Algorithmic Trading: for and by the buy-side

Up to the present time, outside the community of trading-focused hedge funds and specialist high-frequency traders who have undertaken their own developments, algo trading has been predominantly viewed as a sell-side product, provided as part of the overall range of brokerage services by sell-side firms to the buy-side.

The growth of algo take-up over the last several years in both the US and Europe has been impressive, and the field continues to evolve rapidly. It is worth highlighting some of the significant developments of the past year or two, which have been impacted in particular by the post-crisis market turbulence and, in Europe, by the increasing fragmentation of markets since the introduction of MiFID:

• Doubts about the universal effectiveness of certain standard approaches, which unsurprisingly have turned out not to fit all market circumstances equally well – and now what happens to VWAP benchmarks in an increasingly fragmented world?
• The integration of smart routing into algo trading processes – an execution or benchmark algo engine having decided the ‘when’ for a trade, the smart router determines the ‘where’
• The overall complexity of the above leading many smaller brokerage firms to ‘outsource’ their algo provision to tier-one firms, some of whom have been aggressively marketing these capabilities to sell-side as well as buy-side
• Increasingly wide availability of the major brokers’ algo offerings via the networks and platforms of the major trading ISVs and EMS providers.

In the light of these developments it is interesting to reflect on where we might move from here – will algo trading increasingly become a high-added-value service, ultimately provided by relatively few brokerage firms, or might there be ways in which it can become more ‘democratized’? Both the buy-side and smaller brokers have powerful incentives for this direction: the brokers will naturally want to win back the provision of added value that they have (arguably dangerously) ceded at present to their larger competitors, while sophisticated buy-side firms can gain flexibility, unique trading advantage and significant brokerage cost savings by taking at least part of their algo destiny into their own hands. For both communities, the strength of this incentive will increase as algo trading continues to become more prevalent – remembering also the natural growth multiplier of an algo (now often followed by a smart router), which almost always produces multiple trades from a single original order.

A necessary enabler for this broadening of algo development capability is a degree of ‘commoditization’ in some of the algos and also in the underlying development platforms. There is an opportunity here for ISVs and software service providers to move algo development out of the rocket-science laboratory and into the everyday world of replicated (though customizable) packaged software.

We see this beginning to happen. Smart Order Routing has already been successfully packaged by ISVs across many client implementations, though more can be done to make it available on an ASP/SaaS basis. SunGard has also worked with numerous clients on both sell-and buy-sides to integrate algo trading platforms into their operations; these usually run specific implementations of benchmark and execution algorithms, developed using a workbench (GL Tactics Studio) that is specifically adapted for the purpose of trader-driven development. Again, the next step is to take the operational complexities out of the process by providing all of these capabilities as ASP services.

The decision whether to work in house or to buy from a broker is by no means an ‘all or nothing’ scenario. As mentioned above, the algos and smart routers of the major brokers can also be reached via integrated front-ends and DMA links across the order routing networks of SunGard and the other major providers. We envisage a flexible and open-architecture approach in which an asset manager or broker can optimize which parts of its algo/smart routing strategy it chooses to implement in-house or in ASP, while accessing external brokerage services for others. This seems likely to be the best route that the industry can adopt for delivery of cost-effective services to investors.