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Best Execution for Managed Portfolios

Aleksander Weiler, Senior Portfolio Manager, Public Markets Investments, Canada Pension Plan Investment Board (CPPIB) talks to FIXGlobal about evaluating asset managers, best execution within FX and managing risk across portfolios.
Evaluating Asset Managers
We are looking for people and groups who have a sustainable edge and we use all the tools available to ascertain their suitability. That involves an understanding of the investment process and the investment team. This is supplemented by quite a detailed analysis of the track record as well as its veracity.
We spend a fair bit of time looking at risk in all its various dimensions. Typically, that devolves into examining the risk process, people and structure as well as the management of the balance sheet and the debt capital of the fund and how the equity capital is structured in terms of the investor base. Most asset managers are medium-sized enterprises, so an understanding of business structure and sustainability are required.
It is necessary to be able to evaluate expected return and expected risk and it is important for us to ensure that a manager’s definition of profit is as close as possible to ours. While you want someone with a good and sustainable expected return and reasonable and bounded amount of risk, there also needs to be a value proposition that sees a fair split in the profit between us, the capital provider and the manager, the risk taker.
For trading-oriented strategies, we use a number of analytical tools, specifically Excel and Matlab. In addition, a wide range of supporting data is used. We also use risk engines internally such as RiskMetrics and Barra.
Best Execution
We invest in a wide range of managers from those doing systematic, long-term investments to those doing systematic short-term high frequency trading as well as discretionary traders. Regarding best execution within FX, we are looking for people who are aware of both their footprint and the transaction costs that they are incurring; specifically, people with electronic execution and the capacity to execute in all time-zones.
Additional venues offer potentially greater liquidity to managers, which is important especially where managers are running multi-billion dollar portfolios. Not all currencies are equally liquid, bringing additional sources of liquidity that can be accessed in a less obvious fashion. This allows managers to not only get the trade done, but also execute in a quiet fashion that doesn’t disturb the market. We also like the fact that these venues are often technology based, allowing managers to perform finer and better transaction cost analysis, which is important because one of the great things about FX is its deep liquidity and 24-hour trading. However, not all currencies are traded equally at all times during the day. Getting a euro-dollar trade done during European business hours is relatively easy and low cost, but trading something like a minor emerging market currency outside its liquid hours can be quite expensive.
This in turn leads to heavier investment in technology. Managers need to upgrade their infrastructure to accommodate multiple feeds as they need smart routers, improved data storage capability and intercom connectivity with the various brokers or groups. All this means that the old days of picking up the phone to get an order done by your FX broker has been mostly replaced by a heavy rack of servers and top-notch IT people, though phones and people still matter for market colour and depth.
Best execution requires maintenance of a transparent chain of tracking orders from signal generation to execution. FX is not regulated in the same way as a stock exchange but you need to be aware of what is happening just because restrictions on various markets are changing every day. From that point of view, managers need an increased awareness of what is happening in the marketplace and an ability to alter their trading behavior if necessary. This in turn has emphasized the role of technology in best execution.

Flow of Information
We want to understand how mangers continue to execute strategies on our behalf because that is what we’ve retained them to do. If a manager is large then efficient execution matters because they are moving around a larger position when they are trading on our behalf, and we want to know how they are executing, what they are seeing in the market and if that has changed.
If the manager is expecting to make 3-5 basis points on a transaction for us and they used to be able to execute at 1 basis point then the net to us is 2-4, but if that creeps up to 2-3 then that starts to become a less attractive proposition.
We also have internal trading teams that we poll for their views of transaction costs as a way to benchmark what the best practice is. This helps us not only compare managers but also provide a snapshot of the market that can be helpful in understanding if we have internal requirements.
Monitoring, Assessing and Managing Risk across Portfolios
Generally, there is no one risk measure for us. We need the ability to analyse risk using multiple methodologies – not only the manager’s holdings and positions, to provide snapshots of risk at a given time, but also to see if a manger is systematic in understanding the return to the specific factors that they are trading as those are often the risk units that are being allocated. This and the style the manager uses are combined with a number of qualitative insights to ensure monitoring it is a fairly intensive process facilitated by technology.
Assessment of risk is a conversation across the investment team including analysts and portfolio managers. Our goal is to understand the risk an individual manager poses, and, at the same time, what that risk looks like globally across our portfolio.
Technological Solutions
Historically, the large FX banks have been in the best position to see the depth of the order book because they’re the ones collecting it and holding it. Transparency into the true order book is something that would be helpful to people, and the fragmentation of venues offers benefits and challenges in terms of being able to be a little quieter in your execution.
FX is one of the important asset classes for us both internally and externally and it is a market that we do believe offers trading opportunities as well as a fairly wide eco-system of styles and good managers. Today, when I look at what you are able to do with the advent of various initiatives like the FIX Protocol it gives me hope that FX can continue to be an important asset class for institutional investors.