Commentary

Jared Dillian
Traders Magazine Online News

Was it Worth It?

In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

Traders Poll

Would you feel better if the Chicago Stock Exchange were purchased by U.S. firm or consortium rather than a foreign one?

Yes

73%

No

4%

Doesn't matter to me

23%

Free Site Registration

September 30, 2003

Waiting For the New Board

By Nina Mehta

Doug Hamilton, director of trading at Numeric Investors L.P., shares the frustration of many New York Stock Exchange buyside critics who have had difficulty with floor executions. He notes that this is the result of the rules in place governing the specialist system. "I would like to see the SEC take a greater role in ensuring that the rules are tailored so that the playing field is more level than it currently is," said Hamilton, whose Boston-based quantitative house has some $6 billion under management.

"The change needs to specifically address the times at which a specialist is allowed to intervene and trade for his own account. Right now it's too frequent," he said. Nevertheless, Hamilton says he has no preference about whether the marketplace of the future should follow the NYSE or Nasdaq model.

Hamilton says that his desk, which includes himself and three other traders, doesn't use the Big Board's LiquidityQuote and Institutional Express facilities extensively in its day-to-day trading. "I don't think they have evolved or been as effective as anyone hoped they would be," he said.

About one-half of his firm's holdings are in long/short strategies, while the other half is long-only. Assets span the capitalization range from the smallest of micro-caps to General Electric and Cisco.

"We're not as black-box as many other quantitative managers," said Hamilton. Numeric's investment process is 70 percent purely quantitative and 30 percent fundamental.

Portfolio managers also serve as analysts. They conduct fundamental analysis on data generated by the firm's proprietary earnings-based models to ensure their validity in real-world applications.

Approximately 60 percent of the desk's order flow is transacted via an automated platform that allows Numeric to slice its orders throughout the course of day. The firm uses an off-the-shelf software package for which it has written algorithms in-house that enable it to achieve volume-weighted-average-price objectives.

"This allows us to access the marketplace over brokers' lines but to maintain control of each individual order in-house, and it also keeps us relatively anonymous as far as what we're sending into the marketplace," said Hamilton. The desk sends these easier-to-trade orders - such as those for large-cap stocks or small orders relative to the total liquidity in a stock - to large-cap brokers such as Morgan Stanley or Goldman Sachs. These orders go through at a much lower rate than the firm would otherwise pay for a regular cash trade. All of these algorithmic trades are done on an agency basis.

"We then leverage those commissions to ensure we have capital commitment, access to the syndicate markets, and everything else we need," said Hamilton. "We're a relatively high turnover shop and have enough order flow to do that and also keep our commissions low."

Numeric's traders handle the more difficult transactions. These trades are news-driven or event-driven, or need a liquid market relative to the normal trading patterns associated with a stock. The desk uses broker capital to facilitate these trades, just as many fundamental managers do. The firm is also a heavy user of ECNs, including the Instinet overnight cross, POSIT's intraday crosses, and other platforms.

Numeric, which stores its trade data going back to 1995, has an internal transaction costs system that helps it optimize order flow among various venues. A thorough analysis of transaction costs is conducted quarterly to ensure that there are no dramatic deviations from one quarter to the next.