Newedge is an established global player in the CTA industry: it has an estimated 80% market share of clearing relationships with CTAs, is typically the lead prime broker for CTAs, and is often first or second for global macro funds.
It's a position that has been built over a period of more than 20 years, from the point "when CTAs were just starting to evolve from pure trend followers,” according to Keith Johnson, Head of Sales in the Americas and Global Head of Capital Introductions.
The CTA market has evolved considerably in the last two decades, a trend that will inevitably persist. To remain an industry leader, Newedge recognises that it must continually modify its client offering to remain relevant. Johnson explains: "At its core, Newedge provides clearing and execution solutions, on an agency basis. It's a proven business model, with clients valuing the impartiality we offer. However, revenue streams have become squeezed and the pricing of clearing and execution commoditised, meaning firms must now compete on the basis of value-added services."
To this end, while Newedge may offer funds wider market coverage, by dint of having more exchange memberships than any other futures commission merchant (FCM), the firm is also looking to leverage its capital introductions capabilities, thought-leading research papers and events, innovative solutions including fund structuring. It's an offer that is augmented by its globally integrated multi-asset class platforms: equity prime brokerage, FX prime brokerage and OTC clearing platforms, which can help funds to reduce both the burden of multiple counterparty documentation and the level of margin requirements.
Thought-leading research and events
Newedge research events, held in Bordeaux, Tuscany, and the Napa Valley, are distinct from its capital introductions events. Indeed, marketing people are strictly prohibited from attending these symposiums, much to their chagrin in some cases. The concept is to create an intimate environment where a small group of 40 investors can have a candid dialogue with around 10 managers about research themes, without the distraction of a marketing agenda.
Some of the first thought leadership from Newedge revealed how short-term traders were not only lowly correlated to medium and long-term traders, but also showed lower correlations to one another than traditional CTA strategies. This led Newedge to create an index tracking the performance of short-term CTAs. A separate Trend Indicator index also made it clear the extent to which many CTAs were moving away from trend-following, and encouraged investors to distinguish between trend-followers and others. All of the Newedge indices are comprised of managers open to investment, to ensure that they are replicable and potentially investible. Newedge custom reports are now based on proprietary analytics, slicing and dicing returns and exposure profiles from many angles.
The latest thought leadership paper, Capacity of the Managed Futures Industry, contains a large number of insights. Amongst them is that the common practice of attempting to gauge CTA capacity by the percentage of open interest accounted for by CTAs may be flawed. This is because open interest in US government bond futures markets and in US equity index futures represents only around 2% of the size of US bond or equity markets respectively.
The perception that commodities are more capacity-constrained than equities was also questioned. As far as commodities are concerned, the paper points out that daily trading volumes in crude oil futures are 13 times larger than those of the most heavily traded stock, Apple. The research paper also looks at recent CTA performance from a different perspective. If CTA returns are measured as a spread over risk-free rates, rather than in absolute terms, then the recent drawdown is neither longer nor deeper than former drawdowns. The crucial point here is that because most CTAs are sitting on lots of unencumbered cash, historically interest earned on this cash helped to soften the blow of negative periods for CTA investment strategy returns.
Capital intros, UCITS and ‘40 Act funds
Events have been held in financial centres including Tokyo, Hong Kong, Chicago, New York, San Francisco, Los Angeles, London, Geneva, Zurich and Abu Dhabi. These are typically half-day or one-day events with four or five managers invited to present research. In January 2014, Newedge plans a global 24-hour global macro event, with three managers each in Paris, London, New York and Los Angeles. This will review 2013 and present predictions for 2014.
Just as the Newedge roster of managers has grown to include non-CTA managers, so too Newedge events also focus on other strategy categories. There have been events dedicated to volatility arbitrageurs, which Newedge also has an index to track. Some events have focused solely on discretionary commodity managers. Systematic equity managers, such as quant equity market neutral, are also often working with Newedge. In fact, Newedge feels comfortable with just about any liquid strategy, with less liquid areas of the credit markets being the main asset classes where it does not offer coverage. Newedge is keen for fund liquidity terms to be aligned with those of assets traded, so is wary of managers that seek to impose long lock-ups despite running highly liquid strategies.
The diversity of these strategies naturally leads to a wide spread of returns. Although large variations between performances of quant funds may have only recently become well understood, Newedge says that there is nothing new about the degree of dispersion being seen. "What this means is that even if the headline indices seem close to flat, there are always pockets of positive performance," says Johnson. "In 2012 quant macro funds did particularly well, while this year so far many shorter-term CTAs are showing strong performance. Investors need to explore and discover all areas of the quant fund universe to identify as many return drivers as possible, and Newedge analysis – such as the weekly Nelson report – can help investors to expand their antennae."
Newedge also plays a more informal capital introductions role at other conferences, with the MFA (Managed Funds Association) events being those in which Newedge tends to be most closely involved. For the MFA in particular, Newedge has large teams on the ground scheduling meetings for investors, mainly in Miami and other US cities including New York and Chicago. Johnson sat on the MFA Conference Committee for five years, so he and Newedge fully appreciate how the MFA serves to represent the alternative investment industry. As many as 40 people at Newedge spend part of their time on capital introductions.
Market intelligence is important as well as potential on-boarding, so Newedge is always on the lookout for all kinds of funds as well as investors. The firm tries to help start-ups by introducing them to top-tier service providers. There is no hard minimum level of assets for Newedge to pick up the phone; instead, the broker is prepared to take a longer-term view on institutional-quality managers that might launch with moderate levels of assets. In terms of market intelligence, the approach is to “meet as many managers as possible, and when investors reach out we want to know about everyone – whether or not they are a client,” says Johnson.
For years Newedge has been helping managers to structure vehicles, such as UCITS funds, that allow managers to diversify their investor base, by attracting assets from groups that find it harder or impossible to allocate to traditional offshore fund structures. “Alternatives including UCITS CTAs have exploded,” says Johnson, and Newedge has historically used total return swaps to implement these strategies, and minimise performance divergence between the UCITS and offshore versions of CTAs. Johnson continues: "We are already devising new structures to accommodate changes to the CTA UCITS rules, which recently came into force. The hope is that UCITS CTAs can continue obtaining exposure to their entire programmes, including commodities, but they may do so via notes or certificates rather than financial indices." Funds have until February 2014 to apprise the regulator of their intentions regarding portfolio structuring. Over in the US, ‘40 Act funds can also use swaps to run pari passu with offshore funds, and it seems ‘40 Act funds are in their infancy compared with UCITS. Only a few CTA funds of funds, such as Altegris, Dearborn, Frontier, Hatteras, Neuberger Berman and William Blair have so far created ‘40 Act funds to offer retail investors access to CTA strategies.
Equity prime brokerage
Newedge also has a strong and growing equity prime brokerage franchise, to complement its traditional derivative capabilities. The business services a range of small, medium and larger hedge fund managers. Both physical and synthetic solutions, including CFDs, are available. The hallmarks of Newedge’s other offerings are all present here: equity prime brokerage is part of a single global platform, fully integrated for cross-asset class margining, reporting and client services. Newedge offers both electronic or “low-touch” and desk or “high-touch” execution capabilities into a wide variety of exchanges, and has stock loan desks in place covering all major markets, sourcing borrowing from a deep pool of institutional lenders going well beyond assets under its own parent banks’ custody. Andrew Dollery, based in London, notes, “Having a single integrated PB platform means we can service all manner of long/short equity, market-neutral and multi-strategy funds efficiently. This is a growth area for our business, and we believe many small to medium-size firms are currently under-serviced.”
OTC Clearing
Given Newedge’s strength in clearing listed futures and options – and its decade of experience of clearing OTC energy swaps via Clearport since 2002 – it was natural extension to expand into clearing of other OTC derivatives, such as interest rate swaps.
Newedge started doing this in March, before regulatory deadlines kicked in, according to David Amar, prime brokerage salesperson based in the New York office. Newedge partnered with their shareholders, Société Générale and Crédit Agricole, to offer OTC clearing across all business lines.
In contrast to siloed brokers, Newedge is able to book all types of trades onto the same global, multi-asset class platform. So instead of requiring independent margin for each position, Newedge calculates margin according to net exposures and uses cross margining to net off margin requirements for clients holding both listed and OTC cleared instruments. If a manager is long on an OTC cleared swap and short related futures, he or she may benefit from substantial offsets – the CME estimates that margining two related products together can cut margin requirements by as much as 90% compared with margining them separately.
Newedge closely monitors developments in other product areas that are impacted by Dodd Frank, such as FX non-deliverable forwards (NDFs), and plans to clear those products as regulators make it mandatory.
Multiple ISDAs replaced with one agreement
Currency, FX trading is one area where ISDAs are still required, because there is no central clearing institution for currencies – and in any case, hedge funds tend to find far more liquidity in OTC markets than in futures markets for trading FX. In OTC FX, Newedge offers execution and clearing just as it does for other markets. The firm also provides an intermediation service that is starting to attract interest from “real money” clients, such as pension funds and asset managers, as well as hedge funds and CTAs.
Traditionally, funds trading foreign exchange that wanted to access a variety of liquidity providers had to set up separate trading accounts, margin facilities, ISDAs and associated Credit Support Annexes with each counterparty, and all of these were required for each managed account a fund manager traded. Up to 100 sets of agreements would be required for just 10 accounts and 10 counterparty banks. This not only resulted in a large volume of costly legal documentation and operational complexity, such as posting collateral with each liquidity provider and managing multiple margin postings, but also created practical problems, meaning that block trades could not be easily executed. Posting collateral at each service provider is every bit as inefficient as posting margin for each individual position – in either case, housing trades with the same counterparty brings a netting benefit.
Of course, a spider’s web of agreements still exists, but it is now only inside Newedge, which acts as a hub, consolidating the relationships internally so that clients need only one agreement with Newedge, and they effectively trade in its name, using its credit lines. Expanding the client base into conventional asset managers increases the size of the asset pools that Newedge can harness to support its growing FX trading hub. Some funds may also find that accessing a wider network of banks via the Newedge platform lets them shop around for better execution and tap into extra pockets of liquidity.
“Newedge’s FX prime brokerage offering is the only agency-based FX PB in the world that has a network of direct bank relationships,” says Jasper Chua of the New York office, adding, “Anonymity and flexibility are further advantages of an agency model with cross-product capabilities”.
Newedge’s core business and model, agency clearing and execution, has stayed the same for 20 years, but the broker is delivering more value-added solutions, and clearing and executing an ever growing variety of markets and instruments on an expanding range of exchanges. The one constant amid all this innovation is seamless geographic and asset class integration throughout Newedge. As the broker adapts its offerings to the new regulatory landscape, it is appealing to a growing range of hedge fund strategies and managers.