Recently chatted with a GP at a small HF that has market making in some niche derivatives as part of their core strategy and it got me thinking about this from a buy & build perspective. Would love to hear from anyone that has actual experience working at/with market makers about if something like this is even feasible/makes sense and what challenges would be faced.
We all know there are big boys - e.g. Citadel, Virtu, JS, SIG - who rule the most widely traded markets like equities, options, ETFs, and fixed income. Then there's smaller players (large in their respective markets) like Jump, HRT, IMC, DRW, and FlowTraders. But what about the smaller trading desks out there? Firms with 10-20 FT people who know a specific product/group of products super well and dominate their own corners of the market. It seems like there could easily be 100s if not 1000s of these small trading desks that have all carved out their own little niches and, while not able to massively scale like one of the big boys, manage to make a very comfortable living for themselves.
Aside from the obvious points - why would they work for someone else, what's in it for them, etc. - what are other challenges you'd face in trying to combine these into a larger entity?
When I think about what Constellation Software and other aggregators have done rolling up small niche players in a broader industry (often companies that don't strategically benefit directly from being under the same umbrella as a bunch of other unrelated vendors with different products and end markets) and I look at this sector, it seems like there could be something interesting here but I just don't know enough about market making to think deeply about it.
@surge-protector you've been helpful in the past, anything you could opine on here? I realize it's not exactly a multi-manager but it seems like in practice the execution would resemble something similar to one.
Building a market-making business through a "buy and build" strategy is an intriguing concept, but it comes with significant challenges and considerations. Based on the most helpful WSO content, here are some key points to think about:
Challenges in Scaling a Market-Making Business:
Technology and Infrastructure:
Talent Retention:
Regulatory and Compliance Hurdles:
Liquidity and Capital Requirements:
Cultural Integration:
Competition from Big Players:
Potential Opportunities:
Focus on Niche Markets:
Economies of Scale in Back-Office Functions:
Cross-Market Synergies:
Leveraging Data:
Feasibility:
While the idea has potential, the feasibility depends on the ability to overcome the challenges mentioned above. A successful roll-up strategy would likely require: - A clear focus on specific niches where competition is limited. - Significant upfront investment in technology and infrastructure. - A strong value proposition to attract and retain top talent. - A long-term vision for integrating and scaling the business.
In essence, while the concept is interesting, the execution would be incredibly complex and capital-intensive. It might be more practical to focus on building a single, highly specialized market-making desk and scaling it organically rather than attempting a roll-up strategy.
Sources: https://www.wallstreetoasis.com/forum/trading/converts-trading?customgpt=1, How bad are things going to get?, Market making group exercise, Payback: From Michael Milken to HFT, The Mechanics of a Mispricing
There are a lot of small firms like this that focus on one niche and don't want to grow beyond that, but have been operating for many years. Sometimes they are like a pod in a larger firm and use the larger firm for execution, but run their own business separately and have their own legal entity. All the big MM and HFT firms have a few external teams like this. These aren't necessarily ideal for a junior person to learn or grow though, and tend to hire sub-pm with existing strategies from larger firms. They do occasionally change hands and get bought by other firms. One example of a holding company like this is AMG.
if you have a bunch of capacity-constrained financial service businesses, how do you create value by acquiring them? unless there's some legit tech advantage or capacity / scaling upside, this strategy would most likely just be a wealth transfer mechanism to founders. like the traders / partners at each of the firms will still want healthy payouts and youd have issues with defectors leaving after a few years to recreate the biz they sold, b/c they can do it better than you. so in all likelihood, youd be paying a premium for short-dated cash flow with limited scaling / integration capabilities
I would like to think that there could be a tech advantage when it's operating at scale and can share that as a cost center. As far as capacity/scaling, I like to imagine there's some opportunity (albeit a smaller one) when you can pool the data in a "central book" and try to detect cross factors across these different esoteric products when you're looking at them big picture vs these smaller teams would naturally have no way of determining when they're laser-focused on their own specific niche. I would assume there's some degree of a proprietary data advantage that each team would offer for something like that when you're going after groups that have traded a single product/sector for a decade+. Admittedly that could just be a mix of ignorant hubris and wishful thinking.
The defector component is something idk how to solve for... I know some of the big Market Makers have some super aggressive non-competes but idk how realistically enforceable those are. Chances are they'd probably become another barrier to actually getting the teams to agree in the first place...
I think you’re right, but at a very small scale. Speaking for the Canadian market, there are lots of folks who retire from formal trading and offer market making to micro cap issuers.
For 5-20k a month they will trade your stock, and will have 10-20 clients, operating on a P&L basis.
Benefits of rolling these up are increased capital base to deploy when needed, diversification on clients, brand to increase client inbounds (issuers will turn over once they become big enough), and cost synergies on admin / trading software.
A lot of these people operate on referral models of 25% or so with people in the space, so you could realistically adopt a franchise model and let these quasi retired people operate within your platform and pay their pound of flesh.
It’s not a billion dollar idea, but I think it could be tens of millions.
It's an interesting thought for sure and potential way to get the ball rolling, thank you. How would one go about identifying who these mini-market makers are? Are their contracts generally public given they're working with pubcos?
I don’t think they are usually press released. I’d ask issuers
Reprehenderit commodi vero expedita tenetur consequuntur nihil. Consequatur vero deleniti eveniet et. Nihil accusantium molestiae id omnis et ut iusto. Rerum est beatae aut quisquam officiis eius.
Et officia consectetur odio optio. Magni odit quae doloribus architecto in quia. Est iure id esse est.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...