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August 31, 2004

Keeping a Hold On the Buyside

By Peter Chapman

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  • Keeping a Hold On the Buyside

Lehman's algorithmic trading strategy

Lehman Brothers, in a bid to catch up with competitors, is offering direct access to its trading algorithms.

The investment bank has integrated its algorithmic trading server with a pair of order management systems used by the buyside. The move comes as more buyside traders seek to trade orders themselves rather than outsource the work to brokers.

"Increasingly, some of our clients are doing some of their trading through self-service tools," says Jeff Wecker, Lehman's head of global connectivity. "We are trying to accommodate that."

A recent study by the Tabb Group found 61 percent of buyside desks traded

with the servers. Of large shops, those with over $50 billion in assets, the number was 82 percent. The evaporation of visible liquidity, cost pressures and the increasing professionalism of the buyside trader have all combined to boost use.

Lehman customers wishing to self-trade via Lehman's models can now access the algorithms via the proprietary LehmanLive LINKS order management system or their Bloomberg terminals.

Lehman recently entered into a partnership with Bloomberg. This gives customers of the market data giant access to three Lehman algorithms - volume-weighted average price, or VWAP, with volume,' and target strike.'

More Demand

The arrangement is one of many entered into by Bloomberg in recent months. As demand by the buyside for such tools has exploded, broker dealers have fallen over themselves to provide them. No fewer than 12 now offer their wares via the Bloomberg terminal.

"The market is becoming very crowded," says Randy Grossman, a consultant with Financial Insights and the former head of portfolio trading at Instinet.

"You have to wonder where all this is leading. How are these firms going to compete with one another? Whose algorithms are better? Are they going to be supplying back-testing results to their clients?" Grossman asks.

Indeed, Lehman may be late to the party. Other firms such as Credit Suisse First Boston have made algorithmic trading available to the buyside on a self-service basis for a couple of years. The top four suppliers in this area are CSFB, Goldman Sachs, ITG and Morgan Stanley, according to the Tabb study.

Some brokers, including Lehman, have long used algorithms internally, either to trade for themselves or for customers. Offering direct access to their servers is a relatively new concept, but increasingly a must.

"The shift from full service brokerage to direct market access and low-cost executions is what will define the most successful franchises," says Svilen Ivanov, a consultant with the Boston Consulting Group.

"Firms must be able to support three discreet models - full service; low-touch, but sales driven; and human-less direct market access," he adds.

The stratification is based on commission levels. Full service trades, where the broker works the order, are executed at about five cents per share.

Low-touch trades, where the broker runs the algorithm for the client, are being done at two cents. Self-service costs a penny.

Lehman's direct-to-model initiative is not its first foray into self-service. It also offers direct market access, or smart order routing functionality; pre- and post-trade analytics; and direct channels for hedge fund financing.