As the pace of change accelerates in equity trading, some of the largest buy-side trading desks are actively seeking to hire quantitative professionals to bring in a level of sell side sophistication to the trading process.
According to Tabb Group’s new report U.S. Institutional Equity Trading 2014: “Bellwethers of the Buy Side,” released today, the appetite for hiring quants will differ based on the size of the firms. The 33-page research report is based on interviews with 108 heads of US equity trading desks at traditional asset managers with aggregate commissions of nearly $2.5 billion in 2013, in addition to 75 interviews with US head traders of hedge funds conducted last fall. It identifies the five most impactful trends among the bellwether firms that are taking a leading position on a number of different topics, ranging from analytics moving beyond conventional transaction cost analysis (TCA) to engaging with the sell side on routing logic for ATSs and receiving monthly data or summary statistics.
“Certainly, when it came to really trying to dig into how they should be scheduling and routing their orders, those were the firms that were looking to hire quants,” said Adam Sussman, partner, director of research at Tabb Group. One concern identified by the industry is the “absence of quantitative skills among most firms,” said the report, noting that one fifth named this as a major weakness of asset management shops. One factor could be that turnover is low on buy-side trading desks, which means they have "highly-priced, experienced traders" and that technology and communication skills "evident in broader society" are not reflected in their workflow.
Smaller firms were also bringing in new hires with quantitative skills, not necessarily purely trading, but from a combination of trading and investment functionality, said Sussman. “The quants could be folks with sell-side experience or those who come from outside the industry, with a broader quantitative skill set,” he said. In general, as Tabb has seen in the past, said Sussman, “The rest of the industry will follow in the footsteps of those firms, if they wind up being successful for lowering transaction costs or improving performance.”
Consistent with the need for quants, the buy-side’s top trading initiatives are all about data. In fact, 32 percent of respondents cited data as their top initiative. Most of these involve transaction cost analytics (TCA) and are linked to a project for the trading desk. Other projects include internal data, venue analysis, real time TCA and new data feeds. “However, the analytics are moving beyond the convention TCA benchmark methods of “implementation shortfall, VWAP and slippage,” stated the report.
Some of the largest institutions are doing alpha profiling of portfolio managers, “but it takes a big budget to get it done,” noted Sussman. “You can do a lot with building a better mouse trap by talking to their portfolio managers.” he said. The biggest firms “are spending time and effort in terms of capturing all of this data and allowing it to drive better decisions,” he said. While this is not considered ‘big data,’ it’s about capturing more data points within the trading process, and that includes information from the investment process as opposed to just focusing on execution data or order routing data. “It’s looking at why the decisions to buy or sell were made and how that was translated into orders on the desk,” related Sussman. Even within firms that don’t have the same budget, head traders are able to come up with strategies that encourage their portfolio managers to let then drive the trading strategy process,” he said.
More Value in Internal Processes
Interestingly, industry participants told the firm they find more value is to be gained from focusing on “internal" improvements to trading. These firms have measured external performance (i.e., algorithms, brokers and venues including “ATS routing table decision trees”) and found it leads to marginal differences. They found there is far more to be gained from focusing on “internal deficiencies” in their own process — such as the alpha profiling, quantifying alpha added or removed by the trading desk, decomposing trading costs, increasing workflow efficiency and optimizing post-trade processing. If buy-side firms cannot afford to hire a quant, they are working with next-generation TCA tools, which can pull in broker-provided data and limited amounts of internal data. Institutions conveyed they are working with providers such as Markit, Portware and SJ Levinson, mentioned most frequently.
Buy-side asset managers continue to automate pieces of their order flow, according to the report. Last year an additional five percent of order flow allocation went to the electronic side, with DMA, algos and crossing networks stealing volume from sales traders and program desks, a trend, which Tabb expects to continue into 2015. Sales desks had 41 percent of the order flow allocation, while DMA & algorithms had 43 percent, and crossing networks and program trading desks, each had about 9 percent.
“But, as firms sought to automate pieces of their order flow, they told Tabb that a quantitative overlay was critical,” Sussman points out in the firm’s press release. “This issue came up repeatedly in different forms, from portfolio manage alpha modeling, to venue analysis and internal routing optimization,” stated Sussman.
Even so, desks are not planning to reduce their sales-trading volume in the future, which is not the case for program trading. “Major accounts see their exhaust flow going to this desk, which could lead them to seek greater efficiency by simply routing to no-touch broker pipes,” wrote Tabb analysts.
Despite the buy-side’s move to automate their order flow, Tabb heard increased “chatter and commitment” to trading more blocks, said Sussman. “It’s almost as if the market has become so fragmented and this low volume environment difficult to handle electronically, that perhaps veering back to more traditional methods would be more advantageous now,” said Sussman. While block trading picked up one percent, head traders are interested in actionable indications of interest (IOIs), not so much to click to trade, but to call up their brokers to get a better price or find out if there is more size to trade.
OMS/EMS Consolidation Still on Tap
Other top trends cited by bellwether firms include: trading technology changes geared to increasing efficiency, such as order management systems (OMS) consolidation, multi-asset class functionality and auto-routing order flow.
Among this year's participants, Tabb found that the number one ongoing technology project was related to order management systems (OMSs), with ten firms mentioning they were upgrading an existing OMS provider or switching to a new OMS. A number of firms are engaged in consolidating their multiple OMSs in New York, London and other cities, as well as across equity and fixed income to get multi-asset trading functionality. From a technological perspective, these firms are a leading indicator of where the rest of the industry will be, said Sussman. Since OMSs tend to be “sticky” for about eight or nine years, it takes longer for them to be replaced so this trend only may affect only 8-to-10 percent of the buy side firms each year. But Sussman expects the consolidation trend to become more widespread over the next five years. Other technology initiatives pertained to looking at their relationships with brokers and what they are paying them and continuing to rationalize that, or changing the process to better integrate the portfolio manager and trader, said Sussman. These points were mentioned in the past, said Sussman, but Tabb got a clear sense, they are still present. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio