Dark Pools Change Transition Management

Dark pools continue to play an ever-more important role in the search for liquidity. Recently, the opaque liquidity pools have become increasingly popular among transition managers, who often need to trade large blocks without revealing their positions and moving the markets.

Transition management usually is offered by broker-dealers -- though some large global investment management firms, such as Russell Investment Group, Barclays Global Investors and State Street do offer transition management services -- to help asset managers restructure portfolios of securities. A sponsor may look to transition a portfolio as the result of a change in investment managers, investment strategies and asset allocations, or performance benchmarks. During times of market volatility, transitions are more popular than usual, as sponsors keep an even closer eye on their portfolios and tend to change investment managers more often if performance doesn't meet their expectations.

Transition managers' trading objectives are no different from other market participants' goals -- minimize costs (including commissions, bid-offer spreads and market impact) while securing best execution. Typically, they are directly connected to multiple markets or liquidity centers, and they can execute orders using algorithms, which help them find liquidity and the best price in a fragmented market.

But transition managers tend to trade large blocks of holdings, making anonymity and information leakage more important considerations than for single-stock hedge funds, for example, that don't generally execute such large trades. As a result, transition managers have been turning to dark pools -- such as Credit Suisse's CrossFinder, ConvergEx's Vortex or ITG's Posit Match -- to minimize the market impact of their trading activity.

"Transitions tend to be large," explains Mike Plunkett, president, North America, of New York-based agency broker Instinet, which runs the Continuous (CBX), VWAPX, LDX and IDX dark pools. "Many times, with toxic names, market impact can destroy a trade very quickly, so dark pools are valuable."

Larry Tabb, CEO of TABB Group, points out that anyone trading more than 20 percent of the average volume of stock is at risk of moving the market. As dark pools facilitate large crosses while providing anonymity, Tabb suggests, they offer transition managers an efficient means to restructure a portfolio.

"The reason dark pools are good for transition managers is that what you're doing with transitions is swapping out one set of products for another set of securities," Tabb explains. If a transition manager is handling a basket of 50 stocks -- including large caps and small caps, as well as some technology, healthcare and manufacturing stocks -- he continues, the best way to avoid getting overweighted in one sector is to clear all the trades at the same time. Further, to minimize the risk of a price fluctuation, whenever transition managers decide to swap products, they want these trades to happen simultaneously, he adds.

But while dark pools offer transition managers an effective method to ply their trade, Dmitri Galiametdinov, director, head of liquidity strategy for Credit Suisse Advanced Execution Services (AES), says Credit Suisse has not specifically targeted transition managers with its internal crossing network, CrossFinder. "We've just been trying to do a better job of executing large blocks through AES algorithms without having an impact on the market," Galiametdinov says. "We do this for both buy-side and sell-side clients. Transition management is a part of that. We provide a solution to how transition managers can execute without moving prices too much."

As part of its effort to boost the matching efficiency of CrossFinder, over the past six months, Credit Suisse has revamped the dark pool's technology, Galiametdinov notes. "We are able to process more messages faster," he says. "It seems people are very receptive -- they tend to trade more when you have good technology."

Understanding the Portfolio

For transition managers, however, effectively doing their jobs isn't just about the hunt for liquidity or speed of execution. Kal Bassily, managing director and global head of BNY Global Transition Management, says it is essential for transition managers to understand a client's portfolio and strategies before deciding how to execute the transition.

"We make sure that we help the asset owner capture the whole benefit of the investment idea. Our job is to make sure that we are preserving the value of that idea," Bassily says. "So we have to manage two risks: market risk -- the volatility in the marketplace and expediency -- and we also have to make sure the market doesn't move against the asset owner while we implement the transition."

To mitigate those risks, transition managers must understand the individual holdings of the portfolios they are transitioning, according to Sang Lee, cofounder and managing partner of Aite Group, who says, ultimately, transition managers will base their decisions on where to route orders -- dark pools or the open market -- on the types of blocks they are trying to move. "If you have very liquid stock, dark pools might not be very important, since algorithms can help dice millions of shares into a few hundred and disguise them," Lee says. For example, dark pools will not be necessary for the highly liquid FX market, and in particular for extremely liquid currency pairs such as the dollar/yen combination, he adds. "The real issue is when transitions need to be done in less-liquid stock, such as small caps or mid caps," he notes. Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio

1 of 2