FT Mandate: If one accepts the premise that algorithms will become more widely available, with new varieties and flavours hitting the Street, why is it that recent industry research suggests algorithms are currently under-utilised by the buy-side? Do you find that the case with EdgeTrade's organically developed algorithmic strategies and do these differ and why?
Kyle Zasky: Algorithms are under-utilised, because most broker-dealers are not explaining to their buy-side clients how strategies can add value. These firms drop algorithms on the desks of their clients but do not take the extra step of educating them on the ‘how’, ‘when’ and ‘why’ for each strategy. EdgeTrade’s algorithms are actively used by our clients, because we provide each trader with education on the strategies and training for usage.
FTM: Does EdgeTrade subscribe to the view that algo trading has played itself out a bit for the time being? Research on the buy-side’s view and take-up of algorithmic trading reveals that there was a “surprising” disconnect between the level of take-up and usage of algorithmic trading technology and techniques among buy-side institutions - in contrast to some suggestions on the sell-side?
KZ: Algorithmic usage will only continue to increase. The trading role is irreversibly shifting from the sell-side to the buy-side, and good algorithms will continue to serve as an essential element in the tool-kit of the emerging, empowered buy-side trader.
Reg NMS and MiFID are practically mandating electronic trading. Through these regulations, and the fragmentation each will spur, tools such as algorithms and direct market access will take on more importance and relevance, not less.
FTM: What are some of the perceived/actual obstacles to further take-up (e.g., greater connectivity, FIX interfaces, ongoing client education and training)? What are you hearing from the clients that you interact with? And, what do you regard as the role of an ‘execution consultant’ to end users?
KZ: Adoption of algorithms by the buy-side depends, in part, on a strong, consultative relationship with an unconflicted sell-side partner. Here’s the dilemma: in pursuing the proper strategy to meet a particular trading objective, how does a buy-side trader share his/her intentions with a sell-side firm that conducts proprietary trading? Brokers that conduct proprietary trading boast about “Chinese walls” but ask any buy-side trader and they will voice their legitimate concern. EdgeTrade’s algorithms are actively used, because our quantitative team offers an unconflicted, agency-based consultative environment for discussing both a trader’s confidential trading objectives and the customisation of an appropriate strategy for reaching those goals.
FTM: How does the unconflicted agency model play out and how is it being received against large asset managers and pension funds sending their orders to a proprietary desk algorithm?
KZ: In the very near future, asset managers and pension funds will have to deal with greater accountability for demonstrating their commitment to best execution. They will have to explain their trading costs, and provide reasons for why they sent orders to a firm that conducts proprietary trading (invariably resulting in higher trading expenses, both explicit and implicit) rather than an agency-based firm that is unconflicted and therefore more attuned to the importance of meeting best execution.
FTM: The term ‘execution consultant’ in relation to algo trading seems to be gaining traction (but perhaps it never went away). What role does EdgeTrade play in acting as an ‘execution consultant’ to its various clients in both the US and Europe?
KZ: EdgeTrade offers clients the means to trade anonymously through an agency-based model that never competes with or takes advantage of them. We are execution specialists, and establish a consultative relationship with our clients for the purpose of creating customised algorithms designed to meet their trading objectives.
FTM: ‘Best execution’ is a term that has many different definitions. Some say it means delivering the execution that best suits the client’s needs. How do EdgeTrade’s algorithmic trading solutions help in that regard – clearly algos are not appropriate for every trade but can help deal with the “noise” on trading floors and simpler trades – freeing up traders to intellectualise over the more complex transactions? Can they help generate ‘alpha’ too?
KZ: While algorithms are not appropriate for every trade, they are applicable for a much higher percentage of order flow than what we see today. Agency algorithms are not designed to generate alpha. However, any algorithm that increases efficiency will inherently generate some alpha as a by-product of better, reliable executions.
FTM: With algo trading not likely to be going away – especially with a fragmented market place (RegNMS, MiFID on their way) and the buyside becoming more comfortable with using various offerings, measuring the pre-/post-trade dimension becomes all the more important. Transaction cost analysis (TCA) is key – but should institutions be adopting agency broker TCA offerings or more independent solutions?
KZ: The buy-side should never employ a TCA offering developed by a broker. This is counterintuitive. An independent TCA product is the only way to go.
FTM: Are VWAP (Volume-Weighted Average Price) algorithms all the same and as benchmarks are they the ‘only game in town’?
KZ: VWAP remains the most commonly used benchmark algorithm. Elkins/McSherry, a globally recognised, independent provider of trading cost analysis, recently evaluated every single EdgeTrade VWAP trade between Jan-Dec 2005 against all other VWAP trades in their universe. The outcome: our VWAP outperformed 93 per cent of their universe of over 220 large institutions. This proved that not all VWAP algorithms are the same.
In association with EdgeTrade.
