Commentary

John Turney
Traders Magazine Online News

Foreign Exchange Infrastructure: Yesterday, Today and Tomorrow

In this exclusive to Traders Magazine, John Turney, Global Head of Outsourced FX at Northern Trust, discusses the evolution of the fx infrastructure and what is to come.

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November 8, 2005

Easing the Program Load

By Michael Scotti

More programs, more algorithms. That's the trend on the trading desk at the Boston Company Asset Management, according to Larry Peruzzi. He oversees international trading at the money manager, a firm with $60 billion in equities under management.

"It's all about managing cost and adding efficiencies," Peruzzi, a senior trader, says of the trading technology. About one-third of the firm's order flow each day is received in programs. The increase of programs from portfolio managers pushed the desk toward algorithms, Peruzzi explains. There are three primary reasons for that. First, an increase in new assets; second, more sector rotation within the funds; and, third, the firm is seeing clients moving assets from a strictly value strategy to a blend of value and growth strategies. Algorithms account for between 10 percent and 15 percent of the Boston Co.'s equity trading, Peruzzi says.

More programs, more algorithms. That's the trend on the trading desk at the Boston Company Asset Management, according to Larry Peruzzi. He oversees international trading at the money manager, a firm with $60 billion in equities under management.

"It's all about managing cost and adding efficiencies," Peruzzi, a senior trader, says of the trading technology. About one-third of the firm's order flow each day is received in programs. The increase of programs from portfolio managers pushed the desk toward algorithms, Peruzzi explains. There are three primary reasons for that. First, an increase in new assets; second, more sector rotation within the funds; and, third, the firm is seeing clients moving assets from a strictly value strategy to a blend of value and growth strategies. Algorithms account for between 10 percent and 15 percent of the Boston Co.'s equity trading, Peruzzi says.

Today, the desk receives four or five programs a day. That's twice as many programs as it did more than a year ago, Peruzzi points out. But as the frequency and size of programs grew, Peruzzi notes that the desk observed an increase in market impact costs. Simply handing off a basket of stocks to a broker as agent just wasn't effective any more. One reason was that the stocks in the baskets were more volatile, less liquid and tracked the Russell 2000 more closely than the S&P 500. Plus the orders themselves were larger.

For small-cap stocks, Peruzzi has found that an algorithmic trade that participates at no more than 10 percent to 20 percent of the overall volume will not move the stock. For large caps, that rate can rise to a third of the volume, he adds.

The desk will remove the trickier stocks from the basket and manually trade them. Peruzzi explains a best-case scenario when trading the balance of the portfolio via algorithm. "You may not look good. You'll look average. They aren't going to hurt you. They aren't going to make you look like an all-star. You'll basically get it done and add a little value."

Peruzzi believes that the level of algorithmic trading at the Boston Co. could double in the next two years. That's because the firm's traders are getting more comfortable with it, he explains. Another reason is that algorithms are becoming more sophisticated. "As they get more familiar with them, we're finding that our traders are using algorithms more and more," he says.

Still, Peruzzi estimates that four or five general strategies control about 90 percent of all algorithmic trading. He's a fan of the implementation shortfall algorithm, but he also believes that the next wave will be customized algos.

Some of those next generation algorithms will replicate benchmarks from the trade-cost analysis (TCA) vendors, such as ITG's ACE product and the Plexus Group's PAEG/L.

"These algorithms are being introduced at a rapid pace, and it's easy to fall into the complacency trap, always using the same algorithm and possibly losing alpha," Peruzzi says. "Ultimately, at the end of the day, your TCA numbers will tell you if you picked the right one."