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Class acts: the tricky business of trading new asset markets

Published in Automated Trader Magazine Issue 28 Q1 2013

Is it any surprise that firms have ventured off in search of new pastures, trying out different asset classes, given the persistent lull in trading activity in the world's equity markets? Adam Cox reports on what they need to consider when branching out.

Class acts: the tricky business of trading new asset markets

Damp squib (expression, British English):
1) A miniature explosive device that has become wet, preventing it from working;
2) A disappointment;
3) A description of what trading volumes in the equity markets were like in the past couple of years.

Is it any surprise that firms have ventured off in search of new pastures, trying out different asset classes, given the persistent lull in trading activity in the world's equity markets?

Since late 2008, interest rates in the United States and many major economies have been at rock-bottom levels and have shown scant sign of rising. But instead of sending investors flooding into equity markets and spurring strong volumes, the near-zero rate environment has led to subdued and somewhat orderly trading. Some of this torpor can be attributed to a post-crisis hangover, with general investor confidence still fragile after such an extreme, once-in-a-generation event. But market watchers say it is also clearly a function of the low volatility that stems from the ultra-stable interest rate outlook that has been signalled by central bankers.

Faced with such an environment, many trading firms have chosen to widen their horizons and trade new markets. A study by Barclays Capital that questioned 1,300 institutional investors found 85 percent of respondents were responsible for multiple asset classes. That compared with about 50 percent when the survey started in 2005.

In Automated Trader's own survey, which featured more than 650 buy side and sell side participants, more trading was expected in every single asset class listed. In the main cash markets, growth was expected to be most muted, with 53 percent now saying they trade cash equities and just 55 percent expecting to in two to three years. But in several derivatives markets - notably equity options, fixed income derivatives and foreign exchange futures - the share of firms expecting to trade was some 9-11 percentage points higher. All told, the survey highlighted the appetite among trading firms for taking on new challenges.

Still, conversations with market participants, investors and technologists suggest that the business of wading into new asset classes is no simple matter. From mundane, nuts-and-bolts factors such as connectivity and due diligence, to more complicated tasks such as reconstructing models, firms find that trading or selling products for a new asset class can bring up a host of issues to consider. To that end, we set out to hear from executives, quants, academics and others just what those issues are and what you need to think about before diving head-first into a new market.

This year's model

At the heart of any transition into a new asset class is the task of coming up with new models.

"Every market has its own idiosyncrasies, different exchanges, different trading strategies, different supply and demand factors, that make it somewhat difficult," said Scott Morris, head of quantitative research at Ronin Capital in Chicago. "So you have to tailor your models for every market."

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