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February 1, 2004

Guess Who's Coming to Dinner?

By Nina Mehta

The meat and potatoes of the Big Board are finally coming to electronic communication networks. That's according to John Myles, a domestic equity trader at Pioneer Investment Management USA in Boston. As a result of decimalization and other shifts in market structure, ECNs have risen in the food chain. Myles, who uses ECNs a "considerable amount" of the time, notes that it's becoming easier to transact New York Stock Exchange-listed stocks on ECNs.

Listed Names

Nasdaq stocks have always been well represented on ECNs, but there's finally more "buyside buy-in" with listed names, according to Myles. Even in illiquid listed stocks, it's increasingly possible to draw out the natural counterparty on ECNs. This may sound counterintuitive, but Myles notes that it often works.

"If you go to the NYSE with 5,000 shares in an illiquid name with a limit order, it can be difficult to get anything done because you'll get pennied or floor brokers may bid or offer just in front of you," Myles said. "Whereas if you anonymously post in an ECN and you're on the bid or offer or at a slight discount to the bid or premium to the offer, you may draw out the natural business, someone who's looking to take advantage of the liquidity." And that, Myles notes, is the key issue for him and his firm. "In the big picture, my job is to find liquidity and minimize market impact," he added.

Since 2000, Pioneer has been a subsidiary of UniCredito Italiano. The bank, one of Italy's three largest banking groups, has some $145 billion under management around the world.

Although ECNs have succeeded in attracting more liquidity, they may not be the right answer in all circumstances. "There's no substitute for the broker who does a good job and provides us with timely, transitory trading information," Myles said. "Quality information or quality traders that help us with our order flow is invaluable."

Pioneer has a list of research and execution-only brokers. The six domestic and international traders on the desk have discretion over how they execute orders. For brokers that provide research, the firm tries to keep commission dollars paid in line with how the brokers are ranked in the firm's internal research vote.

While the trading goal at Pioneer is always best execution, the firm doesn't put its faith in metrics based on the volume-weighted average (VWAP) price. "We're more concerned with best execution for a given situation," Myles said. A trader, for example, could work an order over five days and beat VWAP, but the stock price may drop $10. In that case it might be better to miss the VWAP by 25 cents on the first day and simply exit the position.

Being on the same page as the portfolio manager is often critical to making the right decision for a particular order. Myles notes that he can choose to be more or less aggressive if he knows why a manager wants to trade.

"If a stock has had a good run and the portfolio manager is taking some profit off the table, I might be heavy-handed in getting out, especially if it looks like it's overbought on an intraday basis," he said.

Market Impact

The trading decision also depends on liquidity. If a stock trades 10 million shares per day, Myles can usually focus more on the overall price because market-impact concerns are less urgent. However, "if a stock trades a few hundred thousand or less than 100,000 shares per day, I may be more concerned with having a bird in the hand," he said. "If I'm able to find liquidity at a slight premium or discount, it might make sense to be more proactive."