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March 1, 2011

Cover Story: What's Ahead?

Passive Investments and Better Technology Propel Program Trading

By James Ramage

Program trading is in again. Its volumes have been rising. Its technology is becoming more sophisticated. And the buyside is warming to its capabilities, so much so that program trading now represents roughly 15 percent of U.S. equities volume. This is a jump of 50 percent in just one year, according to a recent industry study.

Among the players on the equities stage over the past decade, program trading was always the character actor--never the lead, the villain or even the sidekick. Content to plod along in the background in its essential yet workmanlike role, it has performed quietly while algorithms, single-stock blocks, direct market access, dark pools and high-frequency trading grabbed all of the headlines, fame and notoriety.


See Sidebar: Swaps and Programs


But now program trading may be getting ready for its close-up. Last year, traders executed many more shares in baskets than they did one year earlier. Strategic and technological changes at institutions are behind the increase. Brokers have noticed.

"We have seen a steady increase in volumes in the portfolio business," said Jason D. Crosby, head of portfolio products in the Americas at Morgan Stanley.

And he isn't alone.

"In 2010, we saw an increase in [program trading] volume overall, compared to the previous year," said Jeffrey Radtke, global head of program trading at Barclays Capital. "But what we saw was a change in the liquidity profile. In terms of index funds and the investment, we noticed over the last year movement from active funds into passive index funds."

In fact, that change in institutions' investment strategies led to more portfolio trading, program desk execs said. In addition, buyside traders drove program volumes higher by becoming more comfortable using newer and more powerful portfolio trading tools.

Program trading is roughly synonymous with portfolio trading and basket trading. The New York Stock Exchange describes a program trade as any strategy that involves the purchase or sale of a basket of at least 15 stocks. But with different market participants using strategies that include basket-size orders--such as HFTs--the definition may need an overhaul, said John Carillo, who heads portfolio trading at ITG.

Regardless, buyside traders told the Tabb Group for its 2010/2011 study on U.S. equities trading that they allocated 15 percent of their order flow to programs last year. That compares with 10 percent the buyside allocated in 2009. For the study, Tabb spoke to the head traders at 68 long-only asset management firms in September and October last year.

The study's author, Senior Analyst Matthew Simon, said much of the increase has to do with a change in methodology for measuring program trading, and how the buyside has been using improved program trading algorithms to execute orders. But the new methodology does not hide the fact that more of the buyside's orders are being executed as portfolio trades, he added, whether by its own traders using algos or by brokers' sales desks.

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