BestEx Research Group, a provider of algorithmic trading solutions, has launched an algorithm that offers an alternative to the volume-weighted average price (VWAP) algorithm for minimising implementation shortfall (IS). BestEX Research founder and CEO Hitesh Mittal spoke to BEST EXECUTION exclusively on what gap in the market the product fills, how the product will help the buy-side, and whether VWAP is still fit for purpose.
IS Zero is designed to address suboptimal trading and inflated execution costs created by the disconnect between tracking the market’s average price rather than minimise IS, more effectively minimising IS than VWAP for low-urgency orders. While IS Zero is created not to replace traditional ‘IS algorithms’, it replaces the VWAP algorithm when a trader’s aim is to minimise IS.
“There are a lot of PMs and traders who want to achieve the lowest average implementation shortfall (IS) (e.g., average cost vs. arrival price) and do not have urgency in completing their orders. These traders tend to use VWAP algorithms because VWAP stretches orders throughout the day, unconcerned with execution risk,” Mittal told BEST EXECUTION.
“Traditional IS algorithms are not designed to minimise average IS, rather they are designed to balance execution risk with market impact. As a result, they execute more quickly to reduce execution risk at the expense of higher average IS. So, traders with low urgency have been using a product that was not designed for the purpose – they are using it for VWAP, designed to track the VWAP benchmark,” Mittal said.
IS Zero trades on a schedule and does not seek to expedite order execution. However, it introduces optimisations to better align with its primary goal of minimising IS, such as adopting a trade plan that minimises market impact as opposed to a volume profile, implementing dynamic flexibility in following the schedule based on the liquidity of the stock, and providing liquidity in Alternative Trading Systems (ATSs) in addition to exchanges.
“For a long time, brokers have designed generic solutions, but different types of asset managers have different needs. We identified that there is a huge number of asset managers – and even within the same asset manager there are quite a few traders – where there is a need for an IS algo that is not aiming to reduce risk but to minimise average IS. And the most frequently used solution currently (VWAP) is simply not optimal for achieving that.”
“We think VWAP should be used when the goal is to achieve the VWAP price; but if a trader’s aim is to minimise average IS, then IS Zero does a much better job. The results of our A/B testing–including $20B in executions–show that’s true, improving over VWAP’s IS by 37%.”
“Of course, if a buy side firm is using other providers, we think that for orders less than 5% of ADV with low urgency, VWAP may still do a better job than the IS algorithms offered,” Mittal said.
On the direction algos are moving in and how they are changing the relationship between the buy and sell side, Mittal said execution algorithms are frequently viewed as productivity tools, not always seen as products that can evolve according to changes in market structure and conditions. “And that view could certainly drive buy- and sell-sides apart.”
But Mittal said the firm has seen its approach is changing minds on this; clients want to collaborate to develop appropriately tailored solutions for their unique order flow and needs, participating in the process of discussion, analysis, measurement, and iteration. “We find our approach brings us closer to our clients as partners rather than providers of a fixed product.”
“IS Zero is an example of this; a number of our VWAP clients who prioritise IS performance have pointed to the gaps in VWAP for low-urgency orders. They’re not satisfied with IS-focused algorithms that create unnecessary market impact, and we designed IS Zero to address this specific need,” Mittal added.
“We believe that with IS Zero we are also creating a category of algorithm that has not existed before–an algorithm that focuses on minimising average IS rather than the variance of IS. Large asset managers and quantitative hedge funds, for example, tend to be less focused on the performance of individual orders and more willing to accept variance as long as the long-term average performance has improved.”
“And that’s exactly what IS Zero aims to achieve. IS Zero’s design is demonstrably enhancing performance for our clients; a 37% improvement was experienced in our randomised, controlled A/B tests including more than $20 billion in executions,” Mittal said.
Going forward, Mittal believes the buy-side will continue to demand more evidence than anecdotes from execution providers. “We believe that offering algorithms alone will not be sufficient; brokers must commit quant resources to working with buy-side clients to understand how to optimise these algorithms for their order flow. Venues and liquidity sources as we know them today, will over time become more commoditized and the methods we use to navigate the challenge of finding liquidity is where there will be innovation,” Mittal added.
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