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February 18, 2010

Trading the Manager

The New Shape of TCA at JPMorgan Asset Management

By Nina Mehta

In late 2008, Ben Sylvester stumbled upon an idea that would change the way many investment decisions are put to work at JPMorgan Asset Management. His insight was that taking into account a portfolio manager's trading history, rather than focusing solely on a stock's quote, could improve performance.

Ben Sylvester, JPMorgan

The idea began when Sylvester was spending part of his "garden leave" before joining JPMorgan Asset Management watching the World Series of Poker and other TV shows. When he came across a program on Navy SEAL snipers,

he settled in for what he thought would be "blood, gore and bravado." Instead, he saw tough guys modeling the outcome of possible scenarios, based on past behavior, with the aid of computers. It was "a boring exercise in mathematics and probability," he recalled.

That got Sylvester thinking about transaction-cost analysis. Reflecting on the SEALs' approach to uncertainty, he thought: "I don't want to rely on just myself. When I go up against another execution, how can I ensure my probability of success?" TCA, in Sylvester's view, is a necessary tool, but hardly compelling. He wanted to make it more rewarding for traders.

Sylvester has been a trader for more than 15 years, most recently at Babson Capital Management, in Boston, where he worked from 2001 until 2008. Since early last year, he has run the 10-person trading desk at JPMorgan Asset Management, which executes orders for 28 managers with a range of investment styles. The firm manages more than $1 trillion in total assets.

After mulling over how to improve trading outcomes, Sylvester hit upon the notion that traders should focus less exclusively on how the particular stock they're given is trading and more on who they're trading for. In other words, traders need to trade the portfolio manager, not the market.

So what this means is that traders can model the behavior of stocks for a period of time before and after a portfolio manager adds or subtracts them from a portfolio, and can use that past aggregate data to figure out how to trade stocks better for that manager. The premise is that portfolio managers typically have consistent reasons for buying or selling a stock, and that those reasons persist over time and over a large number of investment decisions. Importantly, the immediate post-trade stock behavior associated with those decisions can also reliably be projected into the future.