Senrigan’s Head of Trading, John Tompkins, and RBS’ Andrew Freyre-Sanders discuss the way event based funds use liquidity and the effect of ID markets in Asia.
Andrew Freyre-Sanders, RBS:
What would you say Senrigan is known for among Asia hedge funds?
John Tompkins, Senrigan:
What we are most known for now is being an event-driven fund that is entirely based out of Asia. Nick Taylor founded Senrigan in 2009, and he is known for doing event-driven trading and has been verysuccessful at it. Nick was at Goldman Sachs and Credit Suisse, where he ran Modal Capital Partners for nine years before going to Citadel with his team. Senrigan’s capital raising and first year metrics made the first two years a success.
AFS: I know you trade in the US and Europe as well, so is the global fund entirely based out of Asia?
JT: The entire firm is based in Hong Kong, although we have some analysts who spend extended periods of time in the regions of focus. If we do any US and European trading, it always has an Asian bent to it; for example, a UK or European listed company that has a large percentage of their business located in Asia. The few examples are Renault-Nissan, all the Chinese Depository Receipts (DRs) in the US and some Canadian companies doing M&A into Australia.
AFS: Event driven funds require quick access to liquidity. How does the type of deal or event catalyst affect the relative weighting of these items?
JT: The exchanges and companies are smarter, so they generally halt or suspend the names coming into the announcement, and then you have a short window until a given stock starts to trade up towards the terms. Any reasonably-sized fund is not going to be able to get anything done in that time period. After the event, the main concern is your targeted rate of return for the particular deal, which is impacted by the closing timeframe, surrounding risk, regulatory approval, dividend payments, etc, and you set levels where you want to be involved.
Traditionally safe deals with very tight spreads are viewed as the simplest way to risk-reduce, so people take those off and we give liquidity then because we are comfortable with what we are taking on. A lot of people think about the event as just the announcement on the day, but it is actually the time between when you see it and the range gets set. Only if it closes sporadically do you need access to greater liquidity; most of the time, you just need to be in touch with providers rather than have direct access.
AFS: From a trading perspective, once a deal is gone, it is not about that deal. The only speed liquidity advantage is in having systems that can take advantage of the spreads when they may be moving around a certain level. Is that the case for you?
JT: It definitely is. The big differences between Europe and Asia are the number of auctions and the number of times stocks stop trading, which is quite significant. Between three and four distinct times a day, you will have dislocations in spreads for a variety of reasons, and this is an opportunity to improve. Beyond that, a majority of sell-side firms are setting up their own dark pools and there are alternative exchanges in Japan. In those venues, we deal with liquidity providers and market makers who do not care about the individual mechanics of a name; they simply care about the level of spread that they can access.
The most relevant thing is making sure you have the connectivity turned on to access all the forms of liquidity that exist. There is a big differentiation between counterparties in Asia from an executing broker’s standpoint: e.g. what is their default, what do they turn on for you right away, whatcountries do they have their crossing engines in, who do they have in their pool as liquidity providers? You have to know to ask those questions, and it has been very helpful to do that.
AFS: Does this look different if you go through a sales trader as opposed to trading yourself?
JT: If we are talking about it just in terms of risk arbitrage, there is some level of efficiency in telling our counterparties what level we care about , but the reality is there are going to be various levels of flow that they will just not see. Over the last couple of weeks, spreads and stocks have moved a lot intraday because people turned to DMA and algos but used the wrong type of algo. If a trader was long and wanted to get out, they used VWAP in a deal name or % of volume with no limit. The problem is the liquidity profiles are not the same during volatile markets, so the slice sizes were wrong. As a result, you saw short term sizable dislocations with no desk owning the flow, so it provided an opportunity to add into that type of activity, either through desks or dark pools.
As a result, I have been more cognizant about parking these types of trades in either pair engines or letting part of the order sit in a dark pool versus the lit markets if I can. Cash-only deals are easier to park in a dark pool and get done if the amount that you wish to trade in the market relative to volume being traded might be quite low; on the other hand, it only takes one or two people selling out of a name to cause a dislocation.
For example, I was trading an Australian resources deal name when a broker in Australia informed me the stock traded down sharply, for a name like this, intra-day on lighter volumes. I had more to do, but there just was not that much trading, so we threw a whole chunk of the order into a dark pool, and lo and behold, we completed a large chunk of our balance at a better price that we would not have gotten working with just a sales trader.
AFS: Fundamentally, the key evidence is that obviously in the liquidity constrained environment, you are already executing trades in the dark pools. What we experienced with quite a few people is that they actually start to increase their algo usage over the day, so they will not take so many views. The next question is how critical is liquidity aggregation to your model?
JT: Aggregation is something I take quite seriously, although it is segmented for us. In terms of active deals and risk arbitrage, the relative sophistication of the aggregation has increased, so the ability to randomly get price dislocation in any real size in quite low. Liquidity aggregation across brokers, however, is as much personal as it is technology. The converse is true in Japan, where liquidity aggregation has been important, now that there are so many execution venues. The traditional Japanese risk arbitrage trades are incredibly tight and they tend to be very wellflagged. As a result, we may set up at a target level a long time ahead and wait for the day of the event. The deal timeframes can be 6 months to 1 year to complete, so you have a lot of time for these things to mature before they come out of an index.
It is increasingly necessary to analyze how much of a stock is trading in PTS venues along with looking at overall broker flows.
AFS: So I suppose the answer is that liquidity aggregation is important, but it is more than just a pure multiple venue aggregation. On the topic of venues, Asian exchanges have many models for investor transparency, ranging from full IDs, non-IDs. What macro level benefits do investor ID programs provide?
JT: Honestly, I am in the same boat as a majority of the institutional, non-domestic investors who strongly dislike the ID market. Even Hong Kong’s method of transparency is unnecessary and I would prefer they got rid of it. Traders should be able to trade without worrying about the effects of having large foreign brokers on the offer for a mid-cap name in Hong Kong. As another example, if you trade in Korea you may give your trade to a foreign broker, but they execute through a local broker, what advantage have they gained? Many intelligent investors know what is happening, and they just game around it.
AFS: Do ID markets encourage or discourage gaming and broker shielding?
JT: There is one algo platform being developed in the US, and another one in Europe, that chooses different brokers on your order, and if there is any disruption, it automatically knocks over to another broker in randomization. If enough people are aware of broker shielding, then the ID has probably past its usefulness.
AFS: The whole concept of dark pools is minimizing market impact. If there is a mid-cap/small-cap name that is heavily traded by local retail, would you rather rather give the order to a local broker even though it adds another layer to settlement.
JT: If you need to access liquidity then, yes, you access via the local broker. The key here is developing a relationship that minimizes any information slippage.
AFS: Last big question, do investor ID requirements discourage you from trading those markets or pursuing any deals?
JT: The deals part is actually quite interesting because in Korea, Taiwan, Indonesia and Malaysia, you have capacity constraints in terms of your ability to hedge market and currency risk on the ID format, so we are more selective about approaching situations there, and I imagine other firms have a similar issue.