Institutional Investor's Alpha Magazine - April 2008 - (Page 26)

efx Electronic Platforms Reshaping Foreign Exchange Trading Markets In recent years, increased volatility in global FX markets has attracted the attention of fund managers seeking to increase portfolio returns – an alpha strategy. says. “That increased prime brokerage competition created a surge in prime brokerage activity. Because liquidity was deeper and pricing was tighter, algorithmic trading shops found their models were now applicable to foreign exchange.” But the traditional trading model still exists. After all, FX clients conduct transactions in many different ways. For algorithmic trading, managers need speed, technology and immediate access to all prices. “On the other hand, corporates need a relationship,” says Coyne. “They tend to look at the underlying fundamentals of the market and need access to research and professional advice.” range of instruments may tend to move toward the asset classes that provide the biggest opportunities.” More and more buy-side ﬁrms are treating foreign exchange as an asset class, notes Stone. “With foreign exchange trading migrating to the trading/execution desks, traders are demanding greater control, algorithms and order types that they use in other asset classes,” he adds. As trading styles of other asset classes continue to spill over into the FX landscape, electronic trading gives managers the ability to leverage more advanced trading algorithms. Algorithmic, or “black box,” models allow traders to monitor volatility in equity markets, as well, and apply alpha strategies based on FX pairing. Triangular trading – typically involving the euro and yen as well as the dollar – is also facilitated by eFX platforms. “Speed is really the key,” says Robson. “The faster you can get in and out, the better your chance of proﬁt.” While a relatively small number of traders use FX markets in pursuit of alpha, these alpha strategies, according to the CME group study, tend to be pursued by more levered, active and sophisticated traders. When seeking alpha, traders most commonly use managed hedge or currency overlay programs (leveraged/active, 44 percent; less active, 51 percent), while dedicated FX funds are less common (27 percent and 30 percent, respectively). “For institutional investors, electronic trading can be an efﬁcient way to trade FX, depending on the chosen strategy,” says Godfrey. “For instance, it is particularly useful for those pursuing short-term, intraday strategies, since it lets you get in and out of positions quickly. For longer horizons, it is probably one of several execution methods, including traditional phone and order channels. So the usage of eFX varies with the time horizon and manager’s strategy.” Hedging Strategies In contrast to fund managers hoping to beneﬁt from currency market shifts, a signiﬁcant percentage of institutional investors are using FX trading to mitigate their risks. For instance, a fund may have taken a position in a promising foreign equity and wants to reduce its FX exposure. Today, almost half of FX transactions are initiated as hedging tactics, according to the CME study. Cross-product management of risk is key in this environment. The “High volatility in the FX market tends to attract a lot of attention, bringing in managers looking for alpha. For example, a hedge fund whose portfolio includes a wide range of instruments may tend to move toward the asset classes that provide the biggest opportunities.” Steve Godfrey Bank of America Coyne expects both bank and multiportal eFX platforms to continue to evolve in the next year. “Banks are becoming more sophisticated in the way they deliver their pricing to different channels,” he says. “They are able to be more in control of their pricing and access to their services.” Searching for Alpha In recent years, increased volatility in global FX markets has attracted the attention of fund managers seeking to increase portfolio returns – an alpha strategy. “High volatility in the FX market tends to attract a lot of attention, bringing in managers looking for alpha,” says Steve Godfrey, head of North American electronic trading product development and sales at Bank of America in San Francisco. “For example, a hedge fund whose portfolio includes a wide 4 • Alpha Sponsored Report • April 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - April 2008

Institutional Investor's Alpha Magazine - April 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Here to Eternity The Good Guys: Voice of Hope Cover Story: The Kings of Cash Where the Money Is Into the Light Interview: Proceeding with Caution Strategies: A Convenient Truth Alpha Bytes: Village Voice Unhedged: Commentary: No Time for Complacency

Institutional Investor's Alpha Magazine - April 2008

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