets.

"Equity market trading volumes surged throughout Asia in 2006 and institutional investors remain bullish about the region for [2007]," according to a February report from Greenwich Associates. "Expected returns for 2007 range from a high of 22 percent for Singapore and Hong Kong to a robust 18 percent for China and India," the report says, noting that the growth is expected to continue.

"It's no longer the domain of just hedge funds and international funds — it's traditional long-only managers that are venturing into Asia," comments Bob Iati, partner in charge of research at TABB Group. Because Asian markets such as "India, China and Korea have gone up in the last couple of years, growing faster than the U.S. and Europe, it has been more difficult for asset managers to find opportunities in U.S. equities. And they now feel pressure from the fiduciaries and plan sponsors to get a better return."

"There's been a huge pickup in our exposure to Asia over the last two years," confirms Hugo Molina, director of trading at Philadelphia International Advisors (PIA), who trades from Philadelphia. He says that his firm has nearly 25 percent of its assets — of which at least 19 percent is in Japan, the world's second largest market — invested in Asia. Indicative of the growing importance of the region, the firm "went from having a global analyst to an analyst that is in charge of the Asian region," says Molina.

As institutional investors put capital flows to work in the local Asian markets, combined with the hot IPOs and hedge fund activity, trading volumes in Asian equity markets have surged over the past three years, comments Madison Gulley, EVP of global trading at Franklin Templeton Investments. "Hong Kong, Malaysia and Singapore all have increased their volumes by more than four times over the last three years, and most other markets have doubled their volume," notes Gulley, who spent 2006 on the firm's Hong Kong trading desk as part of a world tour of the firm's global operations. Three years ago, turnover in Hong Kong was about $10 billion a day in Hong Kong dollars (HKD), Gulley reports; today it's HKD$40 billion, he says.

Despite the restrictions imposed on foreign investors, "Growth in China and Vietnam has been driving a lot of the hedge funds toward those markets," says George Molina (no relation to PIA's Hugo Molina), SVP, director of Asian trading at Templeton, who is based in Hong Kong. China was up 126 percent last year and Vietnam was up 146 percent, he notes, adding that Vietnam is up 44 percent for the first quarter of 2007.

As the Asian growth story unfolds, the opening up of the regulatory environment combined with access to advanced technology has made it easier for hedge funds and buy-side traders to use DMA and algorithms. "The markets like Hong Kong, Japan in particular, Korea and Taiwan are now becoming more accessible via DMA," observes Nick MacDonald, head of Asian equities at Instinet, who is based in Tokyo. Still, U.S. and European buy-side institutions continue to push for the further adoption of electronic trading into Asia and there are signs the next wave will be crossing networks and dark pools of liquidity.

"There's no question DMA and algorithmic trading is gaining traction in Asia. It's the third leg of the whole electronic phenomenon," says Templeton's Gulley. "We started in the U.S., it spread to Europe and it is likely to explode in that region after the Investment Services Directive 2, known as MiFID, goes live in November of this year and it's slowly moved into Asia."

When in Asia

But many asset managers find that DMA and algorithmic trading must be adapted to the particular market structures and regulations in Asia. Because of wide spreads and regulatory hurdles, such as foreign IDs required of institutions, electronic trading may not be totally electronic in some markets, requiring manual checks, say buy-side traders.

While U.S. and European asset managers are using DMA and algorithms in Asian markets, the wide spreads can make it difficult to find liquidity. "Asian market structure and the regulatory environment are still evolving in this area, and you have a fair number of countries with some level of capital controls," notes Gulley. "So that does create a complexity when you want to set up an electronic market and have direct unmitigated access."

Despite the restrictions, U.S. and European traders are importing advanced trading strategies into Asia wherever they can. For the month of January, Templeton conducted about 20 percent to 25 percent of its business in Asia electronically. "That was an anomaly," says Gulley. "Normally we're doing about 10 percent of our business [in Asia] electronically," he says, whereas in Europe it's 20 percent to 30 percent and in the U.S. it's 25 percent to 40 percent. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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