From the February 01, 2006 issue of Futures Magazine • Subscribe!

The Great Divide(s)

Paolo di Montorio-Veronese runs a company called PdMV Capital. The letters come from his aristocratic name, and the fund of funds he just launched, the PhD Fund, boasts an impressive 16.6% proforma return, with volatility of just 5.1% and a Sharpe ratio of 3.1.

To assemble it, he reviewed scores of traders across Europe, and he says the trading pool he went fishing in wasn’t much different from the pool of talent you’d find in the United States. “Whether based in Chicago or London, every commodity trading advisor (CTA) follows his own model, and those models vary more depending on the individual than on where he is located,” he says. “We have commodity traders in London who are trading primarily in Chicago, and they use the same methods any would use to analyze markets and identify trends.”

He adds, however, that he specifically sought out traders who were active in the world’s most deep and liquid markets and used automated systems. “These people have trading desks that are manned 24 hours a day, but the actual trades are on autopilot,” he says.

WORLD'S TIME ZONE

While algorithmic traders can be in all time zones, discretionary traders need to be on top of their markets. Several discretionary currency traders like Michael Hecht (see Trader Profile, January 2006) and Mikkel Thorup say the consistent high numbers posted by European currency traders grow from a combination of world view and time zone positioning.

“There are distinct advantages to being a currency trader in the European time zone,” Hecht says. “First, there's the cultural element: We all grew up changing currencies every time we traveled in one direction or the other. And then we have a time zone that enables us to get the meat of Asia, Europe and North America, which you won't find in Chicago, and definitely not in California.”

Thorup, who runs Zurich-based CTA Capricorn Group, agrees. “We get coverage of several time zones,” he says. “We get the late part of the Far East, Sydney, all of Europe and the full open when the U.S. guys come in around 1 p.m. European time.” Plus, he adds, they grew up keeping track of fluctuating currency crosses the way Americans keep track of box scores.

Both men shy away from algorithmic trading and focus instead on discretionary approaches. “I’m not sure we are looking at anything differently than what people look at in the U.S.,” Thorup says. “We take our signals from a 24-hour trading day rather than, say, the International Monetary Market in Chicago. But that is the norm around the world these days.”

NATIONAL NICHES

But perhaps the most particularly, if not typically, European players are those like Michael Rothman, who specializes in Danish Mortgage Bonds (see “Nordic Niche,” below). “Most of the people who trade like we do aren't CTAs,” he says. “As a result, the global funds took a while to find us.” Similar niche markets exist in most European member states, including Germany, Italy

and France.

“There is a tendency for European traders to look for the smaller, inefficient, niche market, where they can achieve large basis-point gains on smaller trades,” says Simon Rostron, a media consultant for hedge funds. “In the United States, the emphasis is on larger trades with smaller basis-point gains.”

But if di Montorio-Veronese's experience is any indication of the future, growth among European traders will come among those in the deepest, most liquid markets employing algorithmic programs. “The new wave of traders making their name in Europe are coming out of American banks with a presence here,” he explains. “They don't trust illiquid markets.”

STRUCTURAL DRIVERS

Both the European love of niche trading and the tendency of American-trained traders to pursue pan-European strategies flow from the evolving structure of European markets, which are harmonizing slowly (see “Hitchhiker’s guide to the E.U.,” July 2005) and still have local markets dominated by local banks. American banks, on the other hand, have been the greatest believers in a unified market and have been the biggest players in pan-European products.

“It makes sense that European traders who learned their trade at American banks will be attracted to international markets, like currencies,” di Montorio-Veronese says, a veteran of Goldman Sachs himself who did a stint with Morgan Stanley before heading Man Group’s European sales operation. “But it also makes sense they will develop systems that can be adapted to the most deep and liquid markets worldwide.”

The differences in the trading rooms reflect a variety of differences in the structure of markets themselves. Even as cross-border clearing and settlement becomes more practicable, cross-border marketing of retail products remains a sticky issue. One result: the prevalence of guaranteed funds in Europe.

Investors in such funds are guaranteed a certain return if they stay in the program long enough (see “Guaranteed profits: Pipe dream or reality,” December 2002). The guarantee is usually ensured by putting most of the money into zero coupon bonds that mature at the same time as the guarantee runs out. In the United States, such funds are generally perceived as little more than marketing sleight of hand, but in Europe, where Man Group has been offering such programs since 1983, guaranteed funds are considered a bona fide value-added product. Rostron offers a reason.

“There is a tendency of people in the U.S. to dismiss guaranteed funds, because they figure they can just go out and buy the bonds themselves,” concedes Rostron. “But if you're sitting in Bahrain, buying the bonds is easy in concept but less easy in fact.” And, lacking a home market the size of the United States, European hedge funds are marketing themselves aggressively in multiple jurisdictions.

HARMONIZATION

Switzerland is second only to the United Kingdom in the number of hedge funds servicing continental institutions. But, since Switzerland is outside the European Union, Switzerland stands to lose out on the retail boom as the European Union moves towards harmonizing financial services.

Laws regarding brokerages based in one member state but with branches in another have come more clearly into focus since we visited the subject in July. On Jan. 1, several countries came into compliance with the “passport” requirements of the E.U.'s Markets in Financial Instruments Directive. As of that date, for example, brokerages based in, say, Lichtenstein could open branch offices in other member states without being licensed locally. Instead, Lichtenstein’s Financial Supervisory Authority will keep tabs on the activities of companies based there and send reports to regulators in other countries.

But there are still plenty of issues to be resolved in terms of hedge funds, which often fall into a no-regulator’s land between institutional and retail. The European Fund and Asset Management Association has come up with two proposals for harmonizing and streamlining hedge fund laws across the European Union. One focuses on the structure of supply, or how funds are structured, perhaps through amendments to the existing UCITS Directive. The other focuses on the structure of demand, or who is allowed to invest in hedge funds.

However, with retail brokerages across the continent gearing up to sell the things to private investors, you can bet which proposal will get the biggest industry push.

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