The evolution of portfolio construction has moved forward with processes and technologies designed to enhance implementation across global markets. Richard Surrency explains importance of program trading.

The most important element in this evolutionary process has been program trading, which today accounts for over 25% of trading volume on the New York Stock Exchange, and is quickly becoming an indispensable tool within portfolio construction workflow.

Program trading is defined by the NYSE as “a wide range of portfolio trading strategies involving the purchase or sale of 15 or more stocks having a total market value of $1 million or more.” By this definition, program trading is utilized by institutions that wish to transact in a basket, or baskets, of underlying securities while avoiding the requirement to allocate these transactions among numerous brokers for execution.

The benefits of portfolio trading within the portfolio construction process extends beyond broker consolidation by offering a suite of advanced trading tools designed to ensure that portfolios are implemented within the guidelines issued by the portfolio manager. The foundation of these processes are complex trading algorithms that execute large baskets of securities in multiple markets, following optimised trading trajectories designed to ensure minimal tracking error, market impact, opportunity cost, and lower average trading costs. This high level of automation incorporates intelligent sourcing of global liquidity, including crossing against internal and external liquidity flows. Access to the increasing myriad of alternative trading networks that are quickly becoming an important source of anonymous liquidity and is incorporated into underlying trading algorithms.

While program trading relies on highly sophisticated trading technology, human oversight of portfolio trades is mandatory. Professional portfolio traders are highly experienced traders, many with backgrounds in cash and electronic trading, and are able to intervene in portfolio trading strategies when necessary. Pre-trade strategies are analyzed and discussed between the client and the program trader prior to implementation, and extensive mid/post trade analysis is provided.

Program trading is also an important component of transition management, a service used by institutional investors in the funding, rebalancing, merger, or liquidation of investment portfolios. These portfolio transitions often entail highly complex multi-day trading strategies encompassing extremely high notional values and potentially hundreds, if not thousands, of underlying holdings. Transition managers rely on the flexibility of program trading to execute client transitions while retaining the ability to alter trading strategies against market conditions over the life of a transition.

The value of portfolio trading within the portfolio construction process is evident in the increasing use of portfolio trading by asset owners and financial institutions around the world. The methodologies required to extend portfolio construction into execution has emerged as a competitive advantage for institutional investors, and program trading platforms are consistently enhanced to ensure that trading algorithms and access to liquidity remain at the forefront of execution technologies.

Richard Surrency is Executive Director or Morgan Stanley’s Transition Management Solutions business, based in Singapore.

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