JLN Managed Futures: June 15, 2010

Five Minutes with Tom Griffo, of FlexTrade Systems

Tom Griffo is the vice president of Global Futures Sales at FlexTrade Systems, a broker-neutral execution management system (EMS) for trading equities, cash, foreign exchange and global futures. Griffo sat down with Ron Sebonia to discuss how the EMS space is evolving in the managed futures arena, how FlexTrade helps level the playing field in an increasingly automated execution environment and what CTAs can do to gain a competitive edge.

Q: Of all the stuff that’s out there, I don’t think there’s a lot that actually covers how to run your CTA, how to be involved in the industry other than performance. I think that that’s a big kind of gap that needs to be filled.

A: What struck me about your last commentary was that FlexTrade is also focusing on that “second tier” of CTAs, the guys who are running between $200 million and $500 million dollars, but they’re kind of flat lining in terms of growing their assets. They haven’t been able to bust out.

The largest CTAs have been adopting more sophisticated execution tools, although probably not to the extent that I would have thought a couple of years ago. But execution really hasn’t been something that the smaller CTA has focused on, and there are various reasons for that. That idea that you just talked about, how CTAs manage their business, should also include a conversation about execution.

Q: Let’s take a look at the execution front. If you could take a step back and talk about how you would explain FlexTrade to a CTA who is looking around for some sort of execution package.

A: Well, FlexTrade is, at its heart, a highly customizable execution management system that is focused on more smartly “slicing and dicing” large orders so as to reduce market impact and slippage. The company was founded in 1996, and it grew out of the equity world, which was of course on the forefront of electronic and algorithmic trading. Fast forward into the early 2000s and where we are today. Obviously, futures trading is now fully electronic, or just about fully electronic, and the power of platforms like FlexTrade can now be accessed and utilized by institutional futures traders such as CTAs.

Historically CTAs have been rather content, and this also includes some of the larger ones, to hand off the execution piece to their brokers, and I think the main reason for that is the execution risk. Either they didn’t have resources, or they just said, “You know what, I just don’t have the time or expertise to manage the actual trading of my positions, so I’m going to give it to a broker who is going to provide value, I hope, and execute my orders for me. As important, they’re going to write me a check if there is an error and I’m covered.” That’s not an insignificant value for a broker to provide. Before I joined FlexTrade, I was broker for almost 25 years. I’m not sure if we actually quantified what portion of our a execution commission was for risk management, but clearly CTAs and other clients were paying us something for managing the risk of execution.

That’s all well and good because it’s really a balance between the risk management side and the performance side. Now that markets are electronic, they are in many ways much easier to manage from an execution perspective. You don’t have to talk to 15 different pits or 20 different brokers to execute your portfolio. Your whole portfolio can be managed from a single front end. So it becomes a lot “easier” to manage the execution of your global CTA portfolio.

Yes, there are natural and justifiable concerns a CTA should have when taking on the execution risk. In my mind what FlexTrade, and products like FlexTrade can do, is help improve execution performance and reduce market impact. If you’re a mid-sized CTA trading a couple of hundred thousand contracts a year or more and you look at the average tick size being $10, give or take, the math is pretty easy: Saving a tick per contract will have a direct and significant impact on your bottom line. Most CTAs are very systematic in the way they approach their business and approach their markets, but sometimes, in some cases, that systematic approach sort of ends at the execution. So we’re saying why not extend that same approach to execution, and use a tool like FlexTrade to accomplish that.

Q: That seems like a pretty reasonable approach. Something that’s always been a problem in the industry, although actually, I think now people tend to look at slippage as being sort of been wrung out of the system, which isn’t necessarily true.

A: I really don’t think it’s true at all. Yes, bid/ask spreads have narrowed in many cases. We could have a long discussion about liquidity and what it means and whether is it better or worse in the electronic world. But even if I make the assumption that liquidity is “better” in an electronic environment than it was in an open-outcry environment, the other side of that coin is that we know – even just with the naked eye looking at a screen – that in many cases you’re seeing a lot of big orders being chopped into ones and twos. So if you have a big order to execute, you can just throw the whole thing onto a machine and “get it done”, and it might look like you got a great fill vis-a-vis maybe what it would have been a few years ago over the phone. But there are definitely more efficient ways of managing bigger orders in markets that cumulatively trade a lot of volume but where orders are being executed in smaller and smaller increments. I think that’s what sometimes gets lost in the discussion.

Another thing that systems like FlexTrade can provide are tools that can quantify, versus benchmarks, just how “good” or “bad” your executions are. This is a lot better than in the old days when you put an order on the floor and you got it back a few minutes later and it was kind of guess whether it was a good fill or not. It was more touchy- feely than quantifiable. But now you know exactly when your order was generated, when it was sent to the broker or exchange and when those executions came back in real-time, and everything can be measured to the millisecond and even the microsecond. So now that you can really measure and quantify your true slippage, you might have even more reason to consider using better execution tools to reduce market impact and improve your execution. I think slippage remains a very big problem – or an opportunity if you want to look at it that way – because I think there remains a lot of slippage that can be wrung out of the market by using execution tools that are a bit more sophisticated.

Q: So this might be a way for a CTA to gain a relative edge against their competition?

A: I’m not going to say that an investor is going to pick CTA A over CTA B because CTA A is using a better execution system. But if CTA A and B are fairly similar in their profiles, say they’re both trend followers, they both have similar Sharpe ratios, they both have the same relative correlations to other asset classes, then maybe the one with the better execution tools gets the allocation. So, yes, to answer your question, CTAs can use execution as a differentiator and gain a competitive edge.

Q: Does your platform do anything for improving transparency for the investor? Does it generate better reports?

A: The short answer is yes. If you make a system like FlexTrade the hub of your trading activity, then anything that happens in the system becomes quantifiable, from cancel/replaces to slippage to P&Ls. All can be calculated in real-time and also can be communicated in many ways to investors. You can clearly demonstrate how you’re executing your orders. If the model says I want to buy at “X” and you get filled at “Y”, you may explain to your investors that I’m doing a lot better on my execution because I’m using superior execution tools.

Q: Where do you see the trip wire for your type of product? Is it a certain number of accounts? Is it a dollar value of accounts? Is it a number of executions? If I am an emerging CTA and I have five accounts, slippage should probably be on my radar so I am not wasting an opportunity, but that's probably not a critical thing at that point at least, five accounts you should all get the same tick and probably not far off your price, whatever it is. On the other hand, if I have five hundred accounts and I am trading a market like sugar than slippage could be a real problem. I would like to get a feel for when you think your type of technology is applicable?

A: That is an excellent question and the answer is going to vary. Certainly the size of your order is important, the markets that you are trading in and what your time horizon is for your typical trade. If you are a CTA that's trading a shorter-term system -- which, by the way, we are seeing as a growing trend since the markets became electronic -- it is a given in my mind that you should be using a tool like FlexTrade because traditional “point-and-click” systems cannot react fast enough to ever-changing market conditions. But, as discussed earlier, the more traditional trend following CTA can still benefit significantly from reduced slippage. So it's not really a “one size fits all” answer, you have to look at all the variables. I would say the key variable is simply your overall volume. For the CTA you mentioned who only has a few small accounts, even a traditional front-end “point-and-click” system may be too much fire power. That CTA might be fine, as he builds his business, continuing to use the broker for execution. However, in general terms, the CTA who is trading a quarter million contracts or more a year, from our perspective and our experience, can really benefit significantly by using a system like FlexTrade.

Taking a step back and looking at the smaller CTAs, I still think there is a case to be made for handling your own execution business using a “point-and-click” platform as opposed to just giving it out to the broker. Now even in this instance, the CTA still has to make the decision to assume the risk of execution and make sure he understands how to mitigate fat finger risk and similar types of execution mistakes. But I still believe a CTA is, more times than not, going to do better executing for himself as opposed to sending an email to a broker saying “get this done.”

Q: As someone who does execution, I totally agree with that, in part because my experience goes back to being on the floor at the Board of Trade. I can remember watching things coming into the order stream and thinking wow that is just taking forever. If you were to look at CTA's and say you guys have all this bit down, what would you say is the most critical thing for execution? Is it speed? What do you see as the issue? If you are approaching a CTA, how do you say you need this?

A: The issue of speed is on everyone’s mind these days. For most CTA's, and again, I’m talking about the more traditional CTA and not the guy who is running a high velocity, high frequency model, I think speed is somewhat overrated. I mean if you think about it, only one guy can be first in line and everyone is behind him.

The new locals are the quants and the black box guys who have co-located their software and hardware. You are not going to beat those guys in terms of speed whether you have FlexTrade or anything else. They build their own stuff, they have the best technology, the best telecom. They get a “look” at every order that comes into the order match engine before anyone else does by virtue of that edge. That's just the way it is. But technology like FlexTrade’s can help level the playing field, so while you are not going to be the fastest whether you use FlexTrade, TT, Pats, CQG or whatever, you still are going to have the ability to execute more efficiently and effectively. You also have the ability to act more quickly by building some level of automation into your execution on the front end and therefore being proactive instead of reactive in your execution. The result is better execution, less slippage, less market impact and overall better performance. So it's just learning to deal with the new execution paradigm and what it is. There are certain players that have better technology than others, but that doesn't mean you can't be successful or compete effectively for liquidity.

I am an old floor guy myself, and it's akin to someone who in the days of pit trading had a direct line to the ring as opposed to someone who sent their orders across the Teletype machine. The guy who had the direct line wasn't in a better position than the local on the bottom step, but he was much better off than the guy coming across on the Teletype. And the same is true today – the guy who is sending emails or faxes to brokers, which still happens, is obviously worse off than the guy using more sophisticated trading technology.

Q: Is there a question or an area you want to shine some light on that I didn't get to?

A: Sure. Another point to make is to bring the broker back into the loop. I don't want to give you the impression that brokers are no longer adding value on the execution front. There are many excellent “value-added” broker execution desks out there. But if you are still giving your orders to brokers, then make sure they themselves are using good technology to get your orders done.
Related to that, many brokers are now offering execution algorithms to their clients. These broker “algos,” which have evolved from the equity world, are essentially execution strategies or tactics, such as VWAP or TWAP, that can improve execution performance. Brokers have put a lot of time and effort into developing these tools, so CTAs should check them out. Frankly, I don't think brokers are overly enamored in many cases by having staff taking orders over the phone or picking up orders off the fax and would much rather provide value via algos.

With a system like FlexTrade, you can access multiple brokers’ algorithms - like anything else, the more choices the better. This is the latest advancement in futures execution, and clearly we are seeing a lot of activity in this realm as brokers are developing more and more algorithms that are constructed and created specifically for the futures markets. Again, if you are going to use a broker, make sure you are going to be using the latest broker technology.

Q: Let's say I am a CTA in the market for a quality execution platform, what are three critical questions to ask?

A: Are you trading only futures? As you know, many CTAs also trade cash foreign exchange, so it is nice to have a platform that can handle both asset classes. Also, what about the risk management piece? We talked about the legitimate concerns CTAs have about taking on execution risk. So a big question to ask is what can a technology provider offer in terms of risk management tools to help mitigate that risk? No vendor that I know would say you can 100 percent eliminate all risk, but an execution system should be able to provide robust and effective “fat finger” and other risk management tools. Thirdly, a quality execution platform should be able to handle your requirements not only today, but also in the future. The futures markets continue to evolve at a dizzying pace. What works today may not work tomorrow. You may not want to invest in a piece of technology that isn’t able to grow with your business.



Lead Stories

Trading firm Headlands Technologies founded by three Citadel veterans
HedgeTracker
Matthew Andresen, Jason Lehman and Neil Fitzpatrick, three former traders at Chicago hedge fund Citadel Investment Group, have joined forces once more to run Headlands Technologies, their own computer-driven trading firm. According to the Wall Street Journal, Headlands Technologies will use a quantitative-trading operation, and while its focus has not been finalized, the trading firm may eventually trade in stocks, options and futures markets
http://bit.ly/aC9ns8

Penson GHCO Announces Global Futures Execution Desk
Press release
Penson GHCO has established a 24-hour, global execution desk for assisting managed futures executions, including bulk order placement and allocations. Penson GHCO also announced a new relationship with introducing broker Colagrossi Futures, which plans to make immediate use of the desk.
http://bit.ly/9FyvWX

Superfund Shuts Six Offices
FINalternatives
Retail hedge fund firm Superfund is cutting back after a difficult 2009.
The managed futures shop, which manages about US$1.24 billion, has shut six offices around the world and laid off staff to cut costs. Superfund blamed a tough business environment for the move.
http://bit.ly/ccTwrB

Superfund shuts 6 offices including S'pore
Reuters
Austrian hedge fund manager Superfund said on Friday it has shut six international offices and laid off staff as part of cost-saving measures amid a tough business environment.
http://bit.ly/aEvd8Y

GCI, Orix Open Computer-Driven Hedge Fund to Profit From Crisis
Bloomberg
GCI Asset Management Inc. and Orix Investment Corp. will start today a hedge fund using computer models to spot trends in futures prices and profit from market turmoil.
http://bit.ly/9Xhk3d

Alternative advisors launches ucits fund of hedge funds
Hedge Funds Review
The fund is likely to include a large proportion of equity long/short managers as well as global macro, commodity trading advisors (CTAs) and some event-driven managers.
http://bit.ly/cVJwWO


Industry News

EU moves closer to derivatives, short selling legislation
The Trade News
The European Union (EU) has pushed ahead with its reforms of the region’s financial markets by publishing consultation papers that outline its proposed frameworks for regulating derivatives trading and short selling. http://bit.ly/doRi8N

CFTC seeks equal access for co-location services
The Trade News
The new rules from the CFTC, which were published in the Federal Register at the end of last week, would require derivatives exchanges to make provisions relating to equal access, fees, latency transparency and third-party solutions for co-location and proximity hosting services.
This includes the requirement to make such services available to any qualified market participant willing to pay for them and ensuring that costs are not used as a way to price certain types of participant out of the market.
http://bit.ly/cclZTJ

May losses cloud hedge fund summit in sunny Monaco
Reuters
Executives such as Man Group (EMG.L) CEO Peter Clarke, whose firm last month unveiled a $1.6 billion (1.1 billion pound) takeover of GLG Partners (GLG.N), and Leda Braga, head of Bluecrest's 'black box' funds, will debate how the industry continues to win back clients in the face of choppy markets and looming regulation.
The 2010 GAIM International conference on June 14 to 17 comes after almost a year of steady net client inflows -- helped by returns of 20 percent in 2009.
http://bit.ly/bQjhFS

Hedge Funds Dodge European Proposal With ‘Newcits’
Bloomberg
Guy Hurley said he’s not sweating European plans for new hedge-fund rules after leaving Bank of America Corp.’s Merrill Lynch & Co. a year ago to start an onshore fund that uses strategies such as merger arbitrage.
http://bit.ly/blgAtm

Bull and Bear Capital & Critical Value Advisors announce launch of Hedge Fund Xchange an Investor Matching Service
HedgeTracker
Hedge Fund Xchange is a powerful new service available to firms wishing to refine and streamline their capital raising efforts via a highly-targeted and customized investor matching process.
http://bit.ly/bX6wNs

The Alternative Beta strategy fared really well during the 2008 crisis
Sagar Chakraverty, Opalesque Asia
Once thought impossible, hedge fund replication has become one of the buzzwords in the finance community, driven by the growing realization that most hedge fund returns come from risk premiums rather than manager alpha,” said Dr. Lars Jaeger, the CEO of Alternative Beta Strategies at Zurich-based Partners Group. http://bit.ly/cQXtNS


Markets

George Soros Discusses the Financial Crisis and Regulatory Reform
HedgeTracker
George Soros believes the financial crisis is nowhere near over and that we have now entered into ‘Act II’, “when financial markets started losing confidence in the credibility of sovereign debt”.
http://bit.ly/bQn4Vf

Newedge CTA Index down 1.51 per cent in May
Hedgeweek
The Newedge CTA Index fell by 1.51 per cent in May, bringing its year-to-date performance to +2.06 per cent.
The Newedge CTA Index top performances for May included Boronia Diversified Fund, up by an estimated 4.32 per cent, IKOS Financial USD, up 3.07 per cent, and Kaiser Trading Group, up 2.90 per cent." http://bit.ly/aQZdTd


Bad Behavior

CFTC Watchdog Launches Review of Market Surveillance Operations
SARAH N. LYNCH - WSJ.com
WASHINGTON—The Commodity Futures Trading Commission's internal watchdog has launched a review of the agency's market surveillance operations to determine how well the CFTC enforces speculative limits for large traders.
The independent review was disclosed by the CFTC's inspector general in the semiannual report to Congress. http://bit.ly/aK1czL


Noteworthy

Cavenagh Capital Launching New Macro Fund
HedgeTracker
Cavenagh Capital, a macro-focused hedge fund manager, is launching a new macro hedge fund in July after receiving a capital commitment from Netherlands’ largest pension fund manager. Cavenagh received an initial investment of $40 million as part of a three year seeding commitment from APG, the asset manager for Stichting Pensioenfonds ABP.
http://bit.ly/bs0Qdx

Rough Spring for Ravi Kaza, Seasons Capital Management to close all three hedge funds
HedgeTracker
Due to the increased difficulties of today’s investing environment, Ravi Kaza’s Seasons Capital Management has decided to call it quits and is starting to return capital to its investors. According to a 2008 SEC filing, Mr. Kaza’s hedge fund firm once had more than $4 billion in assets under management. Seasons Capital’s most recent SEC filing revealed that the firm’s assets had fallen to just under $1.5 billion.
http://bit.ly/aP2Hb8

Julian Barnett’s Ridley Park Capital launches flagship hedge fund with $200 million
HedgeTracker
Julian Barnett, former portfolio manager at fund manager Polar Capital, launched the flagship hedge fund of his startup venture, Ridley Park Capital, last month. According to the Financial Times, Mr. Barnett raised almost $200 million for the new fund manager, although some sources claim Mr. Barnett had originally aimed for figures as high as $500 million.
http://bit.ly/aXKwd8

A former head of risk management at Goldman Sachs is reportedly starting up his own hedge fund firm.HedgeFund.net
Gregg Weinstein, who was the global head of risk management at Goldman is hoping to launch event-driven RocWood Capital by the third quarter, according to a Bloomberg report.
http://bit.ly/af9Axu

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