Quantitative Trading:Sourcing Liquidity And Managing Momentum

 
SBP: Michele, I would like to pick up on your point about order flow information. I agree that the buy-side is best placed to handle execution metrics when using several brokers. However, there are also many questions around how informed the buy-side are with regard to flow intricacies. For example FIX Tag 29 (agency or principal), Tag 30 (last execution venue) and Tag 851 (making or taking) are all highly valuable but are still not uniformly implemented across the industry. For me, implementation should be a priority to assist the buy-side’s own best execution requirements. Having said that, we also need to take tags further still; for instance, I would like to see where the order has been routed/shown before it is finally executed. This is highly relevant in the ‘dark’ – both internal and external broker firewall – particularly internally where external electronic liquidity provider (ELP) programs operate, as well as both internal and external market making. Client discussions reveal the need for more transparency for the buy-side around the internal operations of bank dark books, particularly as average execution size is so small and thus something of a contradiction to the theoretical benefits of dark. The buy-side should have a choice of trading services, but it is important to understand exactly what is being chosen – it is difficult to argue for choice without having clear definitions of what is being chosen.
Ultimately, banks are under pressure to tilt their business model in favour of those clients providing the most upside to the bank commercials; if those are high frequency trading (HFT) clients as external liquidity providers (ELPs) ‘externally market making’ in a broker crossing network/over-the-counter (BCN/OTC) pool, HFT ELPs receiving blind immediate or cancel orders (IOCs), or internal prop trading taking precedence over the institutional investor, then that is the sell-side firm’s competitive choice and right. A downside of this is that tracking, even in relation to those simple top level questions, requires resource – an area that buy-side trading desks continually struggle with. Michele, is there a commercially justifiable business equation for the buy-side to conduct analysis in not just the dark space but also in the execution quality period? How does AllianceBernstein handle this and what are your views on dark today?
MP: It boils down to transparency, both pre- and post-trade.
All the FIX tags you mentioned – even if not harmonized – contain useful information for the buy-side. However, this transparency is limited at fill level and clients have no visibility on what has been done with their order before that. Which venues have been visited? How long have they been in the broker’s own dark pool before moving somewhere else? How has it been split across different venues?
Clearly, this introduces an important trade-off from the data and operational perspective. Trades are only the tip of the iceberg and the amount of data to be communicated from sell-side to buyside would increase exponentially. From an operational perspective, reverse engineering routing logics for each single broker’s algorithm is prohibitively time consuming and possibly adding little value.
Understanding brokers’ algorithmic processes and how they fit into our investment style and trading objective are important. Even in the short term, undesired behaviours in the routing logic will be evident in sophisticated performance metrics.
We are open-minded when it comes to liquidity and we read the endless debates about HFT. However, from a pure trading ‘toxicity’ perspective, trading in an ‘institutional buy-side only’ pool – if your (buy-side) orders are generally smaller than other players – should be equally worrying, given that being filled immediately against larger sized orders could increase your chance of being adversely selected. This is also a concern for HFTs. In current market conditions, it is worth looking at every liquidity pot available, provided that outcomes (i.e. performance, reversion and fill rates) are constantly monitored.