'Black box' hedge funds buy exchange seats to dodge brokers
LONDON (Reuters) - Some of the world's top computer-driven hedge funds are buying exchange memberships to trade directly on the biggest commodities and financial futures markets, saving on the sizeable commissions normally paid to brokers.
Eager to improve returns and keep details of their 'black box' trading strategies as secret as possible, so-called CTA (commodity trading advisor) funds are buying exchange membership seats for hundreds of thousands of dollars.
These include Winton Capital, one of the world's largest with $29 billion of assets, and Cantab Capital with $4.5 billion.
Direct membership allows these funds, which can make hundreds of trades a day, to dodge broker commissions which often run into tens of thousands of dollars a week for the most active funds, one futures broker said.
Cambridge-based quantitative fund Cantab Capital said it spent in September more than $1 million on three seats at the Chicago Mercantile Exchange, the world's largest futures market, where it puts through at least half of its trades.
"We estimated what we have executed over the past year and worked out that we would make back the cost of the three seats in less than six months," said founding partner Ewan Kirk.
"There is a lot of talk about trading costs at the moment and everybody should be focused on getting the lowest cost possible."
Winton became a member of the CME last July, according to a notice on the CME Group's (CME.O) website. Winton declined to comment.
Broker revenues have been boosted in recent years by the rapid growth of the CTA industry, which more than doubled in size between 2009 and 2011 to $188 billion, according to Hedge Fund Research.
But if more hedge funds were to take up exchange membership the largest futures brokers could lose tens of millions of dollars in commissions.
The world's top futures brokers include Goldman Sachs (GS.N), JP Morgan (JPM.N), Morgan Stanley (MS.N), UBS UBSN.VX and Newedge - owned by Societe Generale (SOGN.PA) and Credit Agricole (CAGR.PA).
These firms declined to comment on the trend. A spokeswoman for the CME Group also declined to comment.
CTA funds, which can trade on anything from currencies to orange juice futures, are particularly interested in the Chicago Mercantile Exchange, the Chicago Board of Trade and the New York Mercantile Exchange, all owned by CME Group.
"The big CTAs are seriously considering it. It's probably to do with costs and there's an element of secrecy as well," said Stephen Piron, director of hedge fund consultancy BrightSun Group, which works with CTAs.
Membership at the Chicago Mercantile Exchange currently costs about $465,000 based on the last seat sale registered, on November 2 this year.
A seat at the Chicago Board of Trade might cost $295,000 while membership at the New York Mercantile Exchange comes in at about $310,000, according to recent sales reported on the exchanges' websites.
Typically members pay $0.25 per trade to deal foreign exchange futures on the CME compared with $1 for non-members while members pay $0.05 to trade U.S. Treasury futures on the CBOT against $0.50 for non-members, according to published rate schedules.
The savings are negligible for low volume traders but black box hedge funds churning out many thousands of trades a day can save tens of thousands of dollars each month.
Historically hedge funds have rarely bought membership of exchanges, despite fears that details of their trades - which can be bulky and take hours to execute - can leak from their brokers into the market and hand an advantage to rivals.
Funds have been put off by the high up-front cost of exchange seats and the fact that trades are spread over hundreds of markets globally, meaning they would have take out membership at dozens of exchanges.
But their spending power has been growing thanks to an influx of investor cash in recent years on the back of strong investment performances during the 2008 market chaos, which has seen some large CTAs balloon in size.
"It all depends on size," said Cantab's Kirk. "If you're a $100 million fund with one guy in a garage you don't care. But if you're a fund with, I'd say more than $1 billion, then I'd be surprised if you are not at least considering membership."
(Additional reporting by Tommy Wilkes and Alexander Smith; Editing by Greg Mahlich)
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