The financial crisis has not been kind to the derivatives sector. The number of futures commission merchants (FCMs) – houses that can handle futures orders and provide credit to clients trading futures – has been cut by a third in the US and has shrunk by a similar number in Europe. Newedge has weathered the storm well and has emerged from that storm as the largest FCM globally, prime broking liquid strategies such as equities, foreign exchange and fixed income. James Shekerdemian, Newedge’s Head of Origination & Structuring says that one core reason for Newedge’s continued growth has been the attraction of its agency model, unlike many of its competitors who have proprietary trading desks. Another contributing factor has been the company’s decision to only trade/prime broke instruments for which the underlying asset is priced in a liquid market.
Newedge’s strength in liquid strategies harks back to the early 1990s when investors first started looking at Commodity Trading Advisors (CTAs) and macro-type strategies. Having focused on the relationship between both manager and allocator, and gained a distinct competence in managed accounts, Newedge were able to extend the platform into other liquid strategies, whilst at the same time developing their fund-servicing capabilities. Newedge subsequently developed a multi-asset, multi-strategy prime brokerage platform to cover equities, foreign exchange and fixed income. This focus has now continued into the world of centralised clearing, where Newedge has successfully launched an increasingly powerful platform.
This growth accelerated post financial crisis: “Before 2008 only a very small percentage of investors looked at managed accounts, let alone invested in them. Clearly it has been a while since 2008, but since then many institutional investors have now made the decision they want to invest in both managed futures and indeed managed accounts generally,” says Duncan Crawford, Global Co-Head, Alternative Investment Solutions.
“The universe of institutional investors has become more educated in what managed futures are and who the players are in this arena,” says Crawford. The company has focused heavily on its advisory group, which researches managed futures and managed futures strategies, in order to grow awareness in this field.
The bruises left from the collapse of Lehman Brothers mean that investors are much more focused on the safety and confidentiality of their investments. Managed accounts meet many of their concerns, offering transparency and segregation as well as the prospect of greater liquidity. It is no surprise that the size of the hedge fund managed accounts market grew by over 15% in the 12 months to June 2012.
Newedge’s underlying hedge fund client base is composed in the most part of CTAs, currency managers, macro managers, long/short equity managers and volatility managers. But this is only one half of the audience, the other half being end investors and their managed account needs. This differs radically from the other prime brokerage operations, for whom over 90% of the business is servicing offshore funds. This long history and unique business model leaves it well placed to serve the alternative investment universe of today.
For both investors and fund managers the agency model Newedge has established is equally attractive because “there is no arbitrary valuation of the instruments we are prepared to prime broke and there is no internal prop desk activity – we are 100% non-conflicted,” Shekerdemian says. What Newedge does offer is the execution and financing of trades and the provision of first class custody and clearing services. Given current (and future) regulation under discussion, our competitors are also seeing the benefits of the agency model, he adds.
Beyond the core execution and financing side of Newedge’s operations, one of its fastest developing businesses is the launch of products for managed futures strategies, tailor-made to help fund managers meet demand from clients in different markets, be it within a UCITS framework or solutions for mutual funds in the US. It is critically important that such a launch is accompanied by service providers who understand the more stringent requirements of regulated markets.
“We work very closely both with investors and the underlying managers to help them structure what they are looking to achieve. We are very much an advisory business,”says Shekerdemian. “Our core team has been in place for many years and has an enormous amount of relevant knowledge.”
Market participants U-turn on equities
The equity markets started recovering in late December and have continued to power ahead in January and February with the DJIA now trading around the 15,000 level and the FTSE at 6,500. The market’s change of heart towards equities has meant that hedge fund investors, who have mostly ignored equities for the last five years, have begun to pay attention to share trading again. The equity markets are not out of the woods yet and particularly in Europe, remain sensitive to local politics such as Italian elections or Greek austerity decisions.
Nevertheless, although the volumes and flows have not yet returned to the pre-crisis levels, a generally more positive mood is permeating the market and is felt among investors.
“Typically we look at 2008 as an outstanding year for managed futures, which was an equity bear market. People are looking at returns from CTAs over the last couple of years and are perhaps disappointed. But paradoxically, positive equities markets will be positive for CTAs this year,” says Crawford.
He believes that a steady and rising equity market will result not only in a good performance from CTAs but will also prompt investors who are currently still sitting by, waiting for some better numbers from the CTA strategy to make an allocation. “Investors are still absolutely holding off on investing. They are not short the equity markets but they are sitting on the sidelines with cash, and are nowhere near being in the market to the level they could be; that’s why you are seeing equity markets going up so aggressively,” says Crawford.
Apart from what has been happening on the trading floors in Europe, the US CTA performance numbers were also hampered by government intervention and an ever-increasing list of new regulation both in Europe and the US.
“As soon as markets go in a direction governments don’t like, they step in and this has been tough for many hedge fund strategies, not excluding CTAs,” says Crawford. However, now that the markets seem to be heading up, further intervention, which comes with a steep price tag for the governments in question, doesn’t seem very likely. Instead, the market will be allowed to trend and that will be positive for CTAs.
The effects of previous government decisions on both sides of the pond are still filtering through in the shape of various regulations that will take effect either this year or next – regulation which was introduced in reaction to what happened in the markets five years ago. With this kind of lag it is unsurprising that the current regulatory pipeline remains full and even though markets are turning this will not translate into less regulation immediately.
Shekerdemian says regulation is at the centre of most discussions being held both internally and externally. From the Transaction Tax, to AIFMD and ESMA, there are many moving parts relevant to both Newedge and its clients. Newedge is actively working with AIMA and the various exchanges to lobby for the industry’s interests. Success varies depending on the region. “The US regulators have a more collaborative approach with market participants, to try and address the issues at hand,” says Crawford.
Beyond regulation, much will depend on the liquidity in the markets this year, particularly in the equity markets. With the current uptick in equity markets there has been a commensurate uptick in derivatives too. Related to the underlying flows, in its latest research Newedge is actively looking at how liquidity, open interest and daily volumes will affect capacity in the managed futures industry.
“Our findings are that with current volumes and open interest there is plenty of capacity left in the managed futures industry,” says Crawford.
One of the prominent takeaways from the financial crisis for hedge fund investors was the issue of liquidity. Part of the attraction of managed futures strategies has been that very element of liquidity they can offer. As interest in underlying liquidity grows, Newedge is in a good position to advise both funds and investors about the best ways they can benefit from this growing and increasingly important side of the hedge fund business.