Decimalization is often blamed by trading experts for shrinking the average size of stock trades. But the real culprit, according to Bill Perry, head of U.S. equity trading at Standard Life Investments, is algorithmic trading. The introduction of decimalization in 2001 only accelerated the trend in place.
"The average trade size has come down dramatically since 1998 with algorithmic trading machines slicing and dicing orders," Perry says. "It's the direct result of the smart engines out there." However, he adds, algorithmic trading is now immensely valuable for most traders.
What fueled this development? At first it was the anonymity provided by trading on a smart engine. In addition, in the late 1990s, buyside firms started paying more attention to the cost of execution and market impact.
Some trading desks adopted cost-of-execution models based on the volume-weighted average price (VWAP). This enabled trading managers to judge the execution quality their traders were getting according to a benchmark. While the debate continued over how market impact should be measured, smart engines jumped into the fray to meet traders' needs. Since then, they have branched out to offer trading based on various VWAP-style benchmarks, the arrival price – the price of a stock when the order hits the trader's desk – and other strategies for parsing orders.
Perry accesses smart engines through sellside brokers for small liquid trades and various illiquid orders. "For larger orders, regardless of the liquidity, the human trader can always add value," he says. At Standard Life Investments, he and his trading team use an internal cost-of-execution system based on arrival price.
Standard Life Investments is a subsidiary of the Standard Life Assurance Company, the U.K.'s largest mutual life assurance company. Perry and a junior trader operate from the firm's Boston office, executing trades generated by local analysts and fund managers. Another senior trader in Montreal executes U.S. equity trades that originate with analysts in the Canadian office.
The investment manager's Boston office has $3 billion under management for the parent company and third-party institutional investors. That allocation, based on internal changes, is earmarked to rise to $4 billion by 2005.
On the SEC's proposed Regulation NMS on market structure, Perry has reservations about the potential modification of the trade-through rule. This would allow fast markets to trade through the best bid or offer posted on a slower market, such as the New York Stock Exchange. "I just don't want to see more market fragmentation," he says. In his view, those concerns haven't yet been sufficiently addressed.
Still, Perry insists the NYSE needs to offer customers a more sophisticated electronic execution capability. He tried the NYSE's LiquidityQuote and Institutional XPress when they were launched. "They had too many rules of engagement – you couldn't go out there, take what you see, and come back with your execution," he says. Perry would like to see more pure execution offerings that offer faster execution with fewer restrictions.
On the NYSE specialists, the Big Board needs to beef up its oversight to ensure that all orders are handled "in a correct fashion, with my shareholders' interests first," Perry says. In his view, that's not happening consistently enough. The recent NYSE scandals are enough evidence that the welfare of investors have been hurt by some of these firms, observers note.
"In general, specialists do a decent job, but with the law and order of today, they need to be doing an excellent job," Perry says.
