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March 1, 2003

Benchmarking For the Bear: A Love and Hate Affair With VWAP

By Nina Mehta

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  • Benchmarking For the Bear: A Love and Hate Affair With VWAP
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The VWAP, the trading industry performance yardstick, has many critics. And rightfully so - it is used not because it is the best measuring rod, but simply because it is the easiest way to gauge a trader's performance.

Since the mid-1980s, VWAP, or volume-weighted average price, has been the most common benchmark to evaluate a trader's or broker's executions.

VWAP is calculated by dividing the total dollars traded in a stock by the total shares transacted over the same time horizon.

Gathering the transaction information is easy enough. The data on individual trades, the number of shares executed and the stock price are available from the consolidated tape. Many trading systems calculate VWAP as it evolves over the course of the day.

The comparisons provided by the VWAP serve at least one basic purpose: Keeping an eye on the trader's judgements, skills and market savvy. The VWAP shows a positive measure if a buyside trader's execution price is lower than the VWAP. The measure is mediocre - if not downright negative - if his execution price is higher than the VWAP.

Still, in recent years, daily VWAP's star has dimmed a little. That's because there are now hundreds of benchmarks that purport to measure what traders are trying to accomplish. Not to be outdone, there are several versions of VWAP, which vary based on the type of data used.

One version, for example, might exclude block trade data. Another might record the time the trade entered the market.

There are other measures, besides VWAP. For example, some are not based on average trade data through the day. They use time stamps, closing price, and decision price.

As the benchmark battle rages, best execution - and the importance of benchmarking performance - has gotten a boost from the bear market. If a portfolio manager becomes more efficient at running money, if he can save 100 basis points by executing orders more effectively, that's significant money saved in current market conditions.

Regulators have also been issuing guidelines and watching best execution practices. The final result could be increasing knowledge about what exactly best execution is for traders using different styles, and on large, multi-day, multi-portfolio orders.

But traders are not likely to dump the VWAP. "We all look at VWAP," said Madison Gulley, director of global trading at Franklin Templeton Investments, which has $260 billion in assets. "It happens to be the most prevalent and measurable indicator that exists."

But should VWAP be the sole measure of performance for how a trader handles a stock? Absolutely no, according to many pros.

Indeed, the industry view on VWAP is changing. Trading firms are demanding even more sophisticated approaches. Abel/Noser Corp., an agency broker, became one of the pioneers in trade cost analysis for plan sponsors, based on the VWAP.

"It's not the end-all measure," said Peter Weiler, senior vice president in Abel/Noser's investment management group. "It should be used in tandem with other measures."