In 2009, buy-side traders’ mastery of electronic trading came under the spotlight as they put measures in place to deal with an almost unprecedented trading environment. Tools such as direct market access, execution algorithms, dark pools and crossing networks were crucial in getting trades done at an acceptable price during the period of falling values and unpredictable volumes and volatility.
Self-sufficiency was very much the order of the day. “In the first three months of 2009, the effects of reduced trading activity were incredibly significant. There were very few counterparties and very few brokers willing to commit capital to help us get our trades done,” comments Tony Whalley, investment director, Scottish Widows Investment Partnership (SWIP). “Therefore, the onus was on us to find the other side to those trades and execute them at acceptable prices.”
According to figures from global trading data provider TAG Audit, bid-offer spreads in 2009 were widest in Q1 across Europe. The average spread for the EuroSTOXX 50 index was 6.7 basis points in Q1, and 9.7 bps for FTSE 100, reflecting increased volatility and implied trading costs over the period. However, spreads had reduced by the end of the year, to 4.5 bps for the EuroSTOXX 50 and 7.7 bps for FTSE 100 stocks as values and volumes recovered. In Q1 in particular, buy-side traders struggled to keep costs down. UK-based transaction cost analysis provider GSCS Information Services reported that market impact costs rose to 28 basis points in UK stocks in Q1 2009 from 22 bps a year earlier, only to fall back to 23 bps in Q3 2009.
According to Whalley, almost 50% of SWIP’s trades were conducted using direct market access or algorithms in the first quarter of last year, compared to usual levels of 15-20%.
Pablo Garmon, European business development director, TAG Audit, agreed that self-directed trading increased during the first quarter of 2009, but also noted that the buy-side has begun to take matters even more into their own hands.
“Many tier-one buy-side firms have also looked to take advantage of reduced trading activity by building their own algorithms, as well as using broker algos,” said Garmon. “While building costs more, it is fast becoming the only way for the larger buy-side firms to stay ahead.”
When measuring the value of algorithms, Whalley observes that heads of trading are more focused on performance comparisons against their peer group than beating VWAP or implementation shortfall benchmarks.
Dark pools and crossing networks were also seen as an effective tool during 2009. In a time of reduced liquidity, trading intentions are more easily spotted and
exploited, making controlling market impact costs a priority.
In addition, data from GSCS Information Services suggests that the reduction in liquidity for much of 2009 led to a greater average time required to complete a trade, which in turn increased slippage when trading large blocks.
“On average our estimate is that the time to complete a typical trade was extended by around 15% in 2009 compared to the previous year and in some stocks a good deal more. The incremental cost appears to have been around 15-20 bps on average but that disguises a wide variation,” commented Robert Kay, managing director at GSCS Information Services.
Both the overall increase in time spent and cost of trading in 2009 can be traced to less liquidity at each price point on displayed venues, according to Kay. Despite gaming worries among some buy-side traders, dark pools capitalised, Whalley notes that making more use of crossing networks and dark liquidity sources mitigated the rise in trading costs for SWIP.
“As more buy-side firms became increasingly concerned about revealing their intentions to the rest of the market, more business went through crossing networks, which increased the chances of finding a match,” says Whalley. “The amount of trading we put through dark pools like Liquidnet and ITG POSIT in 2009 represented a higher proportion of our business than it normally would have.”
In many ways much of 2009 was an exercise in damage limitation. As Kay points out,
“The people who arguably did less well were the portfolio managers who still sold into the falling markets and bought into rising ones. Some of this was forced by mutual fund flows and some of it is to be expected.” Nevertheless, firms that marshaled their electronic trading capabilities effectively were able to make the best of a bad job. Many will be hoping that 2010 will not require a repeat performance.
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