The PM & The Trader
Senior Portfolio Manager at Allianz Global Investors Ian Lee looks at the changing communication patterns between PMs and traders.
The nature of the relationship between Portfolio Managers (PMs) and traders is undergoing a constant revolution. Changing communication technology has meant that more than ever PMs can stay on top of their investment actions and executions throughout the trade cycle, either at the desk or on the road. Traders themselves have become much more autonomous with their execution decisions.
Ian Lee, a senior portfolio manager at Allianz Global Investors joined AllianzGI in 2000, comments about the changing relationship between PMs and traders saying “I myself started out on the trading desk and it gave me a bit more perspective than others about what the role involves, however, that was well over a decade ago and I can see how it’s evolved. Among other things, orders get electronically routed and executed, added to the fact that there’s a lot more ‘noise’ in the markets themselves. Gone are the days of having to place orders over the phone and have them read back to avoid mistakes. Today’s traders have to be alert to factors such as high frequency trading, queue stuffing, and high cancellation ratios, plus a whole new mix of hedge fund activity.”
Coming back to the specifics of what the trading desk does for the PM, Ian adds “I trust AllianzGI’s trading team to monitor our orders; that allows me to make the best use of my time, often going out to meet the management of the companies in which we are interested. Although one should monitor short-term drivers affecting stocks, my primary role is to focus on identifying strategic long-term investment ideas and to make sure the structure of the portfolio is intact. I sometimes turn my trading monitors off and focus on research so I don’t get caught up in the day to day price volatility of stocks and noise. I leave it to the traders to watch the markets, as they follow the cash, futures, and derivatives markets and are able to adjust to market conditions on the fly allowing me to focus on what I do best.”
“Traders are on the desk all day, every day, and are more in tune with which brokers are making significant research calls, who’s buying or selling, or may have shown up with changes on the register of substantial shareholders in a host of different stocks. Traders are able to use slower periods to sift through news and commentary of the more meaningfully held stocks; they get a feel for which stocks brokers are pushing investors to buy or sell, catalysts that could trigger short term price action, and if impactful enough highlight these in the daily morning meetings and emails.”
Communication between the PM and the trading desk has undergone dramatic transformation and evolution in recent years. As AllianzGI’s senior portfolio manager, Ian has a long-term perspective on the changes in communication methods, saying that “in this day and age it takes so many forms and it’s the same for the interaction we have with the trading desk. Though I leave most executions to the trader’s discretion, I may make short comments on the electronic orders we send to the desk’s traders. If it can help my own executions to let them know why I’m investing in a stock, the reasons behind it, then I certainly will. Communication between the PM and trader is paramount to executing effectively, and when I’m in the office I may walk over and just discuss my orders with the traders. Should I be away from the office, I can make use of Bloomberg IB’s, messages, Blackberry email, and good old-fashioned phone calls, though for security reasons we’re not going to get into too much detail on those mediums.” “Often on the PM-side we make investment decisions collectively as a team, but each PM or their portfolio assistant enters their own fund’s orders. The trading team coordinates and works them together. When one or two of the PM’s are out and the lead PM for that stock decides to change their execution strategy, or put a limit on the order, the trading team can communicate this with all the PM’s involved.”
The levels of autonomy given to traders are a key consideration. While the PM has views over what they want to trade, and when, sometimes the market can make that difficult. As Ian says “there are times I’ll enter orders and it may turn out to be the ‘wrong day to trade’. Every day is different and just because you find enough liquidity one day to pick up a million shares without moving the price; trying to do the same thing the next day could drive the stock up 5%. I rely on the trading desk to advise me on those cases where the supply and demand is off kilter. This reminds me of that old trading adage, ‘You don’t trade when you want, you trade when you can’.”
And as the information flow goes back up the chain; “I’m OK to take the trading team’s advice on orders with liquidity constraints. There’s always the risk of a stock moving away from you and never coming back, but for the most part, with a bit of patience, they do somewhat revert to the mean. A few will get away from you and that’s unfortunate, but more importantly it is the communication level between the two teams that leads to a successful execution.”
As with all times, when autonomy is granted to a trader, there are occasions when things will go wrong, and the trust and communication between a PM and trader becomes paramount, as Ian adds of his traders; “they certainly don’t always get it right, and I feel it’s important that I don’t fly off the handle when a trade goes the wrong way. I think if I did, it wouldn’t be constructive in the longer term because the traders would move towards not taking calculated risks, resulting in only average executions. Instead I want the traders to take advantage of their insight and seize any opportunities in the market. Empowering them to be disciplined and use their experience, taking a stance with true discretion will help to build their confidence. They want an excellent execution as much as I do. With the benefit of hindsight any of us could do better.”
The trading desk
“In many ways our trading desk has some similarities to the way we as PM’s pick stocks, which is to say we are bottom-up, fundamental investors. The trading desk looks individually at each of these orders. I know they consider factors ranging from liquidity and flow in the name to moves in the stocks peers, sector, and the general market. Every PM has different execution expectations, but having worked so long with the same group of traders I’ve become confident that the traders understand how I work. Though our global benchmark is Participation Weighted Price (PWP) 15%, many times our traders may choose to execute my orders on implementation shortfall strategy, in that they get filled rather quickly in blocks if they can find the liquidity. I rely on the traders to decide to use the market’s liquidity, or for the sake of expediency utilise a broker’s capital to facilitate an immediate completion. One thing I feel strongly about is that traders just like fund managers, have to understand risk, use it, and make decisions based on all the information available to them at the time. However, anybody taking risk over and over knows it doesn’t always go your way. So it’s important to firstly be constructive in analysing actions that don’t deliver the expected outcome. I’ll certainly question a trader why an execution was suboptimal, but I am more concerned that the thought-process was intact, and a mental checklist of how the trade was followed. It’s this expertise and experience that overall achieves AllianzGI’s best executions longer term. I need the comfort that in a larger data-set of trades over time most would be winners, and if that doesn’t happen, then our trading desk would have to make changes”.
“There are more parallels to trading and fund management; we talk to the same firms, talk about the same stocks, and live the markets. But the content to these discussions are different. I may speak with the best couple of analysts but that doesn’t mean that traders at the same broker have the axe or experience executing the covered stock of their analysts. Some firms try to trade franchise names that their research team excels in, but that’s not always the case.”
There is also a large extent to which the traders are expected to be autonomous and exert a degree of control over the fact that they are clued into the trading environment itself, as Ian adds, “traders are proactive and react quickly to take advantage of the temporary mispricing we occasionally see in the markets from time to time. They realise things don’t get done without effort and I see them working hard to stay ahead of the curve. Nobody improves without action and initiative, whether it’s researching and signing up to a new initiative, or showing an innovative approach to do something differently. Years back when stand-alone dark pools were just being introduced to Asia we were the first clients in one of them to get a trade executed. As Marie Curie once said ‘Nothing in life is to be feared, it is only to be understood’. ”
“Traders keep an eye out for accelerated book-builds where time’s short. Kent Rossiter acts as our company’s dedicated gatekeeper for material non-public information (MNPI), and partners with the street’s syndicate departments.”
An important part of any relationship between a PM and trader is the ability of the PM to hold the traders accountable for their part in the investment chain. With increasing granularity of TCA data, and using trading analytics specifically as a measure of a trader’s performance is one area of quantitative feedback flowing between the traders and PMs: “The traders present their TCA results at our offsite meetings, and I know Kent does regular reviews with our Asian Investment Management Group, and separately they’re reviewed by the Regional Brokerage Committee. The trading desk has sat down with individual PM’s to discover styles and discuss some habits that may be impacting trade performance. Observing stocks reverting to their mean after finishing an order can be an indication we’ve been too aggressive in our executions. The over-use of limits put on trades that continue to move against us when the stock continues to trade away is another area of discussion. Percentage of volume (POV) restrictions or preferences is yet another area of TCA results that can be looked at.” Ian adds “As a PM entering a trade I’m generally happy to execute the trade around current levels given my expected upside on the stock, otherwise I shouldn’t put the trade on. I trust the traders to execute it to the best of their abilities.”
Allianz also takes the quantitative performance into account when deciding remuneration for traders, as Ian says “Allianz Global Investors investment culture has long been built on a pay for performance mentality. That’s true of my own remuneration as a fund manager, which is mainly dependent on a rolling three year performance track record, and it’s true of our traders’ performance, where their quantitative trade cost analysis (TCA) metric versus their peers makes up 50% of their year-end evaluation. The other 50% is qualitative, including formal and informal comments of co-workers and fund managers.”
So with traders and PMs increasingly aware of each other’s capabilities while becoming more autonomous, and with communication becoming ever faster, the nature of the relationship between the PM and trader is sure to increasingly evolve over time. Ultimately in any successful partnership it’s often built on communication, trust, respect, and integrity. That’s the Allianz Global Investor’s way.