The Shifting Sell-Side To Buy-Side Responsibility
With Neil Bond, Head Trader, Partner, Ardevora Asset Management
Of the 25 years I spent working on the sell-side, most of it was spent on program trading and algos, which are quite intimately linked. Algos were originally developed for program trading desks but the buy-side were given access to them very soon after.
Why make the move to the buy-side? After all those years on the sell-side, I wanted a change that would be suitably challenging but where I wasn’t a complete beginner. I had been speaking to the buy-side for a very long time so I wanted to have a shot at what they were doing.
Despite many aspects of the role being very similar, it is quite a big transition to move from the sell-side to the buy-side. If a trader is going the other way – from the buy-side to the sell-side – they are doing so as a valued customer. Going from the sell-side to the money management side is trickier, while you may well have helped those people to trade effectively in the past, the move seems to be more difficult to negotiate.
One of the issues I faced when trying to make the switch was investment firms wanted someone who already had buy side experience. This is becoming less of a hurdle as more sell-side traders make the switch. When I did make the jump I could see how many more moving parts there were that brokers don’t get to see such as compliance checks, fair treatment of accounts, management of prime broking relationships and areas like cash and exposure management which I had to learn quite fast.
Moving to the buy-side allowed me to focus my aims and align them with the rest of the team around me, free from the conflicts of interest that arise from the silos commonly found on the sell side (where a sales trader can be stuck between a client that pays commissions and a trader working for the bank that pays his wages). In the current principles based regulatory environment good to be part of a genuinely cohesive team where the only aim is to provide the best return for our investors.
As a broker, if I didn’t find the stock, that tended to be the end of the story; you go back to the client and tell them that you can’t find the stock. If this happened on the buy-side however, there would be ramifications. It might be necessary to buy or sell something else instead which could affect your other positions – so it is far more involved than I had anticipated. Getting brokers on-board is also more difficult than I expected and it is necessary to justify reasons for building new relationships with brokers.
In addition, I had no experience of the relationship between traders and fund managers, and I needed to understand what they want from a trading desk and the best way to deliver what they need. Open communication between the two teams is crucial for success.
There are many advantages of having experienced the sell-side for so long; particularly understanding what happens to orders when they go across to the sell-side. I have a detailed knowledge of how the sell-side operates, what their options are and how difficult it is for them to operate in particular circumstances and these are all aspects which can be shared with my firm and which ultimately gives us more control.
Ardevora’s trading turnover was fairly small when I arrived, but AUM has grown fast and our blocks and programs are now comparable to much larger firms. In order to move away from simply sending orders out to brokers, Ardevora started to build up a wider range of broker relationships and increased use of electronic trading. The company began using dark pools to find liquidity and accessing the expertise of firms like Liquidnet and other dark pools to stay under the radar and have a more passive trading approach. We implemented a more analytic decision process when using risk programs, understanding when to avoid risk, measuring trades and understanding whether the choices made were the right ones. My sell-side skills have helped our trading desk become more scalable to meet the requirements of a higher AUM.
20 years ago there were no algos, no dark pools nor MTFs. There were no high frequency traders or electronic liquidity providers and no one was directly competing with the exchanges. With MiFID I the trading environment changed dramatically, but the exchanges have been around for a long time and they are good at defending their positions. With the technological revolution in the market, the exchanges are developing fast to stay ahead of the technological curve.
An exchange’s primary role is to bring entrepreneurial companies onto the market, to facilitate the provision of capital to those firms. After that, their role is to provide a stable marketplace within which to trade those equities. As long as they keep on doing those two things without abusing their monopolistic position, they’re fine. However, if they get too greedy, market forces and regulations will intervene to increase competition.
One unintended consequence of the regulation has meant a very fragmented market has developed, but the exchanges are responding with developments such as Turquoise BDS, midday auctions and hidden pegged order types to draw liquidity back to the primary exchange.
The proliferation of low touch offerings has resulted in cost savings; however the buy-side having a higher level of control means an increased level of responsibility. The market has become a great deal more sophisticated in so far as the end users of the algos need to understand what is happening with their order once it goes into an algorithm, the venues that it is going to and all the different order types that those algos could be using. There is a vast level of execution data generated that needs to be gathered, analysed and monitored.
Buy-side traders should have a high level of knowledge about what is happening to their orders. The regulators asked the industry who is responsible for best execution and, unsurprisingly, the buy-side said the sell-side did and vice versa! So the regulator has decided that both buy and sell-sides need to take increased responsibility for best execution and trade management. As a result, the buy-side is starting to adopt many of the sell-side’s tools and so ultimately each side should be held to the same level of accountability as the other.
One key difference between buy and sell-side is the access to liquidity venues available to each side. The buy-side can access many more liquidity pools than one broker can alone, because not all brokers share their pools. On the flip side, the sell-side has access to a great many buy-side firms for sales trading. They have access to what my competitors might be doing. As a result of that ‘information asymmetry’ there will always be a need for brokers.
The future for the buy-side
In the future, being able to demonstrate best execution – not simply having a best execution policy – will weigh heavily on both sides. The market will continue to evolve rapidly and there is now a two-way pull due to the new venues, new order types and new systems that are being created very quickly as solutions to the problems the industry is facing but it takes time to get these new projects to critical mass as significant contributions in terms of resources are needed from within the industry.
One curious by-product of the current evolution is that while the buy-side has to go through the sell-side to access exchanges, their direct relationship with exchanges is growing stronger. It will be interesting to see how these direct relationships develop especially if investment banks are excluded from collecting research payments from trading commission.
MiFID II is going to require that firms demonstrate best execution, which means they not only have to do the right job, they also have to gather all the data and analyse it; which is neither cheap nor quick. That requirement will impact far more on the smaller firms than it will on the larger firms and raises the barrier to entry quite high.
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