The Buy Side Takes Charge
OMS: Central Command Post
One of the driving forces behind buy-side adoption of these trading strategies is the integration of the strategies into the buy side's workflow via the order-management system [OMS]. According to the Tabb Group report, two-thirds of larger investment-management firms that responded to the study said they are embedding automatic order-routing capabilities into their OMS workflow.
Pzena Investment Management, for instance, a domestic-equity, classic-value firm that manages $7 billion in assets, utilizes Indata as its OMS. Indata seamlessly integrates access to NYFIX - an electronic trading network that provides FIX connectivity to brokers and access to electronic execution venues. "A huge benefit is that NYFIX fits directly into the Indata trading system, so it's one seamless operation," says Keith Komar, director of portfolio administration at Pzena. That means Pzena's buy-side trader "can manage all of the trades electronically and use the NYFIX network without leaving the Indata platform," he relates. Another advantage of using NYFIX for electronic trading via Indata is that NYFIX acquired Javelin, which provides the FIX language and also provides connectivity to brokers and exchanges.
"NYFIX has connections with the Goldman Sachs, Sanford Bernsteins and Morgan Stanleys of the world. Then you can get into ECNs. You can go directly to the floor. NYFIX has a matching network [Millennium for listed stocks]," as well, says Komar, adding that NYFIX also features certain algorithmic tools.
While investment managers and hedge funds generally maintain connectivity to their brokers using FIX through their OMS, says the report, not all firms have connectivity to trading venues through their OMS. In order to access aggregators like REDIPlus and Direct Trade, "We drop it right off the Internet," says BPI's Miller. "You basically download the software from the Internet or they send you a CD and you load it on your machine. It's very easy," he adds. BPI is in the process of migrating to the LongView Trading OMS, however, which supports FIX connectivity and links directly to ECNs, exchanges and liquidity providers. Currently, it's running the Thomson Oneva EQ, a platform that does not support FIX, which is why BPI is using the Internet to connect to the aggregators.
Meanwhile, a large shop like BGI, which has more IT resources than BPI, also has a more complex OMS setup. "We have multiple pieces. We have an OMS that looks at all of our order flow - credit limits, counterparty restrictions," Tsai explains.
Since BGI manages a number of funds, the traders may have overlapping positions in certain stocks. "We look at overlapping flow on the desk," Tsai relates. BGI uses tools within the OMS to coordinate that flow. Rather than allow each fund to make trades on its own, BGI aggregates the buy and sell orders in the same stocks so that the firm works the orders in the market in a unified and efficient manner. "We factor the market as one entity," Tsai continues. Quantitatively driven, BGI maintains a data warehouse for all of its trades and has the ability to look at transaction history.
Before selecting the ideal venue in which to execute the trade, Tsai says, BGI analyzes a lot of information. "The quality of the information and how you integrate it has a lot to do with access to the liquidity," he explains. He says the firm has proprietary information on the system that provides the traders with the motivation of the trades and the expected transaction costs, with real-time information streaming in and real-time indications from brokers. "All of this gives the traders information on those [stocks]."
BGI is careful to weigh transaction costs. "Every basis point counts," Tsai says, adding that the firm examines transaction-cost models, which are used in BGI's trading strategies.
After doing all of this proprietary analysis to make the trading decision, BGI looks at the liquidity of each stock and the expected market impact. When it's time for venue determination, Tsai continues, "The characteristics of the stock will determine how you trade the particular [stock], and the system will have access to all the different venues."
For example, if there's a very small liquid order, Tsai might use direct access, because he can complete the trade without much impact in trading the stock. "You can simply go down and trade it directly with the market or use some intermediary like a small-order limit model," he says. Tsai might find that he can execute 5,000 shares right away but that the optimal way to trade may be to carve up the order into smaller orders and trade it at direct intervals through algorithmic trading, he says.
Using algorithmic strategies "frees the buy side up to use the aggregation platform and the crossing networks to trade the stuff they can add value to," Larry Tabb says. This tends to be the smaller caps and the medium caps that are not actively traded. Then, buy-side traders will go to aggregators such as Lava Trading or REDIPlus so they can grab as much liquidity as possible across all the ECNs. If all that fails, they call the broker and ask the broker to put up his or her capital, Tabb notes.
Buy-side traders say they still intend to delegate order flow to brokers. "No automated system would be intelligent enough. That's where the traditional trading relationships - dealing with brokers, looking for natural situations - takes over," BGI's Tsai says.
Meanwhile, Pzena, which has just one trader, has been able to handle all the growth in trading volume over the past three years because of e-trading. "We're just trying to stay on the technology curve," says Komar, who believes that there are many areas where the volume is slowly moving away from the traditional broker network. "If you don't start taking advantage of those [tools], then you can miss out," he says.
In terms of how all this electronic trading is going to impact the buy-side trading desk, Tsai says traders will need to be more educated about how the market structure works, how to access liquidity, how the algorithms work and which algorithms to use. "Having the electronic-trading system is important, but having a sophisticated user base" is even more important, he stresses. 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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