Buy Side Still Swimming

Terry Flanagan

Fewer stock trades are going down in the U.S. compared with last year, but buy-side managers are still able to find suitable counterparties, even if some transactions take a little longer than they used to.

“For us the lower liquidity simply means that when we go to purchase or sell names with limited liquidity, it may take us slightly longer to fill or exit the position,” said Brian Peery, portfolio manager at Hennessy Funds, which manages about $850 million.

Stock-market volume averaged about 6.83 billion shares per day in the first quarter of 2012, down about 14% from 7.94 billion shares in the year-earlier period, according to Bats Global Markets.

The tepid market has been a problem for the sell side – broker-dealers and exchanges — for whom order flow is their lifeblood. For the buy side, less liquidity may result in some tactical changes to trading strategies and perhaps an uptick in trading friction, but for the most part, managers’ focus remains with their asset allocation and security selection.

This is especially true for institutions whose bailiwick is in large-capitalization and mid-capitalization stocks. In those names, a 10% or 20% decline in volume still leaves a deep pool of prospective counterparties.

“While all levels are lower than a year ago, we haven’t noticed any disparities between the trading volumes  in like securities, meaning large-cap stocks still have ample liquidity for us to get into and out of with relative ease,” Peery said. “Additionally we haven’t noticed a decline in liquidity within our small cap stocks perhaps due to our investment parameters which keep us out of micro-cap stocks.”

If liquidity does drop off noticeably in smaller stocks, Hennessy deploys a momentum-based strategy that concentrates activity on the securities that are the most easily traded within that sector. Beyond that, the Novato, California-based manager expects the ebb in liquidity to be temporary.

“We do anticipate the volatility and liquidity will pick up,” Peery said. “Considering the VIX is coming off recent five-year lows, one would expect it should trend higher eventually. That being said, markets can stay irrational and/or exuberant for far longer than most traders can remain solvent — that is why we preach not trying to time the markets.”

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