With Bernie Bozzelli, Director of Trade Management, Teacher Retirement System of Texas

Bernie BozzelliFragmentation in the US markets

With over 50 potential venues (exchanges, dark pools, and electronic communication networks) available to execute US stocks, it’s reasonable to suggest markets are too fragmented and are due for some consolidation. However, I think it’s important to point out that in our experience, trading costs (both explicit and implicit) in US equities have generally been declining over the last several years and compare very favourably with the rest of global developed markets so we should not lose sight of the realised benefits from increased competition.

Market Solutions or Regulation?
While I believe US markets are among the most efficient markets in the world, there is definitely room for improvement and I believe that improvement should probably be led by a combination of regulatory changes and market solutions. The Investor’s Exchange (IEX) team has shown that market based solutions do work and can affect change to improve market structure but the pace of change can be slow. The benefit of an enhanced regulatory environment is it can be applied to the entire market structure and the change happens almost instantaneously. For instance, I believe the markets would immediately benefit if the SEC would mandate that exchanges provide market data to participants at the same time and mandate that exchanges remove High Frequency Trading (HFT) friendly order types. (I fully understand this is much easier said than done so this is not a criticism of the SEC.) As institutional traders who are primarily concerned with best execution and the efficient flow of capital from one investor to another, my team only needs a few simple order types to get the job done effectively.
I think regulators are doing the best they can to better understand markets. The SEC and others have very limited resources and the impact of HFT is not the only item they are trying to address. It’s somewhat disingenuous to use the power of hindsight to criticise regulators for the unintended consequences of prior regulatory changes. I don’t recall anyone citing these risks as Reg. National Market System (NMS) was being approved.

Market Structure
We are a global, multi-asset class trading desk at Teacher Retirement System of Texas which means we have experience in several markets that present some type of obstacle to us, however, as US equity markets are very efficient when compared to the rest of the world so I don’t consider US market structure an obstacle.

Processes and Strategies
We are constantly evaluating and enhancing our internal processes to ensure that we are delivering on our best execution mandate. Even before HFTs became a concern, we were dealing with predatory type practices from other market participants such as specialists, broker dealers and fast money hedge funds. One of the most beneficial changes we made several years ago was to decouple research from execution by using a Commission Sharing Agreement (CSA) structure to pay for research. Prior to this change, we used trade execution to pay for research which meant we had to trade with the firm that provided the research. That did not always result in best execution. Under our current structure we only trade with firms that have demonstrated an ability to provide best execution.
We currently use three different external Transaction Cost Analysis (TCA) providers to evaluate the quality of our execution. For example, we use TCA providers to help us evaluate how efficiently our traders and our brokers are able to source liquidity across multiple venues. We also use TCA to identify price action patterns associated with our different portfolio managers. This allows us to then develop optimal execution strategies specific to individual portfolio managers and strategies. Finally, we use TCA to compare our execution quality vs. a peer universe of similar funds.
Technology is also crucial. Currently, we use Bloomberg as our Execution Management System (EMS) provider because it provides most of the analytics we need and it can accommodate all the asset classes we trade on the desk; however, we are constantly evaluating competing EMS products to ensure we are using the right technology.
As far as specific trading techniques designed to mitigate cost associated with HFTs, it’s important to fully understand the logic behind the smart order routers and algorithms we use on the desk. Also, we need to not be predictable. If we were to use just one strategy over a day to execute an order, chances are an HFT or other predator firm would sniff it out and run ahead of us so it’s important to change strategies and back out of the market at certain times. Also, sometimes simple is better. Instead of using a dark aggregator or algo that sends indications to multiple destinations, use a simple Direct Market Access (DMA) strategy with a limit price.


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