‘Alphatizing’ The Entire Firm – Part III
Mat Gulley, Global Head of Trading, Franklin Templeton Investments, is changing how his firm embraces alpha, and is making the PM, research desk, and trader a more integrated unit.
Lastly, for years we have put significant effort into trade cost analysis in hopes we could create metrics, insight and accountability into our process and across each desk and every trader. We have always believed it is impossible to manage what you can’t measure. Furthermore, to accept the notion that benchmarks and metrics were unattainable for buy-side traders was equally unacceptable to us. We have been working with multiple TCA vendors since my tenure began at Franklin Templeton (17 years ago) and have tried to establish metrics which we feel align with our investment process. We also hoped this analysis could become industry standard in order to give all traders the ability to be measured and recognised for their work with a better understanding of their performance and attribution to the investment process. I believe this is still a work in process for our industry. We needed our analysis to handle complex data sets that could be used on a daily and intraday basis and then ensure the results are driving strategy and behavioral changes.
To read Part I, click here.
We have used participation weighted price for almost 15 years. When we first started using it we called it the ‘value added benchmark’, but it was always a Participation Weighted Price calculation. We wanted a benchmark to align with the portfolio manager’s strategies and beliefs around their short-term alpha. We also wanted to allow for the traders to have some way to voice their short-term investment opinions and be able to measure these opinions. Of course, this requires mutual understanding and collaboration to incorporate the PM’s beliefs about short-term alpha and beta. Another challenge is that this requires a relearning of the traditional investment approach by portfolio managers and analysts, but I do believe it is worth the effort. Because there are many times when short-term alpha, liquidity or the market are not the PM’s focus or expertise, it makes sense to push this piece of the alpha triangle to the trader’s level. If tracked and measured properly this should allow the trader and PM to understand the trader’s performance value add to the decision process over time and thus should create a more objective measure of performance for the trader and the trading process.
When we started collecting the specific data around our computer-based trading/algorithm strategies, we had to develop a way to evaluate this data. This was done by taking several benchmarks such as PWP, IS and post-trade price reversions and creating an index. Once we were able to analyse our strategies, we put pro-active trading tools in place which allowed the traders to select the optimal back-tested strategies to use in their daily trading. Our efforts in TCA were really to measure our historical participation and execution performance within these exchanges and dark pools in order to dynamically change our strategies and capture opportunities.
To read Part II, click here.
This leads us back to the integration and collaboration conversation we continuously engage in with the managers. Do they know what you’re trying to accomplish and vice versa? In an ideal environment, there should not be much surprise around execution outcomes: here at Franklin Templeton, we like to say a best execution is a predictable execution. Once we have a conversation with a portfolio manager and the trader takes on the short-term alpha decision and the accountability for that trade, we want to know that those decisions clearly tie back to the original conversations with the portfolio manager. We want to know there is a clear understanding that the trader‘s job is to maximise the short-term alpha horizon and the PM has confidence this is being achieved and measured.
Ultimately, our goal is to have a 50 person global trading team that is constantly relearning, rethinking, evolving, and adapting to what is happening in the marketplace. We want to stress the importance of adapting to technological changes and proactively molding our own behavior as the world around us changes.
There always has been and always will be more to accomplish as we aim to further integrate ourselves into the investment process with research and portfolio management. Buy-side trading, if structured and staffed properly, is generally under-utilised and unrecognised for its potential value. We don’t want to push too far into those distinct areas of investment expertise that delineates the differences between analyst, PM and trader; however a certain level of integration and collaboration is prudent. A properly skilled trading desk knows liquidity, market structure, trading dynamics, market information and should assume his/her role in the value triangle. There is a higher skill level to be achieved and there is an opportunity to think more broadly about maximising all of your resources. The investment process has to, by default, follow the path from research to portfolio management to implementation. I am convinced that there are opportunities for alpha in this area. Overlooking or misunderstanding the potential alpha opportunity that a strong trading team can capture is a direct cost to clients’ portfolios.