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May 31, 2003

A Continuing Education

By Desmond MacRae

Trading skills come from an intimate daily association with stocks. Skills come from a formal study of long-term stock fundamentals.

This experience will help traders spot short-term disclocations, experience which can help them make solid trading decisions.

That's according to William J. Stephenson IV, the director of trading for Franklin Templeton Investments. Franklin Templeton now manages some $267 billion. "You have to understand what moves your stock," Stephenson said.

Stephenson started at Merrill Lynch Asset Management in 1994 as a buyside trader, staying for two years. After a short stint at DLJ, he moved to Franklin Templeton in 1996. Stephenson says that annual portfolio turnover is in the low 20 percent range.

However, trades are often very large, and some may take days to execute. The Fort Lauderdale branch, where he's based, trades in the European, the U.S. and Canadian stock markets. The other branches are in Hong Kong, San Mateo (CA), New York, New Jersey, and Nassau. The desks are linked to a unified trading platform, so a trading book can be moved to anywhere immediately.

Fort Lauderdale has 34 trading personnel who support 130 portfolio managers and analysts located in 17 countries covering 50 markets. They trade equities and equity derivatives.

Last year, Stephenson's trading desk was reorganized into sectors. This helped traders learn faster. The orders come from portfolio managers electronically. Still, traders have considerable discretion. "On big orders, we contact the analyst who follows the stock, then contact the portfolio manager to get a sense of the urgency of trades," Stephenson said.

Franklin Templeton equity traders take a view about 55 percent of the time. "We have the discretion to say a stock will rally because certain conditions, or the market will rally, or that the spread is going to contract," Stephenson said.

If traders are wrong, they will know about it by the next day. All trades are tracked with a proprietary trade cost analysis system (TCA) that shows how much alpha a trader added.

"We built it because Plexus was telling us we looked good all the time," Stephenson said. But the real issue was that most off-the-shelf trade analysis software uses quarterly data. TCA uses trade date T+1 data so that it can track the progression of big orders over time.

Because the TCA report shows high-cost trades, low-cost trades, what countries are buying, what countries are selling, capital flows, performance by trader, everyone can see how much an order benefited from a trader's added value.

"We show these reports to our manager group," Stephenson said, "so that we can show what we have done for them, and how we are managing commissions." Reports are viewed by an oversight trading committee three times a year. "We are compared to customized benchmarks to measure the alpha we are adding accurately," Stephenson said.

Stephenson said Franklin Templeton's commission rate in basis points is down 33 percent over the last eight years. Much of that has come in the last two years because of electronic trading. "I think we have the cheapest commission rates in the business because we can offer size," he said. "For example, we can do program trading globally for six basis points - almost nothing." However, Stephenson wants his brokers to make money. Why? "We need them," he said simply.

For Stephenson, trading is a constant education. It means learning new things; finding better ways to execute and better ways to reduce trading costs. "Traders must always balance market impact versus opportunity costs," he said.