Currency concerns and European debt woes are forcing buy-side traders to rethink their execution strategies as market behaviour becomes unpredictable and historical trends become a less reliable guide.
In recent weeks, euro-zone debt contagion has weighed heavily on portfolio manager’s fears, increasing volatility across asset classes and adding further selling pressure in a market already characterised by heavy selling pressure. European stocks fell yesterday, removing gains made earlier in the day as higher French borrowing costs triggered further fears the crisis was intensifying. Spreads in French 10-year bonds widened, with the yield 20bps higher to 3.40%, while Italian borrowing costs hit record highs since the inception of the euro.
Earlier in the month, volatility indexes surged over fears Greece would default on its sovereign debt. Europe’s VStoxx index rose 22% in one day to 42.96, while in the US, the Chicago Board Options Exchange Volatility Index rose 18% to 35.50.
Sören Steinert, associate director, equity trading at Quoniam Asset Management, said abnormal trading conditions were being heavily influenced by political and country-specific news out of Frankfurt, Brussels, Athens, Rome and Paris.
“I speak to my fixed income colleagues much more frequently at the moment. If spreads widen in fixed income or the dollar or euro move, the equity markets can react in seconds,” he said.
Steinert has dramatically changed his approach to execution to suit conditions. Shelved, for now, are participation-based strategies like VWAP. “You need to be very active and aggressive at certain levels,” Steinert said, adding he is presently retaining more trades in-house to maintain control and react quickly. “Higher volume algos are more suited to the current environment. If the price seems fine, then go get it. It may not be so fine in a couple of hours.”
Rob Boardman, head of agency broker ITG’s EMEA operations, agreed. “Stocks are more influenced by large marco-economic news these days, which means historical data – used by algos such as VWAP – becomes a lot less useful,” Boardman said. “Algos that use more real-time data and short-term signals can be really useful in this situation.”
“Massive anxiety” over a possible Italian default having a domino effect in Spain and France, said Bradley Duke, managing director, Europe, at broker Knight Capital, was increasing volatility, potentially prompting investors to use implementation shortfall over participation strategies.
“What we are seeing now is both volatility and thin volume. People are trading into much thinner markets where they are finding that even the more popular stocks are behaving like small- or mid-caps in terms of volume,” said Duke. “The challenge in this environment is that the impact of your trade can be more easily felt. For this reason we are seeing more people using specific strategies designed to assist with trading thinly-traded stocks. The use of dark access to attenuate market impact is an integral part of these algorithms.”
ITG’s Boardman said the tremendous levels of intra-day volatility in recent weeks had also increased slippage for market participants. “Fortunately, this can be countered using implementation shortfall algo strategies, which seek to minimise differences between the initial price and the end result for the trade,” said Boardman.
However, some traders have not felt the need to radically change their strategies.
“My strategy does not necessarily change if the market becomes more volatile or just because there is selling pressure,” said Peter Baillie, senior equity dealer, Martin Currie Investment Management. “No strategy is set in stone. Flexibility is important, and traders need to be empowered to make the choice on the spot, depending on prevailing market conditions and whether they can achieve the best price.”
Mark Goodman, head of quantitative electronic service, Europe, Société Générale, agreed that volatility is not in of itself a reason to change execution strategy. “You shouldn’t have to change the algos – they should already be meeting the client’s objective, and if the objective hasn’t changed, then volatility should not affect that.”
Goodman said he uses statistical arbitrage models to include signals such as short-term price prediction.
“We look at correlated asset classes, for example futures, as well as the equity,” he said. “This allows us to understand if the moves are sustainable in short-term and allow our algorithms to respond accordingly.”