4 min read
As liquidity begets liquidity, scale is increasingly important for trading clients.
Scoot over, algorithms, smart order routers, and AI.
In an equity electronic trading business that tectonically shifted from human- to machine-driven in recent decades, human brokers are making a comeback of sorts. Wall Street desks that handle and route the trades of investment managers still need to be on the cutting edge of technology, but the personal touch has emerged as a differentiating factor in leveraging that technology stack to achieve the most efficient execution.
“Customization has come back into fashion,” said Mark Louka, Executive Director, Systematic Trading for J.P. Morgan Asset Management, which manages about $2 trillion. “It allows us to very quickly do things with partners who do a lot of good things on their own, but don’t necessarily do exactly what we want. It allows us to quickly build what we want, and leverage partners’ technology in doing so.”
Many trades that went ‘low touch’ years ago are staying that way -- a broker probably won’t be any better than an algo at managing a small purchase of a liquid stock. It’s the off-the-beaten-path buys and sells -- the large institutional transactions, sometimes with specialized instructions, in less liquid securities -- that need finesse and collaboration.
“In terms of customization and workflow improvement, a lot of it is around block trading,” said Bojan Petrovic, Executive Director, Quantitative Equity Trader, at J.P. Morgan AM. “As you get bigger you need to trade more blocks and efficiently source end-of-day liquidity, specifically in the last 15 minutes” of the trading day.
In an October 2018 report, Greenwich Associates estimated that 38% of institutional equity investors were asking their brokers for customized algos, and that number would rise to 48% this year.
Brokers are trying to stay ahead of the curve.
“We do a lot more customization and bespoke work, to understand the customer's intraday and multi-day trade profiles and try to engineer the best outcome for the client,” said Todd Lopez, Head of Americas Cash Equities at investment bank UBS. “We are applying a high-touch type of service to what has historically been a low-touch product. People still make a difference in this business.”
Men and women traders’ raison d'être addresses the core challenge of institutional investors, i.e. quietly finding counterparties for outsized trades. That task has been complicated in recent years by fragmented liquidity due to a steady increase in the number of exchanges and trading venues.
There’s no going back to the simpler times when the NYSE-Nasdaq duopoly was the only game in town: just this past May, the U.S. Securities and Exchange Commission approved The Long-Term Stock Exchange as the 14th U.S. equity exchange. That’s in addition to dozens of active off-exchange trading venues, each with their own protocols, order types and unique strengths and weaknesses.
“As the marketplace gets more complex with a growing number of alternative sources of liquidity, how do we access this liquidity in a manner that benefits the end client?” said Peter Sheridan, Head of Electronic Trading , Americas at UBS. “To this end we are seeing more large asset managers partner up with high-touch sales traders, who have the skill set to put together a block transaction in a way that might not happen in an automated fashion by combining technology solutions with a human touch.”
Neither high touch nor low touch trading is going away, nor are the two functions merging. But market participants note a discernible convergence underway. “They are still distinct channels, albeit expectations from clients are evolving, and they're becoming more similar over time,” Lopez said. “For example the low-touch world is starting to offer principal liquidity in the workflow, and the high-touch desk is becoming increasingly proficient in leveraging low-touch strategies.”
Broker technology is not a commodity, but it's also not the differentiating factor it was a decade ago when the current state of the art was first making its way onto trading desks.
“There is some technological differentiation among brokers, but it’s not large in magnitude,” J.P. Morgan’s Petrovic said. “So one way firms compete is to consult with us on our own execution and give us feedback on more optimal ways to trade. Some firms are very responsive and have the resources to deploy to give us the customizations that we want, quickly. Others don’t have either the budget or the tools and resources, so they can struggle with customization.”
“Our flow doesn’t look like every other (broker) client’s flow,” Louka said. “So when they analyze our flow and come back to us with how they can build customizations from there, that is what differentiates trading partners for us.”
Size and scale is an advantage for buy-side desks as well as for brokers. “We can leverage more tools and resources from our counter parties which smaller firms may not have access to,” Louka said. “In addition, we form conjectures about the future returns of stocks that we trade, based on the performance and behavior of our custom work. The net result is the ability of our team to not only manage more money without increasing trading cost, but also provide unique trading insight.”
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