Fast Times, Slow Systems: Best Execution Means Better Technology
April 23, 2007
NEW YORK-Portfolio managers can buy all the algorithms they want, but ensuring best trade execution starts with investing in an order management system sophisticated enough to handle them, according to panelists at Financial Markets World's second annual "Buyside Technology Forum" here last week.
The problem is, while managers are quick to adopt programs that promise the fastest, cheapest trade, few have the tools to truly evaluate them because as their strategies change, their software systems do not, allowing valuable, analyzable, data to escape.
"I look at technology as something to help with the basics," said Bill Conlin, executive vice president and chief operating officer at Abel/Noser Corp., a New York-based broker that also offers trade cost analysis to clients.
"If you can't analyze what it's doing for you, then you're really going to have a problem," he said.
In the hunt for alpha, portfolio managers are often eager to use tools, such as algorithms, that promise to give them an edge, however narrow, in executing trades.
Fragmenting trades between brokers and the increased implementation of options, futures and derivatives only add to the complexity and frenetic pace.
Last, but certainly not least, are the regulatory statutes requiring fiduciaries to do it all in a way that benefits the investor, not the broker or other interested party, the most.
"Wall Street is great, great, great at one thing: it's good at selling product," Conlin said. But the product not enough fund complexes are buying are order management systems sophisticated enough to capture enough data for firms to do a true trade cost analysis.
"It is very rare that I find a buy-side client who says, O.K., this is my strategy. My trading volume has to have an alpha greater than this,'" said David Mortimer, a principal at Vodia Group, a consulting firm with headquarters in Concord, Mass. "Unless you can answer the tough questions, it leaves the rest of the process in the lurch," he said.
Even if each portfolio manager has his own system for analyzing trade cost when crafting the strategy for the fund or group of funds he oversees, fund companies have a hard time making a detailed comparison of strategies and trade costs between managers, or against peers if they are comparing the trade costs between managers.
"You can't even start to make this type of analysis until you have a system that can capture all the data to do it," Conlin said in a subsequent telephone interview.
One of the barriers is cost.
"On the buy side, there is a lack of appreciation on the [research and development] I need to do," said Brett Ginter, president and founder of SMART Consulting in Chatham, Mass. Because buy-side firms do not have technology departments robust enough to build internal systems that can capture the increased forms and volume of trade data needed firm-wide, they look to vendors.
At the same time, few vendors have invested the capital and resources to develop such programs because, to date, there has been little demand. "There is no economy of scale there," he said.
In turn, the lack of demand stems from the diverse needs of various fund companies, Mortimer said. Because each fund family has its own rules, standards, culture and lexicon, many believe the only answer is a fully customized system. The issue then returns to cost.
Because switching order management systems is such a significant undertaking, there is also a first-mover aversion, rather than an advantage. "There is a certain fear and uncertainty," said James T. Leman, principal in charge of capital markets operations at New York-based Westwater.
But that might soon change, as regulators pay more attention to best execution within funds. Besides being tagged as one of the key focuses of Securities and Exchange Commission sweep exams, best execution is also at the heart of recently passed Regulation NMS (National Market System), which takes effect in July. That rule requires all automated exchanges to list offers with the best price at the top of the screen, and brokerages to execute from the top down, ensuring they get the best displayed price for investors.
Vendors have responded with programs and tools that help companies analyze the markets where they have gotten the best price, something many legacy order management systems are not equipped to do.
Such scrutiny may increase demand, and therefore stoke vendors to provide even more sophisticated systems that can capture the data to handle all the types of analysis of funds, their peers and their complexes.
The result could be a shift from a hunt for tools portfolio managers choose for the cheapest, quickest execution to ones that offer a true evaluation of the strategies they use. "I sometimes wonder if everyone isn't too focused on trade cost," said Michael Boyd, vice president of KABRIK Trading in New York.
Taking a broader, more firm-wide approach may reveal efficiencies between funds or among managers that, if captured, would truly be a better execution of previously touted as "best."
"If whatever your initial idea was is flawed, everything else goes out the window," he said.
(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.