Galen Stops takes a look at how and why Aston Capital Management is planning to scale up following its recent $100m investment. 

Aston Capital Management recently received an injection of $100 million in AUM and an additional $5 million in seed operating capital from private investors.  Following this investment, the firm’s CEO Isaac Lieberman is, perhaps unsurprisingly, bullish about its future.

“We have a goal through our strategic mandate and product development timeline to have capacity to be managing $2 billion in AUM within two years and I can actually see us achieving this goal quickly as this business accelerates,” he says.

To help achieve this goal, Lieberman has deliberately been structuring the firm so that it can easily scale up in the future. For starters, the firm has been getting a whole slew of regulatory and accountancy registrations in place.

Aston has registered as an Investment Advisor with the Securities and Exchange Commission (SEC) and has plans to also register as a broker-dealer with the SEC in the future, while it has registered as a Commodity Pool Operator with the Commodity Futures Trading Commission (CFTC) and has a pending application with it to become a swaps dealer. These various registrations obviously broaden the amount of business lines that the firm can engage in.

However, it’s not just on the legal side that the hedge fund has been busy. The firm has moved its New York office into a new suite in Rockefeller Plaza, opened an R&D centre in downtown Tel Aviv, hired a chief technology officer, chief data scientist, chief compliance officer and a risk manager. The team currently numbers 14 people today, with plans to expand to about 19 over the next two months.

On top of this, Lieberman has been busy overseeing the establishment of various custodial and administrative accounts, registering the fund both onshore and offshore so that it can target a global investor base, organising credit facilities and getting certified with FX prime brokers and migrating the firm’s existing liquidity provision trading strategy into the new business unit being formed.

“We built ourselves from day one to become big,” says Lieberman. “We’ve put all these structures in place so that we can grow without having to get additional registrations and so that we can raise additional AUM in a very seamless, directed manner in the future. Most firms on Wall Street are run in a very siloed portfolio manager model, which limits scalability. By contrast, we’re taking a value chain approach.”

To understand exactly what is meant by this last comment, it’s important to look at the platform that is being built, which will initially consist of three main business lines: principal liquidity provisioning, execution services and quantitative research.

Quant tools > Excel spreadsheets

The FX spot liquidity provisioning business is relatively straightforward and is what the firm has been focused on for the past couple of years. Lieberman says that his fund will aim to continue building its presence on the primary multibank platforms, while maintaining disclosed partnership relationships with wholesale FX trading firms and connecting to any new FX platforms that may crop up.

“We’re always early adopters of new electronic platforms and believe in connecting to every one that exists, regardless of whether they’re successful or not, because we cannot predict who the winning horses in this race will be. Each of these new platforms might have different protocols and technology behind them, so it’s important to connect to them and understand how they function because one of these new ECNs might become an important liquidity venue in the future,” says Lieberman.

Obtaining the swap-dealer registration is key to the firm’s future plans for a few reasons. Firstly, it will expand the number of products that it is able to trade, allowing the firm to move into the forwards, swaps, NDF and options markets.

On the surface, it might seem like there’s limited opportunities in some of these product types for a hedge fund that deploys quantitative trading strategies, but Lieberman explains that the firm will adapt its approach to how these markets operate, hiring voice traders to execute them, while these voice traders will in turn be informed in the background by quantitative tools and neural networks being built in the firm’s R&D centre.

“Although we can’t change how these markets operate right now, we’re not going to sit on the sidelines and wait for them to shift to electronic trading. But instead of using an excel spreadsheet, a pen and a pad of paper, we’re creating quantitative tools as the source for pricing and trading. We’re building a dashboard, a command and control centre, in which will be very deep relative value tools, fair value tools, liquidity sourcing and distribution tools,” comments Lieberman.Acting as a dealer

The swap dealer registration is also important for building out the execution services desk, which will offer end-users access to Aston’s technology, quantitative research and neural networks. Importantly, Lieberman emphasises that this execution services desk will remain the principal to all the risk transfers.

Most real money firms, macro hedge funds, endowment and pension plans have to trade FX at some point because of their international investments. Some will want to trade spot, but then need to roll those positions using forwards, while others might want to hedge their exposures using options or NDFs. Lieberman claims that there is a big gap in terms of servicing these clients and offering the liquidity, pricing, technical expertise and systems research that they need. He adds that Aston Capital Management, as a principal trading business, is already building all these mechanisms for its proprietary trading and could leverage them for these firms as well.

“We’ll be able to offer proxy hedges, so for instance we might be able to get great liquidity in a fixed, three-month date, but there might be an end user who needs to trade at 102 days instead of 90. As a liquidity provider who has capital, we could create a product to give the user liquidity and a deliverable on the exact date they need and then run a relative value hedge against that – which is within our risk trading mandate – to be a value proposition to that client,” says Lieberman.

He adds: “Additionally, we want to create fair value models that take into account, not only the forward curves, but also the deposits and overnight swaps and have a real indication of what the fair mid is for a forward. A lot of people today, when they look for where the market’s at in these products, think about it like spot and focus on the bid/ask, but the bid/ask actually represents a point on the yield curve and so it’s important to think about what interest rate you’re paying in and what interest rate you’re receiving. What we’re doing is thinking a bit more like a dealer in terms of pricing these instruments.”

The swap dealer registration is also important, because it puts Aston in the same regulatory bracket as many major banks and other large financial institutions. This means that when potential investors are doing their due diligence, they know that the fund is a regulated entity capable of being audited, and has documented compliance procedures, operating procedures, risk procedures, disaster recovery procedures, etc. This, claims Lieberman, should give clients greater confidence when investing or partnering with the firm.

On the flip side of the coin, he points out that the registration will enable his firm to engage and trade with other swap dealers on a dealer-to-dealer basis, rather than as a client.

“This means that we will be able to trade with the largest institutions in the world and their wholesale inventories, their wholesale flows. We can then make markets to them and they can make markets to us, dealer-to-dealer. So it puts us in a better place to access liquidity, source liquidity, transfer risk and trade risk, because we don’t have to come in as a custodial client with all the protocols that are in place for the purposes of protecting the client at an institutional level. Dealers need to trade with dealers at a very professional level, that’s ultimately how you can move risk,” says Lieberman.

One obvious question regarding this business model is the extent to which FX spot liquidity provisioning is a good business line to be in, given how commoditised most of the G3, or even G10, spot products have become and how thin margins are as a result.

Lieberman responds that the ability to monetise these markets is twofold. On the principal risk trading side, he says, the firm can produce good regime trading strategies where the liquidity provisioning becomes a feeder of risk into quant-based risk models.

“So in other words, we have models that have a view on where the market is and what we believe it should do, and those models have a certain amount of risk that they need to put on to justify the strategy to our AUM base. There’s no better way to feed a strategy than with liquidity provisioning. Think about it from this perspective: if we need to get long €200 million, what better way to do it than to skew our bid as a liquidity provider into a global distribution network in addition to crossing the spread? So we can blend being a liquidity provider with a principal risk, quant model,” he says.

On the execution services side, Lieberman explains that when a client wants to trade spot, his firm can help by executing that as a principal that has better distribution and systems, in addition to algos that are connected to neural networks which observe real-time data, compare it to historical data and are therefore able to make adaptable judgments on the best way to execute in real-time.

“As we perfect this trading method where we’re connecting this real-time data, historical analysis and back testing, then we can offer these clients not just an algo strategy, but as an integrated liquidity sourcing and execution model. That will be of big benefit to real money users and macro hedge funds. So now all of a sudden the spot market has a value proposition for people that want to engage us and compensate us for plugging into their execution model. We can then give them the full bandwidth of what of everything we have, not just an algo strategy connected to someone who’s an internaliser,” says Lieberman.

He swiftly adds: “Spot isn’t going away, it just gets bigger and bigger and so we’re just finding smarter ways to trade it for principal risk and then to work in a partnership model with other firms to access that spot liquidity.”Secular decline?

Another potential issue with the business model worth considering is whether, despite Lieberman’s claims that being a registered swap dealer gives

his firm a better way to interact with both clients and dealers, banks might come to see Aston as a competitor for client business.

However, Lieberman insists that this is unlikely, stating that he views his firm as being a boutique offering and that, despite the plans to swiftly scale the business up, the end-goal is not to try and disintermediate the top banks in the FX market. Instead, he points out that regional and mid-tier banks are clients of the largest FX banks and thinks that his firm could occupy a similar position, actually benefiting the large banks by bringing them new business.

But there are also broader question marks around currency-focused hedge funds right now. For starters, it’s been well-documented that these funds have, generally speaking, not been performing that well in recent years. This has led to speculation about whether this has been caused by a poor market environment for trading or whether it is symptomatic of a more secular decline in this segment of the market.

“This is the big question that a lot of people have been trying to answer,” says Lieberman. “When there is low volatility and you have trends that start and stop and then don’t follow through, any trend follower – which is what most currency hedge funds are – will not produce returns. You need sustained trends.”

On the other hand, he muses, there have actually been some nice trends recently, such as EUR/USD, which went from 1.07 in January 2017 up to 1.20 in September followed by a small dip before continuing to 1.24 by early February 2018, a 15.8% increase.

“Very few people caught that move. One reason for that is because the old trend following models where you get in, the move starts going your way and then you hold on until your signals tell you to get out, aren’t compatible with these moves where the follow through and pullbacks that happen are much slower. And that might actually be a structural issue because today all information is known, all markets are connected, correlations are precise, tick for tick. On the quant side, that creates great opportunity for correlation trading, but on the trend following side, what it does is it removes that lead lag,” says Lieberman.

He adds: “I believe that a lot of great macro traders of yesteryear used to have this kind of insight where they could see something happen on one side of the world, understand how it should effect a currency on the other side of the world, and then take a position that, over time, would then give them a big win as a result. But today, because everything’s electronic and it’s all connected, there’s no longer this time gap, everything moves in tandem.

“So our model as a hedge fund is to produce returns by being actively engaged in trading in the liquidity premium and the risk premiums as a liquidity provider just as a FICC desk inside a bank would trade. So for us, whether it’s a high volatility or a low volatility market, we should always be putting up a consistent return. The business model is more dependent on relationships and volume traded than any one market creating a trend that we happen to be able to capitalise on.”Adapting fee models

Of course, a lack of volatility – or perhaps more accurately, volatility that only lasts for very short periods of time – has become a characteristic of the FX market in the past few years, and is another factor often blamed by some for reduced returns in the asset class. So another question worth posing to any FX hedge fund looking to scale up is: will sustained volatility come back to the market any time soon, if ever?

“Look, as a trader, you have to engage the present as absolute, but also be willing to change, adjust and adapt as tomorrow’s regime becomes absolute. So this current volatility reality is absolute, and as a trader you have to behave as though that’s how it will be forever because your career and performance is based on the present. Even though only a few years ago this reality was very different,” says Lieberman.

This is again why the neural networks that Aston is building are so important; because they are focused on regime identification, so that complementary strategies can then be built around the existing regime. This, according to Lieberman, is preferable to either waiting for the market regime to change or utilising strategies that are ill-suited to the current regime.

Broadening out the perspective even further still, one of the biggest trends in the hedge fund space in recent years has been the downward pressure on fees. Traditionally, hedge funds charged management fees of 2% and had a performance fee of 20% of profits, the infamous “2-and-20” model.

However, in recent years, investors have been pushing back on this model, with the result that, according to a Credit Suisse survey released last year, 57% of investors reported that their management fees had been lowered over the previous 12 months. How then, does Aston plan to charge its investors and clients for the services it will offer?

“We have our investors, who invest AUM in our firm and we charge them hedge fund fees. We might be open to giving incentives if it makes strategic sense for both sides, whether it be 2-and-20 or 1.5 and 15, that will be on a case-by-case basis. But those are hedge fund fees for our responsibility to deliver returns on AUM. One of the benefits that we offer on the execution services side is we’re principal to the trades, we’re not just an intermediary, so we actually own the relationship, we own the risk on that relationship going forward and we’re accountable for many transactions completed over time. So there the fees are embedded in our trades and they can even be negotiated upfront to be fully transparent. But those fees are different because those are fees for trading as liquidity partner, not for producing returns AUM,” says Lieberman.

Once a trader……

Confident that none of these trends will hamper Aston Capital Management’s growth, Lieberman already has one eye on new business lines for the firm to expand into.

The reason why he plans to register the firm as a broker-dealer is because it will enable it to trade in products such as corporate bonds and off-the-run treasuries and then link those to the futures, options and swaps trading. In total, Lieberman estimates that there are close to 50 potential business lines that he could build out horizontally across the fixed income, currencies and commodities markets globally.

That is a lot of business diversification right there, but even if his grand ambitions for the firm are fulfilled, Lieberman insists that he won’t be straying too far from the trading desk.

“My role now is to make sure that all the pieces are in place at the firm, that everybody has the resources that they need, that the business model makes sense and that it’s being executed efficiently on all gears,” he says, adding, “As the firm grows bigger and bigger I will continue to do all these things. But my heart is in trading, I love trading risk and running a risk book, so I’ll always be working very closely with the trading desk.”

Galen Stops

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