Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Six tips to avoid a high-frequency trading rip-off
(Pictured: Phil Weinberg)
We’ve been telling everyone for years but it now turns out that we were right: good execution of securities trading is important. It’s important not only for fund managers but also for super funds who are their clients and, increasingly, their competitors.
Phillip Weinberg, the founder of Australia’s first broker-neutral trading firm, has put together some advice for managers and big super funds on how to deal with high-frequency trading (HFT), which will otherwise take advantage of novices in the trading world.
Weinberg, who launched BestEx, an outsourced trading desk for equities managers, in 2012 after about 10 years as a trader himself, says the market in Australia is far less favourable to HFT than it is in the US, where they have an unfair structural advantage.
“Fund managers have a far greater ability to protect themselves from interaction with HFT in Australia. If they wrongly take the view that trade execution doesn’t impact their returns or are content to rely on their brokers to execute their trades then yes, they will incur an avoidable tax on their performance from HFT.”
He has six tips for dealing with HFT in Australia:
> Ensure that you have a basic understanding of the types and strategies of HFT, the way different brokers rout orders, the brokers that facilitate HFT in their dark pools and the impact of trading with HFT on your performance.
> Execute exclusively through ‘smart’ brokers and use tools that specialise in searching for liquidity without signalling your intentions to the market. HFT will prey on the most vulnerable managers and brokers.
> Avoid submitting round lot orders that signal to HFT the presence of a human operator. The size of each order placed into the market should be randomised.
> Avoid giving VWAP or participation rate instructions (i.e. ‘per cent of volume’ or ‘over the day’). These types of orders follow a predictable trading schedule and are easily picked off by HFT. Instead, determine the optimal execution that fits the prevalent market conditions.
> Consider other ways to pay brokers for research if their execution methods are harming your performance.
> Choose trading venues that incorporate smart matching engines that benefit you more than the venue operator or other participants.
