With Joe Sowin, Head of Global Equity Trading at Highland Capital Management
As pioneers and leaders in the asset management space over the past twenty years, we at Highland are committed to a world-class investment platform that drives results for our clients. Highland has had tremendous growth and success in the Alternatives space over the past five years. Highland Alternative Investors, the investment platform for our $6.3B in Liquid Alternative assets, has become the fastest growing segment of our $20.9B AUM. Our trading desk remains integral to the success of our investment platform, and below we outline trading challenges generated by multiple product offerings, and the solutions we believe best address them.
We believe managing the trading process as follows optimises process, time management, and execution:
• Organisation of order flow.
• Consideration of how portfolio manager tendencies should influence trading.
• Intra-day trading strategy adjustments.
• Identifying where automation works and where it doesn’t.
Order flow organisation
We recommend tagging each order with a reason code prior to order routing. This allows similar orders to be grouped and facilitates post trade analysis of execution and portfolio management decisions. We benchmark arrival price orders versus arrival price and over-the-day orders to Interval VWAP. Sub-sets of orders are sub-grouped according to order size relative to average volume, order seasonality, transaction side, and sector. Lastly, we compare the groupings and sub-groupings to the appropriate index performance to assess order momentum. We believe order momentum is a significant driver of trading costs. Individual order momentum and index momentum can be analysed by comparing such things as:
• Opening price to arrival price.
• Arrival price to order completion price.
• Completion price to closing price.
At Highland Capital Management, we use Transaction Cost Analysis (TCA) to quantify the value add of the execution process, a constantly evolving opportunity to improve the feedback loop from the trading desk back to the portfolio manager. The trading desk can continue to add value in 2015 and beyond by creating, maintaining, and constantly improving order flow organization.
Portfolio manager tendencies
Once groupings and methodology are established, the trading desk can analyse this data to detect patterns in portfolio manager tendencies and style factors across order size, sectors, and market capitalisation. In other words, traders should understand portfolio manager tendencies and apply that understanding to nuance the portfolio manager’s orders in the market. Is it preferable to work the order aggressively by crossing the spread or work passively over the day? Different paths of execution can be used, in each case guided by information gleaned from TCA, together with historical portfolio manager behavior. It is important to note, however, that the portfolio manager-based approach to trading may not be an effective solution for all trades. For example, we have found small-cap stocks are less likely to exhibit identifiable patterns as compared to large-cap stocks.
We believe implementing intra-day strategy adjustments to expand order duration through the closing auction, thus lowering order participation rate, will provide an ability to participate in intra-day mean reversion, thus combating fund growth and increased order size. Portfolio managers have a higher level of comfort with and understanding of the trading process following detailed quantitative trading analysis.
At Highland Capital Management, we embrace technology and view automation as an imperative and competitive advantage. We leverage our internal and external technology providers to conduct execution analysis and quantify data. The resulting analytical data provides insights that can be utilised to enhance trading workflow and thereby lower execution costs. This data can then be utilised to identify routine trades that can be automated, and those trades where the trading desk can enhance execution through direct involvement.
We view automation in two forms:
• Single point automation: Any function that can be fully automated at a single point and does not require modification, i.e. managing all emails with a single rule.
• Multiple point automation: Any function that requires customization and monitoring, i.e. our trading process.
Both forms of automation allow trading desk personnel to focus on value-add functions like sourcing liquidity for outsized orders relative to average volume, derivative trades, market color, and filtering research/trading ideas.
The end result of these trading solutions is a successful and repeatable trading strategy for all applicable clients. Automation of over-the-day strategies enhances execution and extricates trading desk resources. Automation and use of technology can significantly improve resource allocation and personnel requirements. We envision a desk of traders, trading assistants, technical analysts, risk managers, and portfolio managers engaging in a collaborative process. Technological evolution will be rapid across all asset classes and the trading desk should implement technological enhancements that deliver better execution in a cost effective manner. Accordingly, buy-side desks must be staffed with technologically savvy investment professionals. We believe these trading processes optimise allocation of time and resources while also enhancing execution, and providing a strong basis for repeatability and consistency.
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