Beyond your basic TCA.
Hongsong Chou, head of quantitative analytics and algorithms, Asia-Pacific, and Robert Laible, global co-head of electronic trading and QPS sales and head of program trading sales, Asia-Pacific, Nomura, explore the value brokers can add to execution performance.
Our electronic trading consultants have been working closely with some of the more sophisticated clients in Asia. Some of these institutions are implementing facilities that automatically route orders to different trading algorithms based on the specific liquidity characteristics of each order, with the aim of minimising overall market impact while capturing maximum trading alpha.
The Execution Consulting Services team at Nomura provides the following services to aid buy-side execution performance: historical trading and market data; threshold values for key variables and categorisation of orders into different groups; custom algorithms that dynamically decide trading strategy parameters based on a client's specific requirements; and continuous monitoring of an algorithm's execution performance.
Buy-side gets smart
What these projects have demonstrated is that large institutional investors are becoming savvier when deploying algorithms as part of their overall execution process. Such sophistication manifests itself in three ways:
*Increased level of trading customisation: Traditional custom algorithms are centred on price, volume or spread triggers at a singlestock level. What's emerging are stock profiling and venue optimisation techniques, focusing on how to set different parameters (or triggers) for different stocks in customised algorithms. Both algorithm behaviour and algorithm performance can be optimised for a large group of stocks. Venue optimisation is essential to address the fragmentation of liquidity in the Asia-Pacific region by leveraging different trading venues connected through smart order routers.
*More automation of order submission and execution management: In collaboration with technology vendors, many leading buy-side firms can now automatically route orders to selected brokers with different custom algorithm parameters via preset FIX messages. During execution, real-time monitoring tools closely track execution performance, especially for stocks that may be hard to trade and orders that exhibit outlier performance. Once completed, traders analyse brokers' execution performances on the same day. The resulting analysis gets looped back into next day's trading with increased allocation to those brokers that add value.
*Closer scrutiny of investment strategy performance through execution data: Optimisation of key execution decisions such as market entry and exit times, in addition to the best suitable algorithms, can fine-tune the investment strategy in terms of stock selection and the timing for portfolio rebalances. Figure 1 shows that traders can quantify the decision-making patterns of their PMs, then tailor unique execution strategies with different investment styles to ensure maximum alpha capture.
Meeting client needs
For sell-side firms, the changing consumption patterns of their clients dictate the need to fine-tune their products and re-tool their service delivery mechanisms to accommodate these new trends. The key requirement will be how to customise the algorithm to fit the client's specific execution requirements. To address this issue, three steps must be taken:
* Requirements for customised algorithms need to be specified clearly: Electronic trading consultants need to conduct in-depth analysis on historical executions, and work closely with the buyside to identify key issues. These specific factors will have a profound impact on execution performance leading to enhanced investment returns.
* Quantitative analysis needs to be conducted in order to determine specific parameters for algorithms used on different groups of stocks and orders: This is often different from traditional TCA, which focuses on regular reporting of execution performance. The new TCA - as part of the electronic consulting effort - should combine post-trade execution data analysis, market data analysis, quantitative modeling, and trading simulations to pin down key parameters for new trading algorithms.
* Implement and test new algorithms: This step often requires close collaboration between the buy-side firm, the electronic trading consultant, and sometimes OMS/EMS/OEMS vendors, with a strong emphasis on disciplined project management. In conclusion, we believe that by leveraging existing investment in quantitative infrastructure and by extending traditional TCA services, sell-side firms can provide a significant amount of value-added services to the buy-side in the form of electronic trading consulting, with the same goal as before: improve execution performance by reducing trading costs and enhancing investment alpha.