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December 1, 2003

The Unintended Consequences

By Nina Mehta

Decimalization seems to be working for the odd lot investor, but not for the rest of the market. So says Joan Stack, the new trading manager at OPERS, the Ohio Public Employees Retirement System. Stack frequently thinks about market structure issues.

"Decimalization may be good for the person who wants to buy 100 shares," she acknowledged. "But if you represent 750,000 retail investors and it's now taking longer and costing you more to complete trades on their behalf, that hurts the ultimate retail investor." What's missing is the recognition that institutional investors are often "aggregated retail customers," she said.

The OPERS trading desk currently uses more electronic trading vehicles than it did in the past. Because decimalization has made block trades more difficult, the desk also works its orders in smaller pieces.

Stack and two other traders execute trades for the state pension fund, which has $54 billion under management. The fund represents a quarter of a million employees and retirees. Stack joined OPERS in October from ING Funds in New York.

For its index programs, OPERS uses electronic and alternative trading systems almost exclusively. These include Bloomberg Tradebook, Instinet's Newport, Liquidnet and POSIT. OPERS also recently installed FlexTRADER, an order management and trading tool that lets the desk access the market directly, via off-the-shelf or proprietary execution algorithms. FlexTRADER integrates with the Macgregor order management system and is broker-neutral.

As a public fund, OPERS is required to record a percentage of its business with brokers that have an Ohio presence. The firm also tries to conduct a certain percentage of business with minority and emerging brokerages.

However, within the fund's approved broker list, the trading desk has a "large amount of discretion." The fund turns to brokers to try to find the natural other side on less liquid securities. The fund also uses brokers in merger-arbitrage situations. These are situations in which it wants the broker to have both sides of the trade and help the fund manage the spread.

OPERS uses a trade-cost-analysis product from Quantitative Services Group that evaluates best execution. The trading desk requires brokers to get every actual buy or sell, rather than an aggregated or average price or fill. "If I have 10,000 shares to buy and it's being bought 200 shares at a time, I will get all those 200-share reports," Stack said.

While the market, as a whole, has had dramatic changes, so too has her niche. "Once buyside traders were looked at as execution clerks," she said. "They're now considered integral parts of execution teams, along with portfolio managers and analysts."

Traders increasingly serve as information filters for portfolio managers and analysts, she noted. They might pass along information about how the behavior of an overseas technology stock will affect the fund's domestic technology portfolio.

Besides the changing role of the trader, Stack has some ideas about what regulators should do about specialists. She believes that change is required in how the specialist is paid. "The current structure puts them in a conflict-of-interest position," she said. "They've gone from being facilitators to traders."

Instead of making money facilitating buyers and sellers, specialists make their money basically by trading against customer order flow, she said. "At some point, the specialists have to go back to making some kind of fee for their services of maintaining an orderly and liquid market," she said. In addition, Stack said she'd like to see "some sort of electronic alternative offered as well."