Buy Side Ambivalent on Algorithms

Terry Flanagan

Buy side traders have something of a love/hate relationship with regards to algorithmic trading: While recognizing its inherent efficiency in splitting up orders and directing them to venues to improve execution quality, they know that sometimes it doesn’t work as advertised.

“IF you’re accessing liquidity, you need to make sure you have the ability to execute,” said Craig Jensen, principal and co-head of trading at Armstrong Shaw Associates, which manages $2.5 billion. When you’re trading through an algorithm, it’s frustrating when you enter a market order and it takes ten seconds to execute.”

Craig Jensen, Armstrong Shaw Associates

Craig Jensen, Armstrong Shaw Associates

A well-structured algorithm should execute market orders instantaneously. “We have trading systems that do that, but when we use systems from other providers it doesn’t happen, which means they’re internalizing that order flow in a manner that’s detrimental to my order.”

Jensen said that knowing who your trading partner is can be crucial in determining whether an order is getting picked off.
“We work with shops that we can trust to find the liquidity we need by making calls to the marketplace,” said Jensen. “I’ve always been conscious and concerned about leakage, but I’m not going to let it interfere with my ability to trade.”

Institutional investors spend between $1.5 billion and $2 billion per year on order management and execution management systems for their trading desks, a growing amount due to increased demands for compliance tools and the need to keep pace with rapid changes in market structure.

Barclays has launched monthly reporting volumes in its dark pool, LX, underscoring its belief that transparency benefits the overall industry.

“Our commitment to reporting volumes and other aggregate details about LX underscores Barclays’ belief that transparency is not only important, but that it benefits both our clients and the market overall,” said Bill White, head of equities electronic trading at Barclays. “As the equities market structure continues to evolve, our belief is that more transparency will assist clients in finding natural sources of liquidity and allow them to make more informed decisions on their trading.”

In April 2013, LX reported an average daily volume of 99 million shares, representing $6.6 billion in average daily notional value traded.

The commitment to report volumes in LX follows several other initiatives introduced in recent years which have also promoted transparency to help clients make informed decisions, such as Liquidity Profiling in LX.

Introduced in January 2012, Liquidity Profiling allows Barclays to evaluate each client’s trading in LX based on quantitative factors, thereby providing more accurate assessments of aggressive, neutral and passive trading strategies. Clients can then choose which trading styles they interact with, instead of choosing by the more arbitrary designation of client type.

Annual buy-side spending on order management systems (OMS) and execution management systems (EMS) has increased 10% over the past two years, according to Greenwich Associates. Trading desk technology is playing an increasingly critical role for institutional investors as a means of achieving optimal trade results and meeting tough new compliance demands associated with new regulations and client-imposed reporting requirements.

Many technology vendors offer systems marketed as OEMS, or integrated OMS and EMS. The Holy Grail of a truly integrated OMS/EMS system, however, has yet to arrive. “Many of the platforms marketed as OEMS function more as side-by-side OMS and EMS as opposed to truly integrated solutions,” said Greenwich Associates analyst Kevin Kozlowski. “Today’s integrated platforms are used by only about 30% of institutions we interviewed and to date, the use of comprehensive, end-to-end systems has occurred primarily among smaller institutions and hedge funds.”

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