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February 16, 2007

Trading Between the Lines

By Michael Scotti

Investors look at their money managers' performance day to day the same way sports fans might view the box scores in their morning newspapers: They know the final score, but not necessarily what happened between the lines during the game.

So it's not a stretch to say that investors see their managers' end-of-day performance, but they don't know the intraday portfolio stock score. These investors see little in the way of volatility from one day's close to the next. But traders see a messier world.

"It's safe to say that the average stock in the Russell 2000 can move intraday 300 to 350 basis points," says Gary McAnly, head trader at Oppenheimer Capital, which manages $23 billion in equities. McAnly views this volatility as a positive: It's a way for his trading desk to shine, adding a slight boost to the firm's portfolios.

McAnly, who takes a quantitative approach to trading, says his spreadsheets show that even his large-cap portfolio has an average intraday volatility of 2 percent. Consequently, traders' timing and the decisions they make can have an impact on returns.

A believer in measuring trading costs, McAnly says it's part of that 350 basis points in small-cap land that his trading desk fights to capture. Each morning, he and senior trader Matt Milazzo analyze the previous day's trades. They use different benchmarks to review the outliers, attempting to figure out why a trade may have been costly.

McAnly recently analyzed the desk's trading costs for small caps in crossing networks and with traditional brokerage desks. He found that the desk's timing has fared well. About 35 percent of the desk's flow is executed electronically, with 15 percent in crossing networks.

Still, McAnly says, trade-cost analysis has shortcomings. He doesn't believe in ranking brokers with these measurement tools and thinks the results are suspect. First, the trade-cost analysis benchmarks can't effectively gauge the difficulty of the stocks. To compare brokers' performance, "you'd have to give them stocks with near-identical characteristics with near-identical instructions," says McAnly, who believes the data measured also include the buyside trader's input. "It's unfair to measure one broker against another, especially if the brokers traded in different market environments."

McAnly says he was surprised by one part of last month's survey in Traders Magazine, showing that 39 percent of the respondents get some compensation based on how they fared against TCA benchmarks. "That's a dangerous road," he says, pointing out that traders can time their trades to make themselves look good against a benchmark. Also, the trader doesn't have 100 percent ownership of the order-it's a collaborative effort with the portfolio manager. "Our job is to implement their ideas, not make decisions based on how we measure against a benchmark," he says.

Oppenheimer Capital Equity AUM: $23 billion Desk: 5 traders Broker List: 65 firms Avg. Commission: 3.13 cents Electronic Trading: 35 percent OMS: Advent's Moxy Trade-Cost Analysis: Abel/Noser & ITG