Printer Friendly
While these issues are not new, concern over them is increasing. Frustration over market fragmentation seems to be at an all-time high, particularly with the number of algo products being marketed to traders. Data traffic continues to be a source of strife and only appears to be a growing problem as order sizes continue to shrink and data volumes skyrocket. And despite advances in that direction, the evolution of the execution management system as the main tool for buy-side execution still appears open to debate.
Going into 2008, buy siders are clamoring for solutions to these problems. But most of all, they just want someone to listen.
ISSUE No. 1: MARKET FRAGMENTATION
The fragmented equities trading marketplace, aggravated by the proliferation of dark pools, will continue to present a challenge to buy-side firms attempting to satisfy clients' seemingly opposing desires: coverage of the depth of market, simplicity in trade reporting and transparency of executions. Buy-side traders are under pressure to spread their trades across as many venues as possible to avert market exposure while simultaneously being explicit about where they are trading and holding down ticket charges. Additionally, they must prove that they did all of this to the best of their ability each day -- all while producing acceptable returns on their clients' investments.
"The industry cannot handle any more fragmentation," says Nenad Yashruti, a trader and portfolio manager at Freestone Capital Management in Seattle. "We are at our peak. We're at the point where we can't really add value until we do see some consolidation because the more fragmentation that occurs, the more opportunities there are to miss venues that have a decent amount of liquidity in them."
Algorithm Transparency
Consolidation of execution venues aside, the use of algorithms has become the most viable method for navigating fragmented liquidity pools. But traders say they have become frustrated with the lack of transparency into vendor- and broker-dealer-provided algorithms.
Traders report that the profusion of smart algorithms and dark pools still results in a very poor signal-to-noise ratio -- they are searching for a clear voice amid all the bells and whistles. As a result, in 2008 traders will seek to be better educated about how algorithms and other trading technologies actually work, and vendors can expect them to be much more discriminating about which offerings they use.
"Until we gain more visibility inside the [algorithmic] technology, it is difficult for us to feel confident in our decisions to manage technology," says Yashruti. "We can understand how it is supposed to work and use our knowledge of theoretical models to make decisions. But to be fully effective, we need to know more factually what systems actually do versus what they are supposed to do. I'm really hoping 2008 will be a year of clarity."
Yashruti likens the lack of feedback from algorithms and dark pools while they are executing to a floor broker not being able to tell his buy-side client whether he is on the trading floor or not. He also questions whether newly hired traders in the coming years will understand trading as well as they understand how to pull the trigger on technology that has come to resemble a video game.
"The technology is very user-friendly, and it does a lot for you," Yashruti says. "Vendors have relieved us from having to understand the markets in order to use the technology. But are we able to get trades done properly while maximizing our profits? That is more questionable. Pretty soon we are going to have traders who have never used DMA [direct market access] -- they have only studied algorithms."
