ATSs Seek Alternative Businesses

Liquidnet and Pipeline Trading Systems know that the block-trading business hasn’t exactly been their growth engine as of late.

In fact, they have known this for some time, which is why the two firms–identified by their block-trading crossing networks–started diversifying into new business lines a few years back. And their latest product offerings point to the next stage in each firm’s evolution.

Liquidnet is now branching out into research, expanding beyond its block-trading roots and moving closer to becoming a full-service brokerage. In 2007, it bought Miletus Trading for its algorithms. It now hopes to increase its market share by raising its visibility at money managers. Liquidnet is setting up research meetings between clients and companies–branded Liquidnet Research Forums

In 2008, Pipeline expanded from its block-crossing network to develop technology that trades blocks through managing algorithms–its Algorithm Switching Engine. Its latest service, called Alpha Pro, constructs desk-specific strategies for trading.

Both Liquidnet’s and Pipeline’s switch in strategy marks a new direction for each, said Tereck Fares, the director of equity trading at Chicago Equity Partners. But they represent a positive shift, he added, and a necessary one.

"The one-venue, one-trick pony doesn’t work," Fares said. "As the average trading size got smaller, firms like Pipeline and Liquidnet found themselves almost forced to get more product offering."

Liquidnet is not abandoning its block trading operations or shifting its focus away from the trading desk altogether, said Vlad Khandros, the firm’s market structure and public policy analyst. Rather, it is looking to provide research and garner attention from portfolio managers, analysts and other corporate strategists. This would complement and augment its existing business, he said.

"Liquidnet is spending more time with the decision makers," said Khandros, referring to portfolio managers and analysts. "We are working on strengthening partnerships with our 600 buyside firms to ultimately give them competitive advantages, while building the new social capital market–creating an issuer community and portfolio manager/analyst community, in addition to the trader community we’ve built over the past 10 years."

The research forums discussions provide Liquidnet’s existing and potential corporate, private equity and venture capital clients access to chief executives, academics and other high-ranking corporate officials–who provide insight into their respective companies and industries.

The conferences are global in scope, usually include several dozen attendees and cover topics such as macroeconomic trends, market structure and future trends in buyside trading. The ATS has held three already this year, covering agriculture, marketing and healthcare. A fourth conference on leading economic indicators is slated for either November or December.

Khandros said the forums have translated into increased trading volume both in Liquidnet’s negotiated pool and through Supernatural, the firm’s block algo suite. Supernatural lets buyside traders place orders in the dark pool, where they can either wait for a natural match or be routed to other venues if none is found.

For its part, Pipeline built its Alpha Pro software service to make it easier for the buyside to pick a trading strategy. Pipeline worked with J.P. Morgan Asset Management and AllianceBernstein to develop the technology.

Alpha Pro builds a profile of a trader’s desk. To do this, it will sometimes analyze hundreds of thousands of trades an institution has executed, as well as the conditions in which they occurred.

When a trader receives an order from his portfolio manager to trade a stock, Alpha Pro then scans current trading conditions and compares them to the historical trading profiles it built. From the comparable trading conditions, Alpha Pro recommends algo strategies that in the past generated alpha for the desk. The strategy is then executed in Pipeline’s Algorithm Switching Engine.

Alpha Pro predicts the order’s intraday alpha during those conditions, said Jigar Vyas, a director of program trading at Pipeline. Then Pipeline devises custom strategies that maximize the institution’s alpha capture, based on those similar trading conditions, he said.

"Once the data analysis confirms that those are the custom strategies that they’re looking for, we start the process for them," Vyas said. "Traders and portfolio managers decide which trades they would like to do, based on strategies that we’ve built for them."

And the strategies Alpha Pro creates are interactive–traders can alter them on the fly, or mid-order. They’re tailored to a specific trading situation as it evolves, Vyas said.

"It’s a profile of what historically has happened in these circumstances," added Fred Federspiel, Pipeline’s chief executive. "This is how the price has moved in situations that are roughly analogous to what just happened. … So, once that analysis is done, a strategy is constructed to maximize trading performance, given what’s expected to happen."

Alpha Pro sits atop Pipeline’s order execution hierarchy of services, Federspiel said. A significant part of its business today goes through the Algorithm Switching Engine, which has grown over time. The firm’s goal is to help institutions with alpha capture across the board. If it’s successful there, Pipeline estimates it will to end up with 80 percent of its orders executed through Alpha Pro custom strategies.

"The custom strategies in Alpha Pro help traders decide which orders to expose to block-trading opportunities," Federspiel added. "It’s working its way up the execution hierarchy, from destinations, to managing the algos, to developing custom strategies to manage the algos."

In late July, Pipeline visited potential customers to demonstrate the new service. One of those who kicked the tires was Chicago Equity Partners’ Fares. After the presentation, Fares acknowledged that giving more thought to alpha capture on the trading side was a good idea.

"[Alpha Pro] creates a DNA for the stock selection process," Fares said. "As long as that DNA can be traced and identified, and long as it remains consistent through time, then it can be helpful."

Pipeline’s moves over the past few years show a firm breaking from its brand to generate new sources of revenue in a changing world. Pipeline’s falling volume has shown how block trading has been a stagnating business, at best.

The May 6 "flash crash," and the months of volatility it brought to the equities markets, did block traders no favors, Federspiel said. The market dislocation discouraged many institutions from committing to trade in size.