Buy Side Liquidity Quest Continues

Terry Flanagan

As the buy-side strives to find liquidity, recent trends show old-fashioned block trading and segmenting of orders reign supreme.

An order to buy or sell 50,000 shares in a mid-cap stock raises eyebrows among traders, who smell that a buy-side trader is in the house. Institutions and traditional buy-side firms have long suffered from the plight to mask their large orders because when their cards are shown, undesirable executions may be a by-product.

The stakes grow higher for the institutional buy-side traders as more trader types, such as stealthy hedge fund traders and speedy high-frequency firms, flood the capital markets.

Buy-side firms that are left with the challenge of wielding large chunks of capital in an increasingly crowded marketplace for traders are even left out of trading some markets, due to their liquidity constraints.

“Each market has its own level of liquidity, and trading in those that are not quite as liquid might take away profit opportunities because traders would be forced to reduce position sizes,” said Greg Anderson, chief investment officer of Princeton Futures Strategy Fund, a fund of funds for commodity trading advisors (CTAs). Anderson told Markets Media that Princeton’s managers are challenged when trading certain commodities markets under their mandates.

“Lots of managers can’t trade red beans, milk or orange juice futures but they have no problems with financial futures such as stock market index futures, or currencies futures because these markets are so deep. People are constantly trading in and out of these markets…no one is going to move them,” he said.

The constant concern of possibly “moving the markets”, has forced some active traders to “outgrow” certain markets, such as the less liquid futures markets, according to Anderson, who tries to keep his manager portfolio diversified by including CTAs of all different sizes, so the smaller firms can still be stealthy in the less liquid markets.

Regardless, a growing trend of slicing mandates to allocate and trade the more liquid commodity futures versus the less liquid has reportedly emerged for the largest buy-side players. “Slicing and dicing” is a trading strategy that’s becoming popular beyond U.S. borders.

“In the last couple of years, we’ve seen that Canadian institutional buy-side traders are going for a wider array of trading counterparties and breaking up orders to get the best execution,” said Brad Taylor, global head of investment finance and hedge fund services at RBC Dexia Investor Services, a global custodian half owned by Royal Bank of Canada and Belgian-French based Dexia Group.

Rather than referring to dark pools, which have yet to pick up steam in Canada at approximately 5% of market share at the end of 2011, the “slicing and dicing” of one’s order helps continue to promote positive relations between Canada’s buy-side traders and sell-side brokers, meanwhile hiding the former’s intentions, noted Taylor.

“There is a desire to spread order flow around the Street to maintain good relationships between broker-dealers,” he told Markets Media. “There are a very high amount of transactions that occur through the lit exchanges in Canada. Institutional managers want a lot of transparency. We’re not seeing a lot of dark pool traffic, even though there are managers that have connectivity.”

Another old-fashioned technique practiced by Canada’s buy-side when handling large orders continues to be block trading, said Taylor, who partakes in the settling of some of the nation’s largest institutional trades. Dark pool operator Liquidnet continued to see a healthy dose of block trades in U.S. trading.

“The year has started off on a positive note with institutional investors having more conviction and putting money to work,” said Liquidnet Senior U.S. Equities Analyst Brian Williamson, to MarketWatch.

“Those two factors lead to greater competition to find liquidity in size and trade large blocks of stock. Other factors playing into the bullish tonality of the market include the decline in overall market volatility and positive U.S. economic data and earnings reports.

“Globally, we have also seen the fear factor in the market dramatically reduce as Europe continues to handle its financial issues and concerns about Europe’s future have abated. That is tremendous news for block trading.”

Liquidnet’s U.S. average daily volume was up 80% percent month-over-month, climbing to approximately 1.2 billion shares and dominating block trading in the first month of 2012. Last January, Liquidnet’s traders comprised 37% of the U.S. intraday market block volume.

For many buy-side traders, Liquidnet’s success may be a testament for dark liquidity, contrary to Taylor of RBC Dexia’s observations. For Paul Daley, head of product development at Fox River Execution, dark venues simply provide more options for buy-side traders in an increasingly fragmented marketplace.

“As we moved from eighths to pennies, and from a single exchange to multiple exchanges, the decision was made to promote competition, and with competition you get complexity,” Daley told Markets Media. “The fact that you now can buy IBM and Microsoft at multiple venues, both lit and dark, has driven the need for electronic and algorithmic trading strategies.”

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