The investment industry is experiencing an increasingly rapid pace of change in both the asset classes under management and the way in which they are traded. This creates a challenge not only for portfolio managers and traders, but also for the providers of trading systems and software applications. The buy-side order management system (OMS) must evolve to meet these challenges, and the future lies in fully cross-asset-class platforms that support traditional order management with the addition of broker-neutral execution management functions typically found in the execution management system (EMS).
The search for fund performance in cyclical markets has been the spur to greater asset diversity in portfolios. In particular, the use of derivatives for efficient portfolio management, hedging and trading has become increasingly widespread. Even the most conservative of institutional investors are using, or will soon be using, these alternative asset classes in the normal course of business.
At the same time, fixed-income managers are implementing more front-office technology to improve operational control and efficiency, replacing spreadsheets and paper tickets. While the fixed-income OMS offerings are probably best described as "first generation," the bar will be raised quickly and continually by innovators. Furthermore, the drive to improve portfolio performance has caused managers to look at how currency aspects of their portfolios are managed, and there is now a trend for funds to insource and more actively manage foreign exchange.
As a result, sophisticated support for multiple asset classes -- including management, pricing and position keeping of more-complex assets such as OTC credit and equity derivatives alongside more traditional assets -- is becoming mandatory for OMS vendors. Most new OMS selection processes now include cross-asset requirements, and those vendors with a single-asset history or focus will need to make significant investment in their multi-asset domain expertise and software development to remain competitive in the medium term.
Execution Quality and the Changing Landscape
Aligned with the quest for fund performance, and with regulators and investors demanding more transparency, the execution quality of buy-side trading desks is coming under the microscope. This has lead to an increased analysis of full lifecycle transaction costs. There is now an awareness that the hidden costs, in particular market impact and delay, are in many cases far greater than the traditionally measured visible costs of commissions and other charges. The monitoring and measurement of execution quality is now an integral part of the investment process, with traders expected to contribute to fund performance.
In parallel, there have been some significant market changes. First, the ECNs changed the trading landscape, followed by the block-trading ATSs, such as Liquidnet, POSIT and Pipeline, which have had a more direct impact on the buy side. Brokers and exchanges have responded by introducing new services, with algorithmic trading and broker EMS offerings growing dramatically in the past 18 months. This, in turn, has resulted in an exponential increase in transaction volumes and associated market data. With MiFID bringing an end to concentration rules, this trend is now set to accelerate in Europe.
This changing landscape has a significant impact on buy-side traders, who are now operating in a much more complex environment. They now have the choice of multiple execution strategies, such as using an ATS or broker services varying from high- to low-touch broker involvement; selecting among traditional care orders or principal trades; and choosing newer algorithmic services or dealing direct with the exchange through direct market access (DMA) for both single orders and lists.
The buy side has responded by taking control of this new set of challenges and is taking more ownership of execution quality. In terms of skills acquisition, there has been a concerted and successful effort to recruit sell-side traders to the buy side. And on the technology front, buy-side traders are demanding a lot more from their systems.