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November 1, 2003

The Triumph of Technology

By Nina Mehta

Technology has transformed trading desks. Over the next few years, however, the average trader should expect to use technology to interact even more dynamically with the markets, according to Ben Sylvester III. He is one of three senior traders on a five-person trading desk at David L. Babson & Company Inc., an institutional asset manager that has $95 billion under management.

"We have a perfect storm. New technology, decimalization and fragmentation, as well as regulatory issues with the New York Stock Exchange. All of this is driving the shift," he said. "On top of that," Babson added, "Fidelity Investments, the biggest buyside customer, is saying they want electronic trading. That evolution is going to happen very rapidly."

Babson trades equities across the range of market capitalizations for the Boston-based firm's quantitative team and alternative strategies group, which includes a half-dozen hedge funds. Approximately $12 billion of the firm's assets are in equities.

Sylvester agrees with some of the recent criticisms leveled at the NYSE by Fidelity and other buyside firms, which have argued that the exchange should become more electronic. "The NYSE and the specialists in particular need to migrate further away from the current system because of inherent conflicts of interest," Sylvester said. "It's also increasingly difficult for big buyside firms to electronically interact with that marketplace efficiently." His firm would like to see a more automated NYSE that relies much more on technology and less on the current specialist system.

Babson's trading desk has become almost entirely electronic over the last decade. Babson's portfolio rebalancings are typically done as list trades, which are put out for principal bid. If that doesn't happen, Sylvester, or another of the desk's traders, will trade the list on an agency basis. Babson notes, however, that in the last year brokerages have become increasingly eager to commit capital - perhaps to gain market share in a more competitive environment.

Babson, like other asset management firms, has turned to algorithmic trading to make it easier to trade large blocks of stock. The desk uses Lava Trading, an ECN aggregator, for Nasdaq stocks. It is currently installing Goldman Sachs' TradeFactory, an algorithmic portfolio trading tool. It will soon be integrated with the firm's order management system.

Brokers - especially bulge-bracket firms - are also fueling this algorithmic trend. They are more competitive in their offerings. That's because algorithmic trading is becoming more of a commodity, notes Sylvester. "There's a whole wave of algorithms coming to market because everyone has a different outlook on benchmarking and the aggressiveness or passiveness of the algorithm, the timeframes, and so on," he said. "There's a bit of one-upmanship going on."

With the bulge-bracket firms providing the desk with algorithmic and program trading tools, Babson is increasingly turning to them for electronic trading. For smaller-cap stocks and names that are more difficult to trade, Babson uses crossing networks such as Liquidnet and POSIT and third-market firms. The desk also uses direct-access firms on the NYSE.

Sylvester notes that a long-overdue change is finally coming to the over-the-counter marketplace. This is Nasdaq's move towards a central order style facility that will provide a single, definitive opening and closing price for stocks. "The Nasdaq marketplace has been fragmented on the open and the close, and it's very difficult to be guaranteed a certain price," he said. "This has a lot of potential to change the way the Nasdaq marketplace is structured." An irony, he adds, is that this is an example of Nasdaq "adopting some of the best attributes of the NYSE and the listed markets."