Taking the lead.
Huw Gronow – director, head of European equity trading at Principal Global Investors discusses the firm’s strategy in the post financial crisis world.
What do you think of the trend towards execution consulting on the sellside?
There is a lack of uniformity across the buyside structure and it is difficult to have one, two or three models that meet all of their requirements. The sellside has been under pressure for some time due to the global financial crisis and the fall in volumes, which is critical to their revenues. Successful sellside firms have leveraged technology to enhance their communication conduits to provide choice without losing quality or efficiency. However, there has been a change in the topography and in many cases the race for cost efficiencies has changed the relationship. It has led to what some call “juniorisation” where senior staff are replaced by more junior people to deal with more buyside firms. For us it is important to have the choice to select the relationships that best fit with our needs at any given time, which is why the structural design of a sellside operation is challenging.
How do you select a broker?
The criteria we use focuses on brokers’ abilities to access liquidity and that can take several guises. For example, it could range from a superior suite of algos, which can find liquidity in fragmented markets in a scaleable and efficient manner, to an expertise in small to mid-cap or emerging market stocks. Here we might look at a local or regional specialist. Since the trend has increased to more automated and self-directed trading, we are tending to place more value on technological competency and whether they are sound guardians of our order flow under the instructions we provide. We have about 25 to 30 brokers on our list and we put great store in transaction cost analysis to measure their performance. Given our deeper understanding of market structure, we are looking to integrate that analysis into our investment process.
Does that mean you are taking more responsibility for trading?
Overall, the buyside has taken much more responsibility for their own trading and will use the technology that the sellside has given them. For us though, one of the most critical factors has been the development of TCA in measuring not only broker, but also our own performance. We are now able to do that in a much more granular way, thanks to technology as well as the increased bank of data that is now available. We are able to harvest so much more information, which enables us to better measure the quality of the execution. This has meant that over the past 15 years, TCA has moved from being a pure compliance tool to a real-time strategic tool that enables us to attempt to quantitatively assess the value of the trading desk whether it is on a simple or more complex array of trades.
What is the portfolio manager’s role?
We are seeing a much closer relationship between the portfolio manager and trader. In the past these two roles were segregated but we believe that the integration of the two leads to real benefits. Typically, portfolio managers would be more interested in the post trade review, but this has changed and they are becoming more involved in pre and post trade analysis. This has meant that the trading function is more than just simply a transaction execution function but an integral part of the strategic investment decision-making process. For example, integrating the pre-trade transaction cost estimates allows us to adjust the expected alpha signal with some reasonable estimate of implementation costs. As a result, decisions can be based on realisable, expected alphas rather than purely theoretical ones.
What impact do you think MiFID II’s caps on dark pool trading will have?
I understand the rationale for the caps in terms of greater market transparency but I will be interested to see how they will be implemented and enforced. I would continue to question the economic benefit of dark trading when the average trade size in non-institutional dark pools has shrunk and resembles that of the lit exchanges, with little or no price improvement.
That said, dark trading in large institutional size has significant benefits in terms of reduced market impact and transaction costs which positively impacts investment returns for savers. There is also no guarantee that trading on lit venues will rise if dark pool trading is capped.
What impact do you think high frequency trading (HFT) has on execution?
The thing about HFT is that there does not appear to be an agreed definition of what it entails. People often use broad definitions and generalisations but HFT is not a single type of strategy. HFT is simply a set of techniques, or a description of a set of tools. We take the view that there has been an increase in ultra-low latency, high-frequency short-term alpha market participants and although there is a lot of debate about their role, there is no turning the clock back. These strategies are also not new but have just increased over the past few years. From our perspective, we need to understand the microstructure of the market and move to conduct our own forensic analysis on the impact these techniques have on stock price action, so we can adjust our own trading accordingly. More independent research in this area would clearly be welcome. The regulators could and should deal with any impropriety that takes place and examine any structural or information asymmetry that could potentially compromise confidence in well-functioning and stable equity markets.
What are some of the challenges and opportunities ahead?
The greatest current challenge is the pace of changing regulation and we have a committee In London, on which I sit, that closely monitors and responds to all the developments. In terms of opportunities, we plan to continue to build on the globally-integrated investment process by continuing to conduct our own research into our trading, using quantitative techniques and resources to align our execution with our alpha process, in addition to deepening further our understanding of market microstructure globally.
Huw Gronow is head trader in London for Principal Global Investors. He joined Principal in 2004 and is also an active contributor to many of the firm’s ongoing research and development initiatives relating to trading. Before joining Principal, Huw was a trader at BlackRock International where he specialised in UK equities. Previously, he was a trader at TT International Investment Management specialising in global equities. Gronow received a master’s and a bachelor’s degree in natural sciences from the University of Cambridge. He is a member of the Chartered Institute for Securities & Investment (MCSI).© BestExecution 2014