Multi-asset Versus Cross-asset Trading: Hedge Fund Challenges
Multi-asset trading – the ability to trade multiple asset classes on a single electronic platform – has moved from an industry buzzword to a widely accepted trading model in just a few years. Several factors have helped spur the development of increasingly sophisticated multi-asset platforms, including widespread adoption of e-trading; strong growth in the hedge fund community (and the resulting boom in prime brokerage); the development of advanced cross-asset algorithmic trading and arbitrage strategies; and a desire to eliminate at least some of the overlapping technology infrastructure that supports buy- and sell-side trading operations.
Today, a number of leading brokers offer multi-asset solutions in one form or another. Indeed, for many of these brokers, providing a multi-asset front end is viewed as a core component of their prime brokerage offering. On the vendor side, advanced execution management system (EMS) providers have developed multi-asset trading systems to handle a wide range of client trading activities, all within a consolidated trade management environment.
Multi-asset trading platforms have clearly gained acceptance among a broad swathe of buy-side firms, particularly hedge funds. Indeed, the appeal of multi-asset trading was recently confirmed by the Securities Industry and Financial Markets Association’s (SIFMA’s) EU buy-side e-trading survey. According to respondents, the number one factor when choosing electronic trading platforms was ‘access to multiple sources of liquidity/range of assets supported’. However, exactly what constitutes true multi-asset trading is less clear. Conflicting definitions and industry opinions are the result of numerous different models, whose proponents all claim to offer multi-asset trading in one form or another. For example, is a broker platform considered multi-asset if it supports execution of different products and asset classes, yet segregates those functions in such a way that the client desktop system is simply an extension of a broker’s siloed business structure?
Moreover, what impact does this particular model have on the distinction between multi-asset trading and true cross-asset trading, particularly as end users pursue more advanced multi-asset algorithmic trading and arbitrage strategies? Finally, what are the main challenges facing firms who wish to implement true multi-asset trading systems?
Broker front-ends all have different functional capabilities and are built according to various different business models. However, all of these systems share a common trait: they began life as equity-only trading platforms, and in their present form have been cobbled together from a variety of different asset-specific systems. Because brokers continue to operate their businesses in silos, their systems are supported by individual budgets and development teams, and as such are based on technology and business logic that is asset specific. The result? Clients may have the ability to view and execute multiple assets on a single platform, but they are restricted to trading them independently of one another.
The problem with this kind of solution is that it does not address one of the core reasons for the growth of multi-asset trading in today’s market. The vast majority of traders do not trade multiple, unrelated assets independently for alpha – separate assets, separate strategies. For most funds, the true benefit of having a multi-asset trading system is that it supports the creation of advanced cross-asset trading strategies that are based on the simultaneous, integrated execution of multiple assets as part of a single strategy.
Take, for example, the trader who is creating an index arbitrage strategy, which involves the execution of futures against baskets of underlying equities. He or she needs to create and maintain a specific, real-time view of an index arbitrage portfolio, composed of completely different assets, from which proprietary trading strategies can be launched, monitored, and controlled. In another example, a trader is running a multi-currency equity strategy that he or she would like to auto-hedge in real-time based on current FX rates. Doing so requires an integrated portfolio view showing real-time currency risk exposure where FX and equities can be viewed and traded simultaneously via trader-defined rules.
It is these types of cross-asset trading strategies that are driving the adoption of multi-asset EMSs. Unfortunately, broker systems that only permit side-by-side execution of multiple assets cannot support either of these strategies, or in fact any strategy that requires the execution of multiple products in a single trading environment. It is this distinction – between real cross asset trading support and siloed execution of different assets – that traders must consider when selecting a multi-asset platform.
Other challenges exist for funds wishing to implement cross asset trading systems, not the least of which is integration with existing trade workflow applications. Many funds rely on a host of different back office and risk applications (some proprietary, some not), that are segregated by asset class. Even those funds that use multi-asset order management systems (OMS) have to ensure that communication between their OMSs and execution platforms is robust and supports seamless information transfer for all asset classes. As such, multi-asset EMS should have pre-certified connections to all leading workflow applications, yet be flexible enough to integrate with any proprietary system a client may have developed in-house.
Integration does not end with workflow applications, however. Funds that deploy multi-asset systems must be able to receive, cleanse and normalise a variety of different data feeds. For standardised, vendor provided equity data feeds, this is less of an issue. Other data feeds, such as those received from various FX electronic communication networks (ECNs) and single banks, are often proprietary. As such, providers of multi-asset systems must be able to aggregate and normalise these feeds to create what is essentially a virtual depth of book.
In addition, the issue of market centre connectivity is a key factor in assessing multi-asset systems. Firms pursuing cross asset trading strategies require access to the broadest range of execution destinations. Regardless of any technology or architectural shortcomings, multi-asset broker platforms are, by definition, single broker systems, and as such they cannot offer clients access to every available source of liquidity. Broker-neutral systems, on the other hand, can reach every broker and liquidity point from a single, consolidated trading environment.
A final issue to be considered is co-location support. In today’s ultra-high speed marketplace, firms pursuing multi-asset arbitrage opportunities are increasingly turning to collocation strategies – installing their trading systems at exchange and ECN market sites to achieve the fastest possible execution speeds. Co-location has long been a part of the equities and futures markets, but the market’s appetite for additional asset class support is clearly growing. Regardless of asset class, only systems that support local deployment and can integrate easily with an exchange’s core data feed are suitable for this type of strategy.
As corporates turn to ever more complex trading strategies and seek greater efficiencies in terms of market connectivity and access to liquidity, all of the issues outlined in this article will play a role in choosing an appropriate trading system. The key point that corporates will need to remember is that their requirements will change over time and it is important to factor this into the planning. As hedge funds seek out new opportunities in electronic trading, the ability to adjust without adopting entirely new systems will be a major competitive differentiator. As such, funds must be extremely wary of adopting rigid systems that cannot grow alongside their emerging business requirements. In the end, the extent to which firms’ underlying trade architecture allows them to tailor solutions that meet their specific needs – multi-asset or otherwise – will determine how well they adapt to an increasingly dynamic global marketplace.