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What Do the Good Desks Do?

What Do the Good Desks Do?

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Published by Wayne H Wagner

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Published by: Wayne H Wagner on May 05, 2009
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06/16/2009

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9rorrp
silding BelterPerfottnqnGeCOMMENTARY
71
JULY
2OO2
WHAT
DO
THE
GOOD
DESKS
DO?
A
frequentquestionasked
by
traders is"What
can
we do
toimprove"?
In
this
Commentarywe
search
for
answers bylookingat
the
"good"desks and
delving
into
the
datafor
telltale
signs
of
howgooddesks
differentiate themselvesfrom the run-of-the-mill.
By
our
measurements,
good
desksatgrowth
firms enhanceperformance
by
42bp,62bp
for
diversified
firms and
a
whopping
171bp
for value
firms.
No
wonder CIO's andhead traders
are
keen
to
improve
their
desksl
The
SettcmLine:
How
DO
GoodDesks
Add
Value?
We
were
able
to
identify
five key
characteristics
thatdifferentiatedthegooddesks:
.
Most
importantly,
gooddesks knowhow
to
PRIORITIZE.
Theyquickly
identify
the
dangerous
tradesand focus
on a
strategy
for
doingthem
first.
What
makes
a
trade
dangerous
is
to
be on
the
wrong side
of
a
liquidity imbalance,
a
situation
in
which delay
can
cause
the
value
ofthe
decision
process
to
rapidly slip out
of
reach.
As
Plexus
has
said
before,"do
the
hardtradesfirst."
.
They know how
their
managers
think;
in
general
and
soecific to
the
individualtrade. Qualities
that
make
a
value trade deskgooddifferfromthose
for
agrowth
desk,
yet
both
share
the
advantage
of
style
consistencv.Diversified
desks
that
handle
both
growth
(licjuidity
demanding)
and value
(liquidity
supplying) situationsmustdeal
with
mixed
signals,leading
to tougher
prioritizationdecisions.
.
Theyattune
the
mix
of
brokersto the
trading
needs.
To
increase
their
clout.
too
deskshave
shrunk
broker
listsand
concentrate
on
trading
throughbrokers
who
understand
and can
deliver
the
quality
of executions
consistent
with their
investment
style.
.
Nothing
stays
the
same
very long
in
today's
mar-
kets,
so
top
desks
are
constantly
innovating
and
experimenting,trying
new
trade routes and
refining
desk
processes.
.
Thebest deskshave theconfidence
of
their
portfolio
managers
and
are
seldom
encumbered
by
confusingorders or manager
imposed
price
limits.
The Good
Desks?
WhatDoes"Good"
Mean?
In
order
to
identify
a
desk as
a
superior desk,
we
need
a metric.
This
is
not aseasy
as it
seems,
because
each deskhas
a
workload derived
from
the
unique
nature
of
the
underlying investmentprocessand
the
magnitude
of
assets
being
traded.
Fortunately,
we
have
a
standard
benchmark:
the
Plexus
Average
Execution
Gainiloss
or
PAEG/LrM.
PAEG/L
is
a
measure
of
expected
costs
for
trades
of
varying
factors
of
difficulty.
By
definition,
a
desk
that
consistentlv scores
well
relative
to the
PAEG/L
is
a
quality
deik.
To
qualify,
deskshad
to
pass
four
heuristic tests:
.
Thev
had
to
rank
in
the toothird of costs
vs.
PAEG/Lin
elch
of the
fourquarteis
in 2001;
.
They
had
to
rank
in thetop half in
eachquarterof
2000,
and.
.
New
clientswith
only
'1
year'sdata
had
to
be
in the
top
quartile
for
each
of the
past
four
quarters.
.
Desks
with
non-compatible characteristics
wereeliminated.
Separate samples
were
determined
for
investment
style:
Growth,
Diversified/Core,
and
Value.
The
followingtable
shows
the sample
characteristics:
What
Do Typical Orders
Look
Like?
Managerswho follow
a
growthstrategy tend
to
seize
uponfavorable
news and
thus
oftentrade
in
high
momentum conditions,competing
with
other
growth
managers
for
availableliquidity.Holdings
are
concentrated,resulting
in
largerorders, but since
the
names
are'hot,'
liquidity
is
high.
In
contrast,
ordersfrom
value
managers tend
to
be a largerpercentageof
tradevolume,
yet
often
represent
smaller orders
in
Number
of
Desks by Category
Style
DeskSize
MarketCapitalization
GrowthDiversifiedValue
Large
Small
Large
Small2244
15
44376678*
*
15 desks were small cap only
 
out-of-favor
stocks.
Orders to diversifiedtrade
desksare
Goldilocks,
neither
too
large nor small,
too
illiquid,
too
strongnor weak,
althoughindividual
orders
can
deviate
sign
ificantly.
Past
experienceindicates
that
PAEG/L
is
a
good
predictor
of
investment style:growthdeskshave
the
higher benchmarkcosts,
other
things equal.Thus
we
can use
momentum,
the
prime
determinant
ofPAEG/L,
to
categorize
desks.
We
identify
the
top
momentumquartile
as
growth,
the
bottom
as
value,and
the
remainder as
diversified.
The following tables
detailthe trading characteristics andcosts
by
invest-
ment
type over
that
past
two
quarters.
Shares,
percentvolume,
momentum
and
costs
align
with
expectations.
The
following
table
summarizes
all
managers
in
the
Plexus
universe
-
not
just
thesuperior
ones.
The
table
below reveals thatvalue desks
outperform
in all
kinds
of
market conditions. Growthdesks,
in
contrast,
focus
on
liquidity
anddon't seem
to
know
ouitewhat
to
do in the
infreouentsituations
wheremomentum
is
in
their
favor.
Note
the
large
percentage
of
trading
in
adverse
momentumconditions
for
growthdesks.
We
are
surprised
to
seevalue
managers'
desks
perform
as
well as
growthdesks
for
adverse
orders.
This
may
reflect
ordersize:
33,000
share
average
for
value
desks
vs.
92,000shares
for
growth
desks.
When
providingliquidity
-
favorable
momentum
-
value
desksare adept
at
slowing
down
to
trade
at
betterprices.Trading
delaysgenerally
lead
to
high
adversetrading
costs, butvalue desks offsetslower
execution
withmuch lower brokerage
costs.
Finally,
value desks
beat
PAEG/L
for
large
orders,
whichmay
reflect
easier
market
conditions
more
than
desk
quality.
Trading
size is
usuallynot
a
punishing
issue
unless
momentum
is
present.
In
favorable
conditions,
value
deskscaptureprice
concessions.
Contrarianfirms,
aswe
would expect,are
especially
adept
at
this.
HowDothe
Besf
DesksCompare?
The
nextsectionfeatures
the
top
desks
in
each
style.We looked for those desks
that
consistentlyshowbetter than average
trading
costsrelative
to
PAEGi
L.
The
first
columnshows
the
number
of
desks
by
style
that
qualifiedas a'best
desk.'
40o/o
of the value desks,36%
ofgrowth,and
only
13%
of
the
diversified
desksachieved
a'best'
ranking.
ComparisonofTrade
Gharacteristics
by Style
Shares(000)
Volume
Yo
MktCapValueMom,
Yo
Cost
(bp)PAEG/L(bp)
Growth5639372.7-121
-ILJ
Diversified383742
07
-72
Value305038
-0,7
Trading
Qualityin
Market Gonditions
AdverseMomentumFavorableMomentumLarge
Trades
over
100 KShares
Value
Added
bp
(%ofDollars)
Value
Added
bp(%
of Dollars)ValueAdded
bp(%
of Dollars)
Growth+32
(340k)-83
(10%)
+1(6e%)Diversified+20
(19%)
-48
(13%)
+1
(56%)Value
+33
(13%)
+35(18%)+77
(48olo)
Best Desks by Style
#
vs,
Peers
Timing
bp
lmpact
bpTotal
Cost
bpPAEG/L
bpGrowth
I
of22
-27-93
411
-tLl
Diversified6
of44
a1-L
I
4A
-96Value6
of
15+31
+38
+51
-66
 
Where Top
DesksShrneThe
table
below shows
the
key data
of
this
Commentary.
lt
contrasts
the
bestdesks
with
the
remaining
desks
of
the
same
investment
style.
The
table
analyzes
how
the
desks
respond
under
the
contrasting conditions
of
supplying
and
demanding
liquidity.
lt
also shows how
the
desksperform
under
two
measures
of
difficult
trading
conditions:
orders
exceeding
a
day's
volume
and
orders
exceeding250,000 shares.
Top
Growth
desks:
There
is no
difference
in
dollars
traded,
nor
in
orderprofile
compared
to
ordinary
growthdesks.
Best
desks
show:
.
Low timing costs
when
accessingliquidity,
regard-less of
size.
.
Attention
to
prioritization,ensuringthat orders
with
high
momentumare
traded
quickly.
.
An above average
numbers
of
traders.
.
Few manager-imposed
constraints.All
desks
con-
tendwithsome
level
of
broker direction,
but
most
superior
desks
face little manager
interference.
.
Undirected broker use is more concentrated among
fewer
brokers,
with
emphasis
onfull
servicebrokers.
.
Early
adaptation
to
new
brokerroutes,
recently
emphasizing Bloomberg
and
LiquidNet,
althoughhistory
shows
experimentation
with failed
systems.
Top
Diversified
desks:
Few
Diversified
desks
significantly outperform
or
underperform
thePAEG/L
benchmark.
However,
six
desks
stand
out.
Mostquantitativeclients
fall
in
the
diversifiedgroup,
but none
ofthe
best
diversified desks
are
ouants.Otherkeydiversified attributes:
.
Larger
than
average
orders,
but
below
average
trading activity
in dollar terms.
.
Much higherquality
trading
in
both
adverse
and
favorablesituations.
Top
diversified desks stand out
whentradinglarge,
illiquidorders.
.
Two
thirds of thesuperiordesks measure and
rank
both
theirtraders and
brokers.
Meaningful feedback
results
in
changes
to
their
processes;
e.g.
shifting
fromlow
imoact brokers
to
those that can
deliver
SIZC.
Top
Value
desks:
Thisgroup
of
desks stands
outrelative
toall desks
in
the
Plexusuniverse, averaging+117bo better than
the
PAEG/L benchmark.
The
bestvalue desks:
.
Trade nearly
twice
as
much
as the
average
desk,
contrary
to
lower
activity
levels
for top
growth
and
diversifieddesks.
.
Trade
relatively illiquid
orders, but
not
necessarilylarger-than-averageorders.
.
Show
very
disciplined
and
predictablestyles.
They
limit
their
broker relationshios
and
make
extensiveuse
of low impact
ECN's.
.
Show relatively large inter-day timing
gains,
lfprices
move
in
their
favor,
they
often
delay
trading.
Desoite
this.
none
of
the
desks
show
sionificant
Oppofiunity
costs.
Overall,growth
andvalue
desks appear
to
have
an
advantage.
One key
difference
is
how
these
desks
select
and use
brokers.
The
top
growth
desks
emphasize
full
service
brokers,
while
thetop
value
desksemphasize ECN's
or
brokers who are
capable
of
filling
largesized orders
at
a
discount.
The
topdiversified desks
have
winnowed theirbroker
lists to
fit
with their
needs,
but
most diversified desks
still
use
more broker
than
averaoe.
Other
lmpacts
on
Trading
Quality:
We
performed
separate
analyses
to
address
two
specific
issues
of
interest
to our
clients:
.
Do
deskswhotradelinkedbuys
and
sells
operateat
a
disadvantage?
The answer appears
to
be
yes:
linked tradingdeskslagged PAEG/L
by
17 bp
vs.
a
gain
of
'13
bp
for
all
other
desks
-
a
30
bp
gap!
We
showedabove
that
the
universe
of
trading
desks
Where
Top DesksShine
AdverseFavorable
0ver
1
day's
Volume
0ver
250K
shs
Value
Added
bp
(%of
Dollars)
\/^,^
A,t,.t^.t h^va
uc nuuuu
ug
to" nf
flnllarc\
\/:lrLo Addod
hn
/0/^{
n^il^,^\
\
/O
U
UUIId
D/
Value Added
bp
/0/
^{
n^il^,^\
|
/0
ur
uuildr)/
Growth
DesksBest
'92
(36c0)
-81
(e%)
+18
(13%)
+47
(500/o)
Atl
+32
{
34r:
t
-83
(10%)
-30
(18%)
+5(467,)Diversified
DesksBest
+77119%)
-21(3ot;)
+85
(270k)
+69
(45%)All
+20
(1996
t
-48
(13%)-5
(7ah)
+7
(33%)
Value
DesksBest
+72
(12'k)
+'189(19%)
+1
98
(2996)
+280
(30%)
Atl
+33
(13%)
+35
(19%)
+86
(220h)
+
10Q /?Qo/^\

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