Dark trading: The right balance

With rapidly growing assets, sweeping changes to regulation and growing fragmentation concerns, Ardevora’s Neil Bond talks liquidity and limits with Joe McGrath.

Ardevora – the asset manager established by veteran investment duo William Pattisson and Jeremy Lang – is coming up on its fifth anniversary.

After five years, the firm that started with seven staff now boasts more than 20 and is growing its assets under management at pace. It expects to exceed the £2 billion mark by the end of 2015.

The growth in assets is the result of a combination of clever marketing, tactical recruitment and the pursuit of a very specific investment niche.

Ardevora says the investment process involves an elimination of stocks, starting with small caps, followed by financials and emerging markets due to the opacity.

The firm employs a mixture of long only and long/short strategies (150/50) where the short exposure gives it the option to smooth volatility instead of just hedging it in a traditional fashion. Around half of the business’s funds are now invested in the UK with the rest sunk into global developed equity markets.

Familiar faces

The fund management team of William Pattison and Jeremy Lang have since been joined by Ben Fitchew and Gianluca Monaco.

Oxford alumnus Fitchew joined Ardevora in May 2010, having worked at Liontrust. Monaco joined a month later from New Smith Capital Partners, where he had been for six years prior to that.

Trading stalwart Neil Bond joined the company two years ago as a partner and works with Chris Mahoney who had been responsible for trading at Ardevora from the start, joining from Credit Suisse Asset Management at launch.

Bond is a familiar face to many in the market, having worked on both the buy and sell-side during his 25 years in trading. He started out with UBS back in 1998 before moving to Fidelity six years later. His career since then has taken stints at JP Morgan Cazenove, Sanford Bernstein, Bear Stearns and Espirito Santo.

He can also be credited with building ITG’s program trading desk from scratch.

Today Bond’s role remains a combination of analysis, execution and strategic development. He says his work complements that of Mahoney due to the nature of the portfolios they trade.

He explains: “I think I bring a lot of sell side skills and relationships to the party. Chris has always been buy-side and is very experienced in trading midcap names, often over a long period, balancing waiting for the right price and block trades against opportunity costs, a skill which can’t be taught but has to be learned hands on.”

Team approach

The team’s trading is execution only, so there are no research payment accounts or Commission Sharing Agreements (CSAs) in place.

Fund managers at Ardevora don’t direct trades, meaning that execution venue choice is at the sole discretion of the traders. However, there is some integration between the investor approach adopted by the traders and fund managers.

Bond explains that both teams like to understand what stage of the investor emotion cycle a particular stock is in – from reluctance, to optimism, to excitement, to exuberance, etc.

He says: “We are trying to bring the trading desk closer to the fund management team and trade as much as we can ourselves as we have a better idea of the investment aim than someone who is working an order for us.”

Bond says that the investment team will usually make a decision on stock and agree a timescale for the trade to be completed with the trading team. Once the agreement is made, the traders have the discretion to complete the trade as and when they see fit.

He says: “We are certainly not contrarian investors, but we do make unusual decisions at unusual times. We are not going with the rest of the flow in the market. We feel market timing is where we can add value. We don’t want to ‘just guess.’”

This house approach to what Bond describes as “unusual” decision-making isn’t unique to stock selection. It means the trading team discuss their interpretation of biases in the market when trading.

He says: “When people are buying, they are comfortable to be aggressive, but less so when selling. When they are selling, there is the aversion to making a loss. Therefore the losses are perceived to be bigger than the gains.

“That is the one area where I think the traditional sales trader can be very useful – more so than in electronic trading. We have a concentrated portfolio and we are able to monitor the flows in those stocks using IOIs [Indications of Interest], IB chats and day-to-day talking with sales traders to gauge where we are in the cycle.”

Bond says this is the reason that the cash sales trader role will remain for some time to come, because there is still considerable value in a good sales trader.

He adds: “Our easiest trades tend to be sent to automated strategies. There may be some quant decisions going into how that happens but we decide what strategy to use – portfolio trading, dealing with the cash sales trader or using an algo and we monitor all these things in different ways.”

Bond says the team analyses trades when they hit the blotter to filter out the names that are difficult and could take longer, allowing them to trade the simpler trades in a low-touch manner.

Expected duration and expected market impact are the two main factors they look for when determining strategy. The split between cash desk, algos and program trading is roughly 30:30:40, but the company’s algo usage is predominantly liquidity-seeking and the cash desk use is more reactive to IOIs than some.

Bond explains: “I would describe our trading style as patient and covert when possible. We embrace new ways of trading that help minimise market impact such as Turquoise BDS. The traders are often given a great deal of discretion over trade timing and faster is not always better.”

As it stands, the company doesn’t have any fixed income or derivative strategies. The trading team might handle futures on occasion, but not for asset class diversification, more to assist in achieving pre-set investment goals.

Most of the inflows over the past year have come in through a transition manager meaning that the trading team has not had to trade them on the inbound side.

But, the steady growth in assets under management to date and predicted upward trajectory has meant employing some strict parameters around trades.

Bond explains: “We trade quarterly rebalances, trade for cash flows, stop-losses, profit-taking and occasional strategic trades. While we have been experiencing growth in assets, we have used capital in the form of risk program trades to de-risk the investment process.

“I don’t see that as a long-term solution, but it suits our needs at the moment. Because our portfolios are somewhat concentrated, as we get bigger, we are seeing our illiquid names become more difficult to trade. This has led us to adopting an anonymous-as-possible trading style.”

Going dark

Bond is upfront about his team’s preference for dark pools for less liquid names and he is very realistic about the likely impact of the caps coming in as a result of regulatory changes from MIFID II.

He says: “With the less liquid names, we are quite heavy users of dark pools. When the dark pool caps come in, I think automation will have to become more opportunistic.

“At the moment, they don’t have the data set to calculate how to become more opportunistic so there may be some lag in development.”

One of the unintended consequences of MIFID I was the fragmentation of the primary market. Bond, like many of his peers, now believes that the market is witnessing the start of fragmentation in the non-displayed markets.

He says: “Some of the solutions that are appearing are quite complex, which may explain why the support that these venues have received hasn’t matched the supposed demand.

“I am very much of the opinion that if you are not having any success in non-displayed venues, then you are likely to experience quite a harsh market impact in the lit venues. I would say that if anything, it is becoming more and more the case.”

With participation rates significantly down for lit markets, comparing rates in the early nineties to today, most buy-siders are considering the future of liquidity.

Unsurprisingly, Bond admits that liquidity will remain front of mind throughout 2016 as regulatory requirements demand more of firms to prove Best Execution on behalf of their clients.

He says: “MIFID II will also be a big driver in 2016 and traders will have to become more aware of the venues that they are using and take greater responsibility for their performance.

“There seems to have been a proliferation of solutions to the dark pool caps and while I will support these non-displayed venues, if there are too many, they won’t succeed.”