We approach 2008 with a number of new industry dynamics changing the way we think, trade, manage relationships, service customers, develop technology and operate. While not all of these trends are new, they certainly will become more significant throughout the coming year.
Trend No. 1: The most significant of the trends for '08 is the continued split between alpha generators and their beta counterparts. Alpha is the drive for noncorrelated benchmark returns. As traditional fund managers continue to be challenged in achieving benchmark returns, investors are shifting toward inexpensive beta-capturing benchmark products (i.e., ETFs), driving down the pricing associated with traditional asset management and pushing managers toward high-fee alpha products. To achieve alpha, however, fund managers need to develop unique investment ideas, strategies and tactics.
Trend No. 2: Among the new tactics are Short Extension Funds. SEFs, also known as 120/20 or 130/30 funds, can accumulate long positions of more than 100 percent while funding the excess through shorting. While there are fewer than 200 of these funds, they are enjoying a compound annual growth rate of more than 140 percent. SEFs typically are run by traditional long-only managers. This creates opportunities to service this new customer segment, as traditional funds don't have prime broker relationships or sophisticated tools to manage short positions.
Trend No. 3: Derivatives. As SEFs gain the ability to short securities, the number of poor performing securities will be squeezed. As Regulation SHO requires funds to secure borrow commitments before they short, and supplies of short securities will be, well, short, we will see increasing use of derivatives by traditional managers and institutions overall.
Trend No. 4: Risk management software for the buy side also will gain a resurgence. As the buy side takes on more short and derivatives positions, it will need tools to better analyze and manage them.
Trend No. 5: Hand in hand with looking for alpha and managing risk, the buy side will need a wider selection of trading tools, namely cross-asset, direct-market-access and algorithmic platforms. Most funds and brokers still offer only single-asset-class platforms.
Trend No. 6: The quest for alpha also will push funds into a wider diversity of geographies. As more funds search for investments that are uncorrelated with major markets, they will increasingly look in the most precarious and interesting places, challenging operations to settle, clear and manage positions in these frontier markets.
Trend No. 7: On the execution side, the world will get more complex. With markets being regulated toward individuals and algorithms breaking up larger orders into smaller ones, finding blocks and liquidity will continue to become harder. While we have seen a significant movement toward dark pools and block crossing networks, the process of finding liquidity and gaining access to all of the liquidity pools increasingly is becoming fully electronic and incapable of being done individually.
Trend No. 8: This brings us to our last trend for '08, which really is a super-trend. The previous seven trends all have one thing in common: They will make it increasingly difficult for buy-side firms to do it all themselves. The technology complexity, the geographic coverage, and the ability to synthesize the vast data sets and execute any product around the world will be completely out of reach for the vast number of buy-side firms, solidifying the position of vendors and increasing the sell side's influence and position in the market.Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio