Knowing Me, Knowing You
The Trader-Portfolio Manager Relationship Evolves
March 2008
Buyside traders' relationships with their firms' portfolio managers are clearly evolving as PMs fret more about performance amid a rapidly changing and fragmenting marketplace.
While not all traders and PMs work closely together, enough have decided that closer collaboration will result in better trades. This is particularly true when the markets hit a patch of extreme turbulence-as they did in January.
Confusion, frustration and incriminations can surface between the desks during these times, as each side watches price and market impact estimates quickly become irrelevant and chunks of orders go unexecuted by the day's end. In an environment where the Chicago Board Options Exchange's Volatility Index (VIX) hovers around 30 and quick decisions mean everything, both sides say it's helpful if PMs know what they can expect from the markets and traders know what's crucial for their PMs' portfolios.
"In times of volatility, you realize how much communication [between the two desks] matters," says John Despotopulos, head trader at Boston-based Lee Munder Capital Group. "Because in volatile times a stock moves so quickly, we need to make our decisions faster. The better updated we are on what the feel of the PM is, what their thought process is and how aggressive they want to be, the better we are."
The relationship matters because the two must work together to ensure that PMs manage their portfolios' components to get the best rate of return on their clients' investments. The trader's ability to buy or sell those components at certain prices or times has a direct impact on this.
If, for example, a PM wants to buy a stock trading at $25 for his fund that he thinks will jump to $35 in a year, and the trader pays $27 for it, the PM's projection will have lost 20 percent.
But the extent to which PMs and traders interact over a specific buy or sell varies. Traders generally work under PMs, but are given autonomy in how they trade. For some traders, PM oversight is minimal. PMs focus on picking stocks while trusting the traders to do the right thing.
This is the situation that works for Cheryl Cargie and Jason Tyler, both at Chicago-based Ariel Capital Management. Cargie, head trader, and Tyler, senior vice president on Ariel's investment committee, describe their relationship as a partnership. Cargie says Tyler needs to feel confident she's getting her trades done, but doesn't need to know exactly how she's doing it.
"They don't understand all the technologies we have, and I don't know the technologies they have," Cargie says. "From a trader's point of view, the more understanding of trading technology a PM has the more micromanagement comes into play. And that's the last thing any trader wants."
From Peripheral to Integral
Communication is one important factor in the relationship. But how well firms manage clients' investments can also boil down to a PM-trader relationship predicated increasingly on how much each knows about the other's goals at all times.
Over the decades, traders learned more about market microstructure and portfolio strategy. In return, as the exchange floor has gone electronic, they've started to educate PMs about trading technology and venues. Make no mistake: PMs still do the stock picking while traders do the trading. But increasingly, each knows more about how the other does his job, to help him do it better.
"In the old days, a trader may have just taken the order, given it out and moved on to the next trade," says Joe Burrello, global trading director at IronBridge Capital Management. "The buyside trader has to become smarter in understanding the investment process."
Four years ago, this magazine wrote about how buyside traders had redefined their relationships with PMs over the past two decades as they emerged from the operations side of the business. Decimalization had forced them to gain more trading and market expertise to execute block trades. Many started earning MBAs and CFA designations to get it.
Today, the relationship has evolved to the point where buyside traders have, with the help of technology, become a more integral part of the investment process alongside PMs. They've transitioned from merely settling securities 20 years ago to entering orders electronically around five years ago to sometimes helping PMs fill out sectors in their portfolios today.
Portfolio 101 for Traders
IronBridge Capital has about $4 billion tied up in small-cap, small-and mid-cap, and large-cap global products. Burrello, a 20-year-veteran trader there, sits about 10 feet away from the firm's PMs and talks to them constantly. He knows the direction of their valuation models and uses that to help them. His strategy is to join trading-and what he sees in the market-to what the PMs are trying to do.
"On the trading side," Burrello says, "it allows us to run through our stocks and say, I know you're trying to add to a specific sector, and this one of our stocks is getting to a level where it looks good to buy.' Or, the stock's been under pressure and the pressure's off because a big trade goes up.
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