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June 30, 2003

Program Trading Upheaval

By John A. Byrne Editor

In these hard times, sellside trading desks are angry at how the regulators have turned the business

upside down. It came with a series of dramatic shocks, which included the move to decimal pricing. The idea was to improve the market for retail investors. Some might think the buyside, which has a fiduciary duty to millions of retail investors, would be pleased. Actually, some buysiders are probably shellshocked. Levelling the playing field has had a cost. Some buyside pros, catching up with the resulting changes, have been humbled. So they have turned to program trading, and a category of it called portfolio trading. Unfortunately, this trend could transform some buyside pros into glorified order clerks. And it is no laughing matter. The historical growth in mutual fund investing has contributed to an upsurge in program trading. But another reason for this trend is the excessive drive to transform Wall Street into a sport dictated by popular vote. The commission rates in program trading are bargain basement and the executions are efficient. It is also productive for profit-squeezed sellside desks. On some days, portfolio trading accounts for about 40 percent of volume on the New York Stock Exchange, up from five percent in 1992. However, there is a slightly sour note in all of this. The growing use of these algorithmic-driven orders - essentially the purchase or sale of at least 15 individual stocks in one trade - is enough to alarm some buyside traders.

Brian Pears, a respected buysider at Victory Capital Management, notes that some block traders may be made redundant. "You don't need a professional trader to press buttons on a system," Pears recently wrote in his popular column on our Website ( "A portfolio manager could do that himself. And as commissions get squeezed even further, a guarantee as technologies improve, you won't need to pay someone a lot of money to watch over fewer and fewer dollars." The pioneers of program trading could surely not have imagined this. About 20 years ago, most of these brains assembled at Kidder, Peabody & Co. The group included Steven Wunsch, Joseph Schmuckler and Joanne Hill. The earlier forms of program trading involved stock index futures and options arbitrage. Index arbitrage was blamed for the crash of 1987. But today, another kind of program trading - portfolio or basket trading - is becoming more wildly popular. It is becoming so popular that it was impossible for Traders Magazine to ignore as a major event. This month's Cover Story by Gregory Bresiger confirmed what is helping propel the growth in portfolio trading: decimal pricing, technology, margin pressure, attractive razor-thin commissions and the regulator's drive for execution quality. Among the traders quoted by Bresiger is Alan Rubenfeld, a director at Deutsche Bank Securities. Rubenfeld authored and edited The Super Traders, which was published in the early 1990s. In one chapter of his fine book, program trader Stephen Bodurtha asks what does the future hold. "This may be speaking too soon, but it is possible that it will be a calmer and gentler world for program trading," he writes. For my money, it might not be a perfect storm that follows.

John A. Byrne