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sarals

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sarals

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Tuesday, 07/03/2001 2:39:07 PM

Tuesday, July 03, 2001 2:39:07 PM

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eVWAP article

VWAPing Problem of Poor Executions: Vendor Launches New Market Beating System
Peter Chapman

A vendor from Philadelphia is betting its technology will make life easier for traders trying to beat the market.

Ashton Technology Group has begun a full-scale launch of the eVWAP component of its iMatch platform. That platform matches block orders before the opening, at the day's volume-weighted average price (VWAP).

The system, a facility of the Philadelphia Stock Exchange, will allow both buyside and sellside traders to anonymously input orders of 5,000 shares or more in 300 of the most liquid listed stocks. Use of eVWAP is intended to reduce or eliminate the possibility that, by the end of a day's trading, a trader will have, on average, executed at prices worse than the average for the market as a whole. About 45 sellside and 45 buyside desks have signed on, according to Philadelphia-based Ashton.

For sellside traders, the system, operated by Ashton unit, Universal Trading Technology Corporation (UTTC), is positioned as an alternative to the often-ineffective "time-slicing" technique traders have used for years to accommodate VWAP executions for their clients. For buyside traders, it is intended to help them match a benchmark - VWAP - against which they are increasingly evaluated.

"By using our system a trader reduces his downside risk of losing to VWAP," said Marc Gresack, president and chief operating officer of UTTC. "These broker dealers are willing to give us their agency orders because they lose to VWAP all the time."

VWAP Battle

Most traders, it seems are losing to VWAP. Cost consultants Elkins/McSherry estimated that 83 percent of all institutional trades in the second quarter of 2000 failed to beat VWAP.

Statistics like that don't sit well with pension plan sponsors, the owners of a good chunk of the country's assets under management. More and more they expect buyside traders to execute trades at no less than the average price for the day.

The current focus on trading benchmarks is reminiscent of the 1980s when indexing took hold among money managers. Many threw in the towel on their active management strategies and switched to passive indexing strategies.

The S&P 500 is a common benchmark. Data still shows most active managers fail to beat the market.

Market Proxy

For traders, VWAP is viewed as a valid market proxy. The derivative price is calculated by dividing the dollar value of all shares traded in a stock on a particular day by the number of shares traded.

Buyside traders are not crazy about VWAP. They don't like to ask their brokers for VWAP executions. And most deny they do so. Accepting VWAP implies their talents are unnecessary. They are paid to beat the market, they say, not to acquiesce to it. "We are supposed to be traders, not VWAPers," said Putnam's head trader Leo Smith.

For the sellside, using a matching system like eVWAP may not be as injurious to their egos. Getting a VWAP execution for their clients, in the conventional manner, can be laborious. Sometimes, it can also be futile. And that outcome affects the sellside's - but not the client's - bottom line.

"Half of our client base is large broker dealers," said Fred Rittereiser, Ashton's chief executive and a former chief executive of Instinet. "They see an opportunity to execute without the problems of trading tediously all day long and trying to get the VWAP on Bloomberg."

Rittereiser offers an example of a sellside trader charged with selling 100,000 shares of 10 different stocks at the VWAP for a client. "He has to catch the higher sides of the trades all day long," Rittereiser said. "Every time it spikes he must catch it. So he time slices. If he's gonna get his five cent [commission] he needs to get this number. It's a ballbuster to watch 10 stocks like this. But with eVWAP he's guaranteed the VWAP and he doesn't lose his commission. He's done. This is a wonderful thing for the traders."

Rittereiser predicts that 70 percent of eVWAP's business will come from the sellside in the future. The product is not intended to disintermediate brokers. "We will provide the weapons for the sellside," he said. "We will help them retain and enhance customer relationships."

VWAP executions are not new. Brokers have been guaranteeing clients VWAP since the early 1980s. By time slicing, or feeding pieces of the order into the market throughout the day at opportune moments, brokers, in theory, come close to executing at the day's average. But if they don't, the losses eat into the commission.

Automating VWAP

Elkins/McSherry estimates that from 10 percent to 12 percent of all trades are executed at VWAP. Most are off-set by time-slicing.

Ashton hopes to automate that process. Its eVWAP has two critical components: a rules-based matching engine and a calculation engine. The matching is similar to other "blind" institutional trading systems such as POSIT, Instinet and Lattice. Buy orders meet sell orders anonymously thereby eliminating market impact.

The major difference between systems is the price used to execute the trade. Instinet's crosses are done at the market's closing price. Crosses in POSIT create prices. VWAP is not an actual price. It is a derivative based on an entire day's trading across all markets.

Critical to the legitimacy of eVWAP is its VWAP calculation. "Our calc [calculation] is approved by the Securities and Exchange Commission," UTTC's Gresack said.

"It is superior to those of the vendors particularly when markets are fast and they don't pick up every cancel and correction," he added. "They don't scrub it the way we do."

All Trades

Gresack says eVWAP's calculation takes into account every trade on every exchange, including all re-prints and corrections.

"One of the biggest global managers in the world has adapted our calculation because they want to make sure they have the precise price," Rittereiser boasted. "They told their consultant of 18 years they no longer wanted to use their calc. They told them to adapt their [transaction cost analysis] program to Ashton's calc."

Rittereiser would not identify the institution's name by press time. (The top three global managers are Barclays, State Street and Fidelity.)

Broker dealers also calculate a daily VWAP, but it is usually based on transactions that occurred only on the primary exchanges, according to Rittereiser. That leaves out the five regional exchanges which account for about one-third of all listed trades.

Bloomberg's calculation is popular with traders and its TradeBook unit also has an electronic VWAP trading system ready to go. But TradeBook said it's not yet ready to launch it in the U.S. It did introduce an electronic VWAP service similar to Ashton's in Japan last October.

"We decided to first go into markets where traders would view a passive VWAP trade as attractive," said Sanjiv Gupta, TradeBook's director of trading research and strategy. "Japan is a market which they don't feel skillful enough to trade or else they don't have the resources to build a night desk." TradeBook's product is dubbed Visible VWAP.

Gupta says most buyside traders are reluctant to embrace a domestic VWAP trading system. They feel they must beat VWAP, not match it. "I suspect [Ashton] will face significant resistance from institutions that have quality trading desks," he noted. "A trading desk is evaluated on its ability to beat VWAP." In fact, some buyside traders are paid a performance bonus based on how well they do vis-a-vis VWAP.

Gupta is also skeptical such a mechanism will add much value to a sellside desk. "A skilled trader should be able to beat VWAP," he said. "A quality prop [proprietary] desk would take on that risk. Plus you get a double-commission to start." Commissions are higher on VWAP trades at some shops.

Not all traders agree with Gupta. Rich Bartels, who runs the electronic program desk at Jefferies and uses eVWAP, finds it both a good source of liquidity and an effective way to trade. "Even when you [time slice] mechanistically like we do it's still hard to meet or beat VWAP," he said. "It's nice to see part or all of a trade being done before the opening. It reduces the load for the day." Bartels notes liquidity is starting to build in the system.

Manual Resistance

At least one sellside trader is not enthusiastic about a computerized substitute for what his desk does manually. "No interest," said Aldo Parcesepe, head of trading at Bear Stearns. Parcesepe is not convinced Ashton will be able to accurately calculate VWAP, especially on days of great market swings.

The company has spent between $20 million and $25 million on eVWAP since 1994. Ashton recently hired Jefferies & Co. to smoke out investors for UTTC. Ideal candidates, according to Arthur Bacci, president of Ashton, are broker dealers that want to make markets in VWAP securities or vendors of other trading systems.


http://www.tradersmagazine.com/articledetail.cfm?mag_id=1&aid=791&year=2001

Sara

"I never give them hell. I just tell the truth and they think it's hell." - Harry Truman

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