By Tony Cheung, Head of Quantitative Analytics, Liquidnet, Asia Pacific, and Lee Porter, Head of Liquidnet, Asia Pacific.
The start of 2016 has proven difficult for most investors in APAC, to say the least. Not for a decade has the Hang Seng Index seen a worse first two months to the year, with the drop universally slamming large and small cap stocks alike. China followed up a botched attempt to install circuit breakers with a significantly dialled down GDP target – hardly a sign of confidence. And now Japan is showing signs of Abenomics fatigue with negative interest rates not helping to boost markets. While it might be easier for mom-and-pop investors to wait out the storm, institutional investors are faced with tough decisions on what to do with their positions today. And equally important, how to do it.
According to results from a recent HKEx survey, institutional investors made up a major part of the trading in Hong Kong – coming in at 51% of all market trading. Retail and proprietary trading (bets placed by brokers’ using their own money) made up the balance, and actually became more active in a very volatile 2015. There is a strong likelihood that some of this was from the residual euphoria associated with Shanghai-Hong Kong Connect but with indices on both sides of the border plunging, volumes dried up.
Daily Southbound trading via Connect fell to less than 1.7 billion HKD from a peak of about 13 billion. Barring a significant turn of events this year, trading by institutions should clock in at a higher rate than last year with retail and proprietary flow stepping back. We believe this reduced pool of liquidity will make portfolio manoeuvring by institutions significantly more difficult.
In absolute terms, the ownership of Hong Kong companies by major fund managers may not be high, but relative to trading volumes the holdings can be staggering. For the constituents of the Hang Seng Index, the top 20 major shareholders (excluding family members, strategic partners, and government entities) own anywhere from about 30-days to 400-days of shares in Average Daily Volume (ADV). Normally, an instruction from a portfolio manager to buy or sell a single day’s worth of ADV is enough to make traders cringe at the potential market impact. Needless to say, liquidity becomes a major concern when wholesale changes to portfolios are required. And this is just the story for Hong Kong.
Other markets in the APAC region have not been spared the problem of lower activity, and its impact is especially pronounced in emerging markets with volumes dropping anywhere from 15% in India to 37% in the Philippines compared to the first two months of 2015. In these days of lower trading volumes, head traders are increasingly searching for new ways of unlocking liquidity.
The role of the head trader
Surprisingly, a head trader’s involvement with day-today-day trading has also been on a downtrend despite the increasing workload of trading in tougher markets. Head traders nowadays approach Liquidnet to discuss workflows and trends rather than haggle on prices and shares. This shift away from the traditional “handset on each ear” image of the head trader is an indication of structural changes within buy-side organizations.
First, as the markets covered by the typical trading desk in APAC become increasingly complicated, buy-side desks can no longer digest and react to every single rule and regulation change in an efficient manner. This is where the heads of desks create value by liaising with peers and brokers to ensure all available information is looked at from every angle, drawing on their collective knowledge and experiences rather than going it alone.
Second, and more important, money managers are more than ever emphasising operational efficiency, realising that the difference between a good and an average year can very well be reduced to how smoothly a desk is run. To achieve this efficiency, more resources are now being invested into systems and processes. The holy grail of each head trader is to establish a platform where his or her team can focus on sourcing the best liquidity in any types of markets.
While it is widely accepted in the buy-side circle that the best liquidity comes in the form of block trades (a single trade in large quantity as opposed to a handful of smaller lots), from our experience not all blocks are quality liquidity. A recent study we conducted in Australia uncovered that some block trades reported by brokers can cause the stock to swing as much as 40-50% more than its typical trading pattern over the short term. If information about a potential block trade hits the market, it will send signals to predatory traders who can trade in front of that block and adversely affect that price. The only proven way to execute a block without signalling the market that there is a large buyer or seller is for the two trading parties to negotiate directly with each other.
Buy-side traders in APAC will need to continuously adapt their workflows according to trends in money flows both locally and regionally. For example, while solely relying on algorithms might have worked well for last year’s “Big Era” in Hong Kong’s market volume boon, executing in larger blocks today will serve traders better as liquidity reverts to the norm. For head traders, we believe broker evaluations will place increasing emphasis on block crossing successes in addition to algorithm performances. Advanced transaction costs analyses can be used to measure block qualities not just on a P&L level but also on the degree of signalling around the print. Especially for overnight APAC traders, there is nothing better than the ability to place an order confidently expecting both quality block and algorithmic executions.
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