Hedge funds are seeking more direct connectivity to execution venues as their search for alpha intensifies, according to Isabel Schauerte, an analyst in the securities and investments group at consulting firm Celent.
“In the quest for alpha, hedge funds are tapping into ever more sophisticated algorithms, requiring more direct access to the market,” Schauerte told theTRADEnews.com. “Direct connectivity to market venues allows for faster and cheaper trading so that funds can focus on generating alpha.”
Celent’s new report on hedge funds, ‘Challenges and Innovation in the Hedge Fund Industry’, says that hedge funds are slowly putting the credit crisis behind them and looking for new opportunities. With competition for both returns and investment heating up, the report says that avoiding commoditisation is “one of the biggest challenges for the industry”. In the front-office, this has led to a number of hedge funds to explore the scope for high capacity, low-latency smart order routers to access liquidity faster, reduce market impact, increase speed and reduce trading costs.
Schauerte, who co-authored the report, believes use of algorithms and DMA by hedge funds is continuing to accelerate. Although direct market access is still largely an equity phenomenon, there is a growing adoption of multi-asset-class algorithms. “Independent agency brokers in particular are seeking to add execution capabilities in options, FX, and futures,” she said. “Bigger DMA players, like Goldman Sachs, have been connected to options and futures exchanges for a number of years already.”
Trading venues will also need to adapt to the evolving trade execution needs of hedge funds, according to Celent. “Exchanges and other liquidity venues need to revisit their technological standards and execution quality in order to keep up with DMA developments,” said Schauerte.
In May the London Stock Exchange announced an upgrade to its TradElect electronic trading platform to attract high-frequency trade flow, which would halve latency to three milliseconds by October. And in June the exchange introduced Performance Channels, a high-speed delivery mechanism for its Infolect market data service, which is designed to give algorithmic traders better visibility of trading during high-volume periods. Fellow exchange NYSE Euronext has adopted a new pricing strategy, called Pack Epsilon, designed to appeal to hedge funds using statistical arbitrage trading strategies.