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The benefits of going in-house

David Ketley, head of dealing, Harmonic Capital

Founded in 2002, Harmonic Capital believes in doing things in-house – a reflection of the idea that the buy side should take control of its own destiny. Yet this is not a free-for-all. David Ketley, head of dealing sees his role as something similar to a pilot, an aircraft through potentially turbulent skies to a target destination. That destination is decided by the firm’s computer models, built by an in-house research team.

“My role is to manage the execution of trades that the models give to us,” he told the Buy-side Perspectives. “As traders, we get involved in sourcing the data that feeds the models and looking at which instruments to trade. But the core is with the research team. As for
execution, the priorities involve hitting the right liquidity, the right venues and counterparties.”

Ketley joined the company ten years ago, in 2007. Working his way up through the company, he has been head of trading since October 2014. Harmonic Capital employs an investment philosophy that has been consistently developed and applied since the firm was founded in 2002. Specialised in spread based trading strategies, the aim is to provide uncorrelated absolute returns in all market conditions. For example, Ketley describes the firm’s approach to analysing pricing as “very quant”, a term sometimes associated with high-frequency traders. Yet Harmonic Capital is emphatically not an HFT business – on the contrary, Ketley states that slow and steady is more the firm’s style than an aggressive intra-day approach, and points out that Harmonic Capital tends to hold positions “for a long time”, adding that the firm finds a more passive trading approach to be appropriate for its goals.
Perhaps the single most distinctive feature of the firm’s approach is the fact that it uses so much in-house technology, rather than relying on brokers or third-party tools. 

“We do the vast majority of  our FX trading via a home built FIX API,” said Ketley. “We have direct lines and we have an in-house pricing system. The advantage of doing that way is it gives us a lot of control over the data. We harvest data on spreads and look at it over bespoke periods, by size bucket, currency pair and component we can really tailor it to suit our needs.” 

As with any decision, there are advantages and disadvantages to this approach. Selecting in-house solutions does provide the ultimate control; the down side is that when a change needs to be made, whereas with a ‘plug and play’ system it could be done very quickly, a custom-built system may take longer. 

But Ketley believes this is a trade-off that is well worth making, particularly as the firm’s counterparty strategy is stable and does not involve too much changing anyway. 
The flexibility to tailor the system exactly to the trading desk’s needs is key. 
For the most part, the use of trading algorithms in FX by the buy side is relatively limited – although there are some exceptions (see Patrick Fleur, Issue 7). However, many recognise the increasing electronification of the non-equity asset class markets, including FX, and at least one pioneering firm has been using them in FX since 2002. Once the decision to use algos has been made, the main question becomes whether to build it in-house, obtain it from a broker, or consider a third-party algo. 
Harmonic Capital uses in-house algos that can be customised to its specific needs – but the firm does not use any third-party algos for FX. While Ketley wouldn’t rule this out in the future, his concern is being able to maintain the transparency and understanding of how they work and being able to explain it if need be. With external algos, this could be difficult, especially as by their nature the way algos work is not always totally transparent due to the need to retain some element of commercial advantage for the vendors. 

 

“We use in house algos,” said Ketley. “We do that via the FIX API. We speak to the developers directly so that they understand what we are trying to achieve. Those in-house relationships and those conversations make it so much easier to customise the algos exactly the way we want them.”

The firm’s approach to data is similar. Harmonic Capital does all its pre-trade analysis in-house, as well as most of its TCA – although in the case of TCA, the firm is starting to incorporate third-party TCA. However, even here Ketley feels that caution is warranted, and prefers to create the firm’s own TCA, within reason, due to the flexibility that in-house solutions provide. That said, there is a balance to be struck and the firm is keen to get the best understanding of the market possible. 
Harmonic Capital performs a systematic multi-strategy approach, with the objective to capturing alpha from liquid futures and currency markets through macro-economic understanding. In terms of trading performance, relationships with brokers are key. 

“We would rather have a low number of high quality brokers than a huge panel,” said Ketley. “Having a meaningful relationship pays dividends in the end because you get better pricing and spreads.”

Some buy side firms have cut their broker lists in recent years. Notably, Deutsche Asset Management cut their broker list down to just five brokers. However, Ketley points out that the right number of brokers really does depend on the level of assets under management, the types of flow being traded and the business objectives. 

“You need a sufficient number to get the liquidity you need, which in turn relates to AUM and ticket size, so there is no magic number,” he said. “But we stay prudent and keep it on the low side. We want to avoid a formulaic number, e.g. 25 brokers; we review our brokers quarterly.”


“Day to day we have questions and want to talk to them. If we have a liquidity provider who is under providing in a currency pair, we can go to them, show them charts that show the performance and they really appreciate that. To evidence it is much better than shouting at the trader or using arguments which ultimately come down to anecdotal evidence. We find using hard data is something the banks really appreciate and it makes them hungry to do business with us.”

If there are areas where the services provided by the sell side could improve, David believes these can be around NDF liquidity and being more responsive to the buy-side’s feedback on the broker’s performance. The firm has an emerging markets book which includes NDFs, in which liquidity can be variable and streaming sizes can be quite small. One challenge Ketley has found is that banks may not be able to stream pricing in less liquid products in the sizes the trading desk would like – although he acknowledges that this has improved in recent years as the market has shifted towards more electronic trading. 

 

“We have a challenge in that our trades are spread-based so we have generally more than one currency to trade at a time, and our models have to change their views at the same time of day, so we need to find periods of liquidity through the day where we can adjust the models,” said Ketley. “For example, we trade dollar versus Korean won. We need to change our views in our EM book at the same time together. Korea is an obvious challenge. The Seoul hours are at night. We also have some Latin American currencies in the same book so finding a time of day is a challenge and the window is quite narrow. This is where the liquidity providers review process has paid off. Years ago we would be met with raised eyebrows trading KRW in the afternoon but through sharing appropriate data and transparent relationships, we can get decent pricing on say a Friday afternoon due to good relationships with the brokers.”
 

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