Demand from the buy-side for risk prices to support equity trades has risen more strongly than the sell-side’s ability – or willingness – to supply it, the latest monthly poll on theTRADEnews.com has found.
When asked to identify the biggest change in the market for risk pricing over the last six months, 41% of respondents cited an increase in demand for single stocks, while only 14% claimed that greater supply of risk prices for single stocks was the most notable development since March. A total of 33% of participants in our September poll said the buy-side’s growing interest in risk prices for basket trades was the major trend since the end of Q1 2009, but only 12% suggested that a stronger sell-side desire to commit capital to basket trades was the headline story over the period.
One reason for demand apparently outstripping supply is that – despite a six-month bull run and some surprisingly positive macro-economic data – the equity markets have not returned to the benign conditions before the gathering storm that culminated in the collapse of Lehman Brothers last September.
Tony Whalley, head of dealing and derivatives at Scottish Widows Investment Partnership, said the recent period of relative stability has resulted in a decrease in the “astronomical” risk premiums charged for both single stock and basket trades in the immediate aftermath of Lehman’s bankruptcy. “But while these levels appear attractive compared to those available nine months ago, they are still considerably higher than those on offer two or three years ago,” Whalley observes. “Rather than saying that the demand has increased, we should be saying that the supply has returned to a level where it can be viewed as mildly attractive.”
A combination of uncertain market conditions and unhealed scars are giving the banks plenty of pause for thought, market participants observe. “Natural liquidity is still subdued and volatility has still been relatively high, so the banks find it harder to price risk capital profitably,” said Richard Balarkas, CEO of agency broker Instinet Europe. As a result, risk pricing is not as widely or easily available as, say, two years ago. “It is entirely at the discretion of the broker as to how much capital they are prepared to supply and it would be a risky approach for them to provide this service to clients who are likely to generate high loss ratios,” commented Paul Squires, head of trading, AXA Investment Managers.
Less clear, perhaps, are the reasons why buy-side demand should have picked up so strongly in the last six months. Are asset managers returning to traditional practices despite some very evident changes to the trading landscape? Not necessarily so, according to Squires, who suggests buy-side traders are simply choosing appropriately from the trade execution options available. “Self-directed trading is optimal for certain types of trades, but not necessarily when the trader requires immediate liquidity which can be supplied by use of capital commitment from a broker,” he said.
Instinet’s Balarkas says internal pressures as well as fine judgments may be driving the buy-side’s increased desire for capital. “Some buy-side traders know their stocks as well as the sell-side and are therefore good judges about whether the risk is priced correctly,” he said. “Others, unfortunately, are pressured by their PMs to ‘get something done’ at or about the screen price when the order is first given to them.”
The fact that the poll found a slightly higher level of buy-side demand for risk pricing when trading single stocks compared with baskets can also be attributed largely to the greater urgency of single stock transactions.
“PMs are generally taking a very specific view on a single stock and might want to maximise immediacy of liquidity at certain market levels, whereas baskets are more often as a result of portfolio changes (asset allocation decisions) or cash flows (subscriptions or redemptions) whereby a less aggressive execution strategy would be more likely,” explains Squires at AXA Investment Managers.
“This probably depends a great deal on how you define ‘basket’,” adds Instinet’s Balarkas. “The large transition players and buy-side program desks are highly attuned to overall transaction costs and many seem to favour the agency approach to handling their business.”