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September 22, 2005

Working Out the Pre-Trade Kinks at Franklin Templeton

By Michael Scotti

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  • Working Out the Pre-Trade Kinks at Franklin Templeton

For money managers, trading does not occur in a vacuum. It's part of the larger investment process, according to Bill Stephenson, director of trading at Franklin Templeton Investments, which manages $250 billion in equities. The firm measures the cost of a trade over the life of the order, starting before the trade even occurs, he said. It's important to have an understanding of what a stock will cost to trade before entering the market, Stephenson explained.

That pre-trade analysis could help in choosing the appropriate venue or broker, one that might have the least price impact, he added. And in a low-return investing environment with low market volatility, any boost to performance can be meaningful.

Franklin Templeton has three programmers on the trading desk who work on pre-trade and other technical issues. It is about to introduce another third-party platform, Portware, to aid in its analytics, Stephenson said. It currently uses ITG's data and methodology, as well as its own, he added. "If you believe in the model, I'd say that it's pretty good right now."

The key word is "process" in best execution, he pointed out. It's the necessary due diligence that a trader should undergo before entering the market, he believes. "How do you prove best execution? The only way to know is to do your due diligence and to have an idea of your expected costs," he said.

Still, Stephenson admits to "limitations" of pre-trade analysis, noting the accuracy of single-stock pre-trade can be way off. Sometimes it's ineffective because of the size of the order. Any order greater than one day's average daily trading volume makes pre-trade an inaccurate tool, he said. News and other events can't be factored into the pre-trade measurement, either. "It's hard to look at it on a trade-by-trade basis," he said.

Still, pre-trade is a large part of best execution, he asserted. Stephenson said that pre-trade is much more accurate over a longer time frame. For example, Franklin Templeton can review all its trades over a six-month period, comparing its expected costs to its actual costs, he said.

But there are other benchmarks besides pre-trade measurement by which a trader and costs can be judged, Stephenson said. One relates directly to a trader's ability to make a decision based on market conditions.

Essentially, Franklin Templeton would review how aggressive or passive that trader became in the eyes of a volatile market: Did the trader make decisions that added valuable basis points, or did the trader sit tight without altering strategy? Either is measurable, Stephenson said, and either could be the right decision.

One example would be if the trader was a buyer and the stock became more attractive because it became cheaper. Did that trader get more aggressive or continue buying at the same percentage of volume?

Still, on a daily basis, there is value with a pre-trade benchmark, Stephenson said. Traders can look at their performance in real-time and have the ability to change strategy when a trade begins to go haywire.