Cutting down portfolio trading risks
Following the success of POSIT, its electronic, equity crossing system, ITG Europe has developed the theme and launched PORTRAIT, a quantitative, agency portfolio trading and research service giving investment professionals greater insight into the technicalities of trading. PORTRAIT draws together four constituents designed to control risk, to minimise hidden costs and to control the process. Portfolios are loaded into Platform, the central system, and pre-trade analysis in then run. Agency cost estimator (ACE) calculates trading costs and computes an optimal trading strategy; ResRisk allows traders to send orders to POSIT and the market while maximising liquidity and maintaining the original risk profile and transaction cost analysis (TCA), tackles the often-neglected practice of studying a completed trade’s performance.
Each constituent performs differing roles that complement the initial step. Once a portfolio is loaded into Platform, ITG Europe’s electronic desktop system, the pre-trade analysis assesses how difficult a trade will be and the likely market impact. It then produces a strategy for slicing up the portfolio to produce efficient trading. “It comes down to understanding the benchmarks, looking at the portfolio in detail and analysing the data,” says John Minderides, head of portfolio trading and research at ITG Europe. More specifically, a trader (or a client’s Platform) can select on-screen what they want to analyse. For each trade or equity you can analyse a number of different parameters including liquidity, the number of shares, volatility, weighting within the portfolio, spreads, the number of market makers and volumes traded over the past five and 21 days.
Using this the programme rates how tricky the trade will be. This is important as there can be disparities between an equity’s portfolio weighting by value and by trading difficulty. Discrimination between the buy and sell sides is important as a client may want cash neutrality or to maintain a specific ratio of volumes bought and sold during the day. Pre-trade also looks at liquidity and a trade’s market impact. “This will influence how we want to slice and dice between different traders and different strategies throughout the day to best achieve the benchmark,” says Minderides.
Databases containing trade tick information published by stock exchanges grease the wheels and design a trading strategy. If a client wants to trade to a specific benchmark, the database will produce volumes traded over the previous periods. “You’re able to get the volume profile and how the market has traded…if our client wants to hit a VWAP benchmark, we obviously need to trade in line with this as best as possible,” says Minderides. The system can also produce a weighting for any period such as the morning or afternoon, depending on a client’s trading needs.
Now there’s a trading benchmark and strategy, the system can produce a tranche, for argument’s sake 10% of the portfolio, to trade in line with the agreed strategy. This tranche is then sent to its destination be it POSIT, SETS, Xetra or another Platform trader. Once the fills are executed they are fed back into platform real time enabling a user to see how many shares have been traded, how many remain and the average price paid. “You can monitor continuously where you are in relation to your benchmark,” says Minderides.
Platform has more strings to its bow though, including ResRisk and ACE both fine-tuning the trade’s efficiency while controlling risk. ResRisk is a quantitative tool maximising liquidity while maintaining the risk profile of the portfolio. Put simply, its role is straightforward. Take the arbitrary 10% tranche. “After I have traded the slice,” says Minderides, “the portfolio I have left to trade over the rest of the day is no riskier to trade. What you’re doing is putting in risk factors you want to control; you’re carrying out an optimisation.”
Parameters include sector weights, size bias, benchmark misbalances, tracking errors, active alphas, liquidity and cash at risk. Managers are able to specify, for example, they don’t want sector imbalances to exceed X% or tracking error to rise by more that Y% and these restrictions apply to both sell and buy sides. Once the restrictions are in place Platform runs a “what if” analysis and if the result is satisfactory, the tranche is almost ready to trade.
Not before ACE has had its say though. ITG’s quantitative research team designed ACE which uses a technique called dynamic programming to minimise the sum of market impact and opportunity costs. It also estimates the cost of trading and produces an optimum time horizon over which to trade. ACE is also one of the components of ResRisk. When setting the parameters for the latter, a manager can order the system to minimise ACE. Says Minderides: “in your optimisation process you not only create a wave that is reducing risk but you’re also minimising opportunity cost against market impact”.
Having used the pre-trade analysis, ResRisk and ACE and executed the trade, PORTRAIT’s final attribute, TCA, or transaction cost analysis, comes into play. TCA is a web-based tool allowing clients to study completed trades. Those with a password can access the ITG website and analyse their strategies. TCA’s strength lies in its versatility. Clients can break down trades into equity type, specific trade dates, buy and sell side, and by single trader or broker. Trade files over any period and from other brokers can be loaded onto the system, thereby enabling comprehensive analysis.
Clients can compare each trade file with up to three benchmarks at a time- either daily-based (open, high, low, close etc.) or so-called range-based benchmarks where you specify the start and end times and the database uses tick data to construct it. Comparison to the benchmark is therefore easy and the system even allows adjustment for ACE. Objectivity in another attribute. The service essentially provides users with the wherewithal to monitor trade performance at their leisure. “They can do it themselves. They are not relying on us to tell them how we’ve performed,” says Minderides.
PORTRAIT’s components are not new, but the package is. ITG Europe has been portfolio trading in Europe since last year and in America, where the programmes were developed, ITG Inc is the third largest portfolio trading firm. What PORTRAIT does though is draw together quantitative solutions from pre- to post-trading problems to produce a comprehensive package. In an environment where investment managers consider the cost of trading as more than commissions and where risk management is under greater scrutiny, this is an attractive package.