The golden age of cross-asset strategies
Gary Stone,
chief strategy officer, Bloomberg Tradebook, explains the popularity of
relative value arbitrage strategies and demonstrates how automation is
simplifying their execution.
Since the
2008 bottom, most markets have predominantly traded in a range. A glance at the
weekly charts shows that the US S&P 500 index has crossed 1,200 around 13
times, similarly the MSCI World Index has crossed 1,200 around 10 times and the
NYMEX perpetual front contract crossed $95 approximately 19 times. With market
direction uncertain and volatility being driven by unpredictable geopolitical
shocks and other exogenous events, many investors are finding that relative
value and hedged multi-legged strategies may deliver more alpha per unit of
risk.
Relative
value (RV) arbitrage exploits the difference between two or more securities in
the same or different markets. Investors will sell an overvalued security and
use the proceeds to buy a security that is perceived as undervalued or offering
better value. The strategy is attractive in these market conditions because it
reduces directional beta. According to Hedge Fund Research, relative value
hedge fund strategies had strong net capital inflows of US$35.8 billion in
2011. Additionally, RV was the only hedge fund strategy to generate positive
performance, gaining 0.51% for the year.
New
structures
In two short
years, the complexion of the global markets has changed dramatically. Globally,
regulators have approved electronic market structures across different asset
classes. In some cases, regulators have gone beyond establishing electronic
central limit order books at primary exchanges – approving fragmented market
structures where liquidity is spread across several competing venues. The
implication for RV is that electronic markets: (1) make possible direct access to
global multi-asset class liquidity and (2) enable algorithms to implement
complex multi-legged strategies that were impossible to efficiently execute
manually. In the past, while a market maker might have conceivably provided a
price for an N-Leg strategy, the spread reflected the complexity of the trade
and transaction costs made the strategy impractical.
Now, with
platforms such as Bloomberg Tradebook, technology can connect widely scattered markets
and asset classes; algorithms can then manage the wide variety of multi-asset exchange
and security-specific rules, the liquidity aggregation across lit and dark
pools, control slippage and maximise liquidity capture while simultaneously
executing multiple securities efficiently. Hitherto impractical complex
strategies are now becoming viable.
The Bloomberg
Professional service and Bloomberg Tradebook together create a logical workflow.
Bloomberg Professional advanced search and analytic functions all help identify
investment opportunities. With functions such as the Custom Index Expression (CIX<GO>), investors can create a
synthetic security representing the complex strategy. The index can be
integrated into Bloomberg’s charting packages (G<GO>) and can utilise advanced technical studies such as
Capital Market Research’s ATM studies to gain a technical perspective on the
strategy (Figure 1). A Bloomberg Tradebook pairs ticket (Figure 2) can be
launched from CIX to seamlessly move from idea generation to execution.
Tradebook algorithms
enable traders to implement single-market and cross-border equity pairs, option
spreads, fixed-income future curve trades, option/equity volatility and delta
strategies, etc. Additionally, multi-leg strategies such as commodity crush and
crack spreads, butterflies and option/equity 90/110% risk reversals can be modelled
on the Bloomberg Professional service and implemented on Bloomberg Tradebook. These
algorithms can be integrated into third-party order management and execution
management systems.
Gaining momentum
Relative value arbitrage is a strategy that
is gaining momentum. Today’s environment combined with advances in technology make
it possible to implement more complex strategies. If you want to stay competitive,
you have to automate. This is especially true when dealing with highly
fragmented markets, cross-border strategies and across asset classes. Traders
need to have all of the information from the strategy on the same ticket so it
can be delivered to an algorithm that efficiently manages execution. With
Bloomberg Tradebook’s pairs platform, now you have all required information in
one place. Tradebook’s algorithms can reduce scrambling to find thin liquidity
to complete a final leg, the fretting of losing alpha due to slippage or having
to pass on profitable opportunities because you don’t have the bandwidth (or
systems) needed to take them.
Final result: New opportunities, improved
productivity, less hassle, less leg risk, more alpha.