Wall Street & Technology is part of the Informa Tech Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Trading Technology

01:10 PM
Connect Directly
Google+
Twitter
RSS
E-Mail
50%
50%

Do Traditional Buy-Side Firms Need to Colocate?

Wedbush Securites' new low-latency trading platform recently scored a number of long-only buy-side clients. But experts disagree on whether traditional asset managers need such high-speed, and costly, market access.

Wedbush Securities is aiming to settle the score with high-frequency traders. According to Wedbush, long-only asset managers have been getting the short end of the stick when it comes to technology and direct market access. To level the playing field, the brokerage and clearing firm rolled out earlier this year a high-frequency trading platform that it says is designed to allow traditional buy-side firms to colocate at every major U.S. trading venue and data center, and gain speedier access to dark pools and alternative trading systems.

The launch follows Wedbush's 2011 purchase of Lime Brokerage, which specialized in providing electronic access to a range of lit and dark venues for systematic and automated trading firms. Wedbush's HFT platform also features a suite of liquidity-seeking and benchmarking algorithms -- such as volume weighted average price, percentage of value, implementation shortfall and custom-made algos -- that Lime initially developed with help from clients.

So far, Wedbush's latest offering appears to be gaining momentum. In May the firm announced that 10 long-only buy-side firms -- a mix of hedge funds and traditional asset managers -- signed on to use the new HFT platform. Despite the platform's early success, however, industry sources point out that the notion of an asset manager going through a broker to gain electronic access to the markets isn't new.

But Wedbush counters that many of the systems traditionally offered to the buy side don't actually provide the type of direct connections to the markets that high-frequency traders typically enjoy. Instead, sell-side offerings often first push trades through a central hub and then route them to the exchange, putting their buy-side clients at a disadvantage, according to Kevin Beadles, the head of Wedbush's execution solutions group.

"Most buy-side firms are going through a bulge-bracket firm, and the bulge-bracket firms have their own electronic access, but they're not necessarily colocated at the exchanges," Beadles explains. "In addition, the bulge-bracket firms have their own dark pools and crossing networks, so they're really optimizing the order on their own behalf instead of giving the institutions that ability," he argues.

[ Options Trading Isn't Dead: Future Growth Will Occur When Investors Refocus on Equity Markets]

"Institutions are being disadvantaged because high-frequency traders have the ability to go to the exchanges, colocate their servers there and have direct access to the markets," Beadles continues. "Institutions aren't going to do that, and they're not in business to do that."

Although long-only asset managers by definition aren't as speed-sensitive as or in direct competition with high-frequency traders, according to Prashanth Nandavanam, an expert in quantitative and algorithmic trading with EMC Consulting's financial services practice, the massive amounts of data that are the norm in today's markets will make it necessary for many of them to adopt low-latency services such as Wedbush's, which also features colocation at data centers. "There's just too much information out there for purely fundamental trading methods to be used," he insists. "Whether it's being able to react to changes in the market or understand what might cause volatility, there's just too much information out there in the electronic form that cannot be ignored. Firms are going to be better off looking at that data. Maybe they won't pursue alpha-generation using purely quant methods, but I think [quantitative analysis] is going to help them analyze the market much better."

But arguably the most valuable element of a platform such as Wedbush's, Nandavanam says, is its ability to help the buy side prevent information leakage. These systems, he explains, can help firms spread out large orders as a means to avoid tipping their hands and moving the market. "The reason long-only firms care about direct market access and low latency is really about reducing slippage -- that's the key thing," Nandavanam says. "Many of these firms have taken control of how they do that by chopping orders themselves and then farming them out to the market. That's an investment in technology they needed to make. But where they care about low latency is being able to fill these large orders across multiple venues without necessarily leaking anything into the market."

Sacrificing Speed

However, Robert Iati, a partner with Tabb Group, argues that, with the economy performing so poorly, many buy-side firms are willing to move a little slower and forgo high-speed access to the exchanges in order to keep costs in check. "We've reached a bit of a point of resistance when it comes to colocation, in particular, on price," Iati says.

The firms that are most likely to have an appetite -- and the budget -- for colocation are those that are deploying latency-sensitive strategies such as statistical arbitrage or pairs trading, Iati continues. "Those kinds of strategies are sensitive to latency because there's correlation involved," he notes. But while colocating through a third party such as Wedbush can keep costs in check, Iati adds, the practice still isn't widespread among long-only firms.

"Years ago the budgets were less of an issue, and buy-side firms were spending on everything," he says. "Now, when there's less money to spend, how important is it?"

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

Register for Wall Street & Technology Newsletters
Video
Exclusive: Inside the GETCO Execution Services Trading Floor
Exclusive: Inside the GETCO Execution Services Trading Floor
Advanced Trading takes you on an exclusive tour of the New York trading floor of GETCO Execution Services, the solutions arm of GETCO.