With James Li, Head of Asian Dealing, Baring Asset Management
The early buy-side trader was originally more of a processing role between the portfolio managers (PMs) and the broker before evolving into today’s specialist, alpha generating, professional trading role.
The catalysts for evolution came as a result of the growing complexity of market structure, increased adaptation of technology and tighter regulation. The buy-side, cognisant of all of these factors realised the advantages that specialised market professionals would add to performance and the protection of client assets. As the buy-side firms began looking at execution quality and the mitigation of operating risk, the buy-side trading desk has become more integrated with the investment teams to generate alpha to portfolios, whilst operationally looking at how processes could be improved to reduce the dependence on outdated manual processes, simply because they had always been done like that. The buy-side trader has had to evolve into the space between the PM and the broker, with responsibilities including deciding on the appropriate execution strategy to pursue, where to source liquidity whilst minimising information leakage and then post-trade, analyse the quality of the execution and take away any lessons from the conclusion.
Rather than rigidly sticking to one trading benchmark, fund managers realised that different market conditions, such as changes to volatility or momentum require a variety of approaches, recognising that traders could add value to the investment process.
The use of benchmarks has also evolved over the years due to the ever changing market landscape, from a traditional scheduled based VWAP approach to a more price sensitive arrival price or PWP approach. Whilst historically there was typically one main principal benchmark used in TCA measurement, to gain a true picture of the quality of the execution, this analysis has evolved into looking at multiple measures to achieve a clearer picture of the effectiveness of different strategies being employed. From this we can learn how to tweak our process to increase the alpha generated from the investment decision. I feel this approach gives my team the freedom to utilise their skill-sets and market knowledge in the pursuit of best execution as opposed to being constrained by a more narrow measure of their performance.
Changing relationship with portfolio managers
Communication is always the key and we encourage active dialogue between the portfolio managers and trading desk. As client mandates are getting more complex and market structure is ever changing, we look at positioning ourselves to help the portfolio managers focus on their investment decision. In reality, we are providing high touch sales trading to the portfolio managers.
Whenever portfolio managers put on a trade, the dealing desk should be in a position to understand what they are trying to achieve – whether it is a regular distribution of a cash inflow across positions or an investment decision with a time urgency. To help the PMs with the investment decision process, the dealing desk can reflect the opportunity to trade block liquidity in core names or give colour on market noise. That is part of the value proposition a buy-side trading desk should bring.
Changing sell-side relationship
With the introduction of new regulations and technology, there may be a need to look at the range of counterparties we trade with. Our dealing desk has commission sharing agreements set up with most of the global brokers in which best execution has become more important than ever. Best execution involves looking at the duration of an order and examining how to achieve the order with minimal market impact. It involves careful examination of all the tools available: electronic trading, block trading, crossing networks, agency versus principal trading. Regulation has forced the buy-side to examine and justify those choices a lot more carefully.
We place considerable emphasis on brokers that provide us with intelligent execution consulting and block liquidity. One of the biggest challenges facing any buy-side trading desk is sourcing blocks to trade and we do need to use our counterparties’ expertise to locate liquidity, against the backdrop of increasingly fragmented markets.
Driven by regulation
It is difficult to underestimate the impact of regulation, particularly on the buy-side. Conversation is now taking place around the impact of MiFID II and other global regulation on best execution and transparency requirements, and the impact here in Asia needs consideration too.
We can also examine the wider electronic trading rules, looking back particularly to the SFC’s introduction of electronic trading rules. Those rules meant that once signed up to a broker’s algorithmic trading products, the emphasis is very much on the buy-side trader to understand how those products work and how they might impact the market. In Europe, there is now a similar consultation exercise for asset managers to comply with the new systems and control guidelines issued by ESMA and similar work being carried out by such bodies as the PRA.
This has been a major shift from a buy-side perspective, as the previous ability to subscribe to a multitude of different electronic trading services in the market has been replaced by a more subjective approach to handpick those few who will best serve our needs and even these are reviewed on a regular basis. It is crucial we carefully examine which brokers (from a TCA or a coverage perspective) are maintaining the standards we need them to meet. The trading tools we use on the desk are a lot more targeted and precise. For instance, we may subscribe to a broker but we won’t subscribe to the whole algorithmic suite, only to those algos that are to be used on a regular basis.
Driven by technology
Each industry goes through a paradigm shift and trading is no different, with technology playing a big part. At Barings, we are a big supporter of using technology to enhance performance and mitigate risk in a cost effective manner. Whereas buy-side desks used to predominantly use high touch sales trading, there has been increasing use of electronic trading over the years to the point where we are customising algorithmic strategies with brokers. This year, I would like to further deep dive into individual markets to see where our electronic usage rates are. Ideally, developed markets which trade in narrow spread such as Japan, HK, and Australia should have higher usage rates than the rest of the region.
Barings is also actively participating in various industry initiatives. Our Head of Dealing, Adam Conn in London, has chaired a FIX Trading Community working group working to provide automation of new issue applications and allocations in both equities and fixed income, and in both the primary market and secondary placings process. We also participate in joint Investment Association and AFME working groups to bring standardisation to IOI definitions and industry oversight of electronic trading in Europe, similar to what we have developed in Hong Kong.
It will also be interesting how new initiatives such as Symphony for messaging will develop. Blockchain has become the hottest topic this year. I am not exactly sure how this will reshape the industry but I believe it is going to have a huge impact at some point.
What qualities we look for in traders Aside from a basic aptitude to trade and the ability to process information in a timely manner, strong communication skills (both delivering and listening), especially with the PMs is a priority. Understanding market structure and the impact of changes in global and local regulation are increasingly vital in the ever changing market landscape. Innovation is effectively problem solving so the ability to work as a member of a team is critical. As markets change, new skill-sets such as being technology savvy or someone who has a strong quant background who can analyse and identify trends from large amount of data will help us find answers to new questions. Most importantly, the best traders need an open mind and be prepared to continually learn whilst maintaining a degree of humility.
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The Evolution Of The Buy-side Trader
