Transforming the trading desk

Christoph Hock, head of trading, and Michael Muders, portfolio manager, detail the sweeping overhaul of Union Investment’s trading desk following Hock’s appointment at the Frankfurt-based asset manager in April 2014.

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Christoph Hock, head of trading, and Michael Muders, portfolio manager, detail the sweeping overhaul of Union Investment’s trading desk following Hock’s appointment at the Frankfurt-based asset manager in April 2014.

What was the mentality you wanted to introduce when you arrived at Union Investment?

Christoph Hock: ‘One team, one dream’ is really the philosophy. Firstly I looked at our trading team, where traditionally you have had cash equities and derivatives on either side of the fence. Regardless of whether you are on the buy- or sell-side it is an extremely difficult task to bring those two segments together. But this was one of my first initiatives to make sure these two units worked in unison as we moved forward.

I believe there should be one interest and that is to deliver the best products and the best performance to our end-investors, our institutional investors and our retail clients. To achieve this, communication is a vital component in the way the business is now being run. You have to make sure you come up with the right investment decisions, but ultimately, sharing information from different angles is vital to running a successful asset management business.

Has improving the relationship between the trading desk and the portfolio managers been 
a focus area?

Hock: In terms of where I see us compared to our peers, one of the key differentiators is that we now see our PMs as our internal clients.

The portfolio managers don’t just want to talk to the cash team or just the derivatives team, they want to make sure they get the best service they can from the trading team as a whole. So this ‘one team’ philosophy is applicable to trading itself, in terms of combining asset classes, but also when looking at the relationship between the trading team and the PMs.

In the old days the execution desk at a buy-side asset manager firm typically existed for performing the execution for the portfolio managers. In terms of interaction, there was not a lot of conversation between the trading desk and portfolio management.

Within your changes, how much emphasis have you put on ensuring that everyone takes a multi-asset view?

Hock: I’ve worked for a sell-side firm running sales trading, I set up a hedge fund and headed up derivatives prop trading at J.P. Morgan. So I have a fairly broad picture through looking at various asset classes.

The members of my team should also have this breadth of knowledge so they are not purely focused on just cash equities or equity derivatives but you take the impact and market intelligence around other asset classes into account as well.

Also this marketing and sales DNA was less developed in certain individual members of the trading desks. This led to less communication with the PMs. So I am working hard on reforming the execution desk to become a dedicated service and solutions desk.

That for me has been the biggest change we have implemented yet and are still working on. I think Michael and the other portfolio managers have been happy about the changes.

Michael, as one of the PMs at Union, what kind of impact have Christoph’s changes had on your role?

Michael Muders: Christoph has made a huge difference on the trading desk side since he started. Especially for me as manager of German small- and mid-cap products, it is essential to know the market and the flow that is out there. The new approach is an incredible help to me as I have more time to actually focus on the companies, fundamentals and bottom-up research.

The mindset has really changed on our desk since April, and the rise in communication has benefitted everyone. As a small-cap manager it is absolutely essential that those who trade for my fund know what I am thinking. We sit on the same floor and I usually go over several times a day and make sure they know what my intentions are and what I am expecting from the market. This gives them the opportunity to be more or less aggressive in fulfilling their orders.

Has the rest of the team reacted positively to these changes?

Hock: Absolutely. We had some people who believed 100% in this sales and marketing DNA story from the start and then others who have now adopted it and are keen to bring the trading desk to the next level.

On a daily basis we have morning meetings across asset classes. Firstly the asset allocation team, then fixed income and finally the equities team. For us it is important to know their positions and intentions, their views and ideas, and which underlyings they are focused on.

Muders: I have been at Union for 10 years now and that time was characterised by continuity – which also means that not a lot had really changed. The trading set-up of the 1990s carried on into this century and it was one focused purely on execution. Now we have that client-driven philosophy that Christoph brought in and we are now much closer to the market and the flow than ever before. It gives the traders more interesting things to do throughout the day and the close interaction gives them more information from our side.

How have the wholesale changes affected your investment strategies?

Hock: Michael is one of the guys who lives this modern investment style inside-out. On the one hand you have the selection process which is deep fundamentally based on the bottom-up process, but on the other hand he has a top-down allocation process which allows him to take impact from various other asset classes on the equity market. This allows you to look at your portfolio construction from a 
sector perspective. Risk premia are currently among the key topics.

Muders: We are constantly developing our investment process to take into perspective the top-down considerations and macro developments, and also technical analysis. We believe we have an edge by combining these three elements in our investment process.

How do derivatives fit into this investment process?

Hock: In equities we have a multi-asset approach, through equity-related derivatives, fixed income, credit derivatives and we are also involved on the FX side.

In equities, it is predominantly the listed business we focus on, OTC in general makes up a very tiny amount of what we do. The advantages of listed equity derivatives are evident on a daily basis – you have an easy-to-trade market, a settlement price, and a fairly easy margining process. Standardised contract specifications and maturities make life easier.

Muders: By running the German small-mid cap fund in a very active way, we are also active in derivatives. If we come for instance to the conclusion that a set-back in the market is due, we have to consider how we can profit from that and position the portfolio more defensively. The way to do that has been by using derivatives.

There are only imperfect hedges for German small stocks, so together with the derivatives desk we found a way around that issue by looking at correlations, shorting sector futures, and implementing put spreads on the DAX. We have come a long way on those strategies since Christoph joined.

We now take a pro-active approach so the traders come to me. They now know what I am thinking and what I expect from the market and are able to come up with ideas of how to implement strategies more efficiently.

How has your use of equity derivatives changed over the past decade?

Muders: Because we apply technical analysis and proprietary models along with working on the top-down macro developments on the fund, we have an edge here. We have put that together over the last 10 years to get a more timely view of market developments. So I would say I am a much more frequent user of equity derivatives now than I was 10 years ago.

Hock: From a PM’s perspective you have various sources to generate alpha for your fund and smart use of derivatives is definitely one of these sources. You don’t need to trade equity derivatives on a daily basis inside out, but just knowing you have the ability in certain situations to improve your performance, that is the kind of approach you should have when it comes to derivatives trading.

The derivatives industry has been subject to sweeping regulatory change. How are you keeping on top of the changes and adapting the Europe’s new rules?

Hock: I joined Union Investment in April 2014 and I had already been involved in my first meeting on MiFID II just a couple of weeks into the role. When looking at my weekly schedule now, every second or third meeting involves forthcoming regulations and the changes facing us as an asset manager in general and also changes for each individual asset class on top of that.

The consultation and the discussion papers from European Securities and Markets Authority (ESMA) were published earlier in 2014 and the buy- and sell-side have had the chance to give their views on the regulatory changes. We have been quite vocal and pro-active in this space, sharing very openly our views.

I feel like in terms of regulation we are quite ahead of the curve because there are some real game changes surrounding access to certain venues and liquidity, so it is important for us to be in constant discussion with the various asset manager associations, regulators like the German BaFin, and also our brokers. This will definitely be a topic we are talking about for a long time with MIFID II coming into force in 2017.