Buy-side traders are struggling to align their execution capabilities with the objectives of portfolio managers because of the single-stock focus of trading tools and execution venues, according to a new report from research and consulting firm TABB Group.
The report, ‘Portfolio Decisions and Trading: Aligning Execution to Investment Needs’, contends that while portfolio managers make trading decisions at the portfolio level – using analytics to examine the correlations between stocks as well as the characteristics of the individual stocks – few tools available to traders can translate these decisions effectively into executions that both minimise transaction costs and take account of risk exposures.
As a result, traders are less able to minimise execution costs at the portfolio level, claim TABB.
“In general, when portfolio managers hand off their decisions to the trading desk, the trader is left to execute in a market structure where single-stock execution has become the norm,” Matt Simon, analyst at TABB and author of the report, told theTRADEnews.com. “The products released in the last year or two are very focused on the single-stock side. Very little development has been devoted to execution across multiple securities.”
Simon acknowledges the launch of portfolio algorithms around three years ago, but adds, “To date, they haven’t really solved the problems of risk management or of fitting all of the correlations appropriately to the strategy that the portfolio manager may want to implement.”
According to the report, the incorporation of portfolio capabilities into trading tools in the US has also been delayed by regulatory factors such as decimalisation and Reg NMS, as well as the recent focus on forging links between execution venues and shaving milliseconds off execution times.
Nevertheless, the reduction in availability of capital commitment that has forced buy-side traders to resort to more self-directed trading methods is leading to a renewed emphasis on achieving best execution at the portfolio level. TABB expects greater development of portfolio algorithms and basket trading capabilities at execution venues and has identified point-in-time crossing as particularly useful because matching orders simultaneously at scheduled times offers a greater likelihood that constraints imposed by the portfolio manager, such as currency exposure, can be met.
“Point-in-time crosses will be developed more, innovation will continue to increase and some of the newer systems and newer firms will be able to introduce new functionality into the marketplace that will permit greater control and more flexibility for the trader,” said Simon.