Master of all Trades:
Rising competition in the asset management industry is pushing heads of trading to embrace more sophisticated trading strategies in a bid to beat their peers. For many, that means a fundamental shift on the trading desk towards the multi-asset class model. But it’s not just a matter of changing how you trade – market structure changes can also present formidable obstacles, according to Gianluca Minieri, global head of trading at Pioneer Investments. “At Pioneer, we manage strategies that cut across asset classes,” Minieri told K&K Global Consulting. “Directional strategies might be combined with hedging strategies; FX trades might be combined with equity trades, or equity and fixed income might be combined into a single strategy – and this is where a multi-asset class trading model brings benefits.”
For Minieri, those benefits are mainly to increase the speed and quality of execution, to minimise market impact and operational risk and to reduce alpha slippage. But to make these advantages a reality, the trading desk needs to be reorganised. The problem with the traditional, highly specialised asset-class specific model is that it doesn’t adapt so well to a mixing of multiple asset classes into the same strategy.
“High specialisation of the trading desk might lead to inefficiency and to poor execution, for example when different traders are executing different legs of the same strategy, or when the same trader is executing more than one leg, and one leg is filled and the other is not filled, or when traders have to execute two strategies on different venues.”
Training and expertise
One solution is to start moving traders to asset classes that share similarities with what they already trade. For example, equities and bonds that are executed on MTF platforms are executed in much the same way. Or an equity derivative might be a natural extension for an equity trader; likewise, a local currency equity trader might get involved in currency trading for hedging or speculative reasons.
Naturally, there are limits- Minieri does not expect an emerging markets fixed income trader to start trading something drastically different overnight, such as US smallmid caps. But the overall principle is to develop the traders’ knowledge at a manageable pace. Over time, from a competency perspective, the additional experience and wider frame of reference will ultimately give the multi-asset class trader a formidable edge over the competition. The increasing correlation between asset classes around the globe adds urgency to the argument.
“The variety of situations that they come across is certainly much higher than trading single asset classes,” said Minieri. “They are capable of picking up signals that a single asset class trader might have missed. For example, often the earliest signs of a market change happen first in the bond market. A trader of equities who is also trading corporate bonds is capable of picking up those warning signals much earlier. That definitely gives an edge.”
When it comes to performance, the Pioneer ethos is that the measure of a trader can’t be taken from a single measurement. There are several elements that Minieri uses; these include the performance of the fund, the number of trader errors, quantitative measurements, TCA results, compliance with regulation and TCA data for fixed income, which we have. The firm also tries to quantitatively evaluate the job overall – but it would be “an error to evaluate only on the TCA. If the only thing you are focused on is trying to look good in the TCA, that’s not necessarily giving the best service to clients. TCA should not be an obsession,” Minieri added.
Choosing the right broker
In terms of broker relationships, Pioneer takes a careful approach based on liquidity, geography and above all, confidentiality. For large orders, Pioneer primarily relies on long-term relationships. For smaller trades, the firm tends to opt for electronic execution using trading algorithms. Pioneer has a large list of brokers, but a relatively short list of algorithms – Minieri does not want his traders to spend too much time choosing which algorithm to use.“Confidentiality is much more important than anything else, because there are a lot of algos and HFTs out there, and if they sniff out what your trading intentions are, they can anticipate you and undermine your trading strategy.”
In terms of selecting which type of broker to use, Pioneer’s trading desk calls on both the large global houses and a number of smaller local players. “We need both,” he said. “We need global houses because they can provide a one-stop shop for a variety of execution needs. We also value the niche players, because in local markets they can help us with the local regulatory jungle and the ownership restrictions you find in markets like India or China. Usually these smaller brokers have an edge in terms of local access and expertise, and they provide good local intelligence on local flows and liquidity.”
Taking care of due diligence
Due diligence is an important area for the modern buy-side trading desk. Over the last few years various scandals have emerged around trading venues and trading algorithms. A notorious example of the former was provided in 2011 when US trading platform Pipeline was discovered to be misleading the buy-side. Pipeline had claimed its dark pool was a safe place for long-only traders; in reality, the majority of orders were secretly being filled by Millstream, an HFT firm chaired by Pipeline’s chief executive. Pipeline later closed down, its reputation irretrievably tarnished by the incident.
To protect itself against this kind of deception, Pioneer has developed a due diligence questionnaire which consists of 25 questions. Its purpose is to uncover the details of any new venue or broker algorithm and establish exactly how it will interact with the asset manager. In the case of an algorithm, that is not the end of the process since Pioneer will then usually ask the broker to customise it. Particular attention is paid to which venues the algorithm will be accessing – “we are very selective on which venues the algos access,” said Minieri. “We block access to some venues.”
Preparing for regulation
Running a trading desk also increasingly requires heads of trading to be engaged with regulatory changes that are reshaping the industry. In Europe, that often means getting to grips with the European Commission, and its MiFID II legislation which seeks to harmonise the rules for securities trading and to ensure an effective, competitive market structure. But the problem for the buy-side is that some of the measures contained in this legislation may have seriously negative unintended consequences.
The best examples of this concern the application of transparency requirements onto the fixed income market, and the application of restrictions on dark trading in the equities market. In the case of the former, Minieri is concerned that blanket application of principles originally developed for the equities market could harm fixed income liquidity, at a time when the fixed income market is already struggling from serious liquidity shortages.
“The problem in Europe is that regulation very often emerges as a response to an extreme case,” he said. “Don’t get me wrong, there are thousands of cases where the regulation benefits the market. But often the discussion becomes immediately politicised. Take transparency for example. “Transparency is always good”. This is the type of conversation we hear from regulators. Unfortunately, it’s not true that transparency is always good for the end client.
“The regulators are trying to consider transparency an objective itself, rather than a mean to achieve the real objective, which is to make the market a place, where fair competition and best practice can emerge. For us, forcing full transparency irrespective of the asset class, irrespective of the liquidity, irrespective of the type of order, irrespective of market position, just wrong.”
Instead, Minieri would prefer to see transparency decided based on a strict correlation to liquidity, and with the caveat that transparency may not work for all markets, especially non-equity markets. A push for a genuine consolidated tape of post-trade data in fixed income would also be a huge improvement – and a necessary precursor to more effective fixed income TCA. While Pioneer has its own fixed income system which takes data from a number of venues such as MTS BondVision and others, not every player in the market may necessarily have access to the same data. Minieri notes that despite a call from EFAMA during the MiFID II process that placed a consolidated tape as the number one priority, it is “disappointing” to see that there is still no answer to this issue in MiFID II.
Trading debate: lit versus dark?
Meanwhile in equities, MiFID II introduces a number of restrictions on dark pools, which are typically used by the buy-side to place large orders and minimise market impact. The European Commission has indicated that it is concerned that dark pools may be undermining the price formation process. The fears stem partly from fears that dark pools are shifting flows away from the lit exchanges and trading venues, and partly from concern over the lack of pre-trade transparency in those pools.
However, according to Minieri such fears are entirely misplaced, and may end up doing far more harm than good. “There is no evidence whatsoever that dark pools harm price formation,” he said. “If anything, it is the opposite. From the data we have, dark pools actually improve price formation, especially on large orders. We feel that dark pools add value and we find them very useful for large orders.”
Under MiFID II, caps will be introduced on the amount of volume that can be traded in the dark, both on the basis of specific venues (4%) and in the dark as a whole (8%). Aside from unresolved questions around how the data to manage these caps will be gathered, the main objection from the buy-side is that these caps will not serve to force flows back onto the lit markets. Instead, they will simply reduce liquidity, damage price formation and increase the cost of trading.
“There is a common assumption that when the cap is implemented, all the volume that cannot be traded on the dark pools will automatically shift to the lit market. In our opinion, this will not happen,” said Minieri. “That type of liquidity will simply disappear. In addition, because of the large in size waiver, there will be a result that traders will wait until their orders will reach the size needed to use the large in scale waiver, because they can execute, with the consequence that the price formation process will be worse, not better.”
“The only reason for a market participant to go to the lit market is if we see an improvement, if we see a business opportunity,” he added. “If instead we realise that by moving to a lit market, our orders will be exposed to a deterioration in terms of market impact and execution quality, it will reduce the level of turnover and the amount of trading. Liquidity and price formation in equities will deteriorate. It will be worse for clients and they will end up paying more, because the cost of execution on the lit market for large orders is higher.”
Head of Global Buy-side Research
“There is a common assumption that when the cap is implemented, all the volume that cannot be traded on the dark pools will automatically shift to the lit market. In our opinion, this will not happen”
“We are very selective on which venues the algos access. We block access to some venues.”