By J. Kolman Estreicher, Wolverine Execution Services (WEX)
Intended for Institutional Investors.
BlazePortfolio has invited Wolverine Execution Services to participate in our newsletter. Access to WEX will be available via BlazePortfolio. We are privileged at the opportunity for Kolman Estreicher, Director of Trade Execution at WEX, to provide commentary on trade execution. In this article, Kol provides insight into the trade execution process and how it impacts performance for investment advisors. Kol can be contacted at: kestreicher@wolve.com (312) 884-3281.
While there are several differentiating factors that prospective investors could evaluate when choosing a manager, performance is an obvious and major consideration. When we look at the core components of alpha, there are really three key areas that can erode or eliminate return altogether, and they are all controlled by the manager. The first component is the asset allocation, which is the reflection of the manager’s strategy or investment philosophy. The second component is the management fee, which needs to be economically prudent for the business or fund. The last component is trade execution, the method by which the manager accesses liquidity. As a provider of execution services, trade execution is an area about which I am most knowledgeable and on which I will focus here today.
Trade execution actually plays a larger role in the performance equation than conventional perception and wisdom might indicate. In this context, are there any key variables that investment advisors sometimes overlook when delivering returns to their clients? There are many managers who have accepted the myth that they have no control over trade execution, or who believe that it is so highly commoditized that it just doesn’t really matter. I can assure you that managers have much more control over trade execution than they probably realize. Improving trade execution efficiencies is one of the simplest ways for managers to protect some of the alpha that they’re trying to deliver so they can give back more basis points to their clients.
It doesn’t matter if the portfolio implementation approach is tactical, strategic (i.e. “buy and hold”), or even a hybrid combination of the two. How the investor or money manager accesses the marketplace will affect liquidity; influence price discovery; and, ultimately, impact the slip average.
Conventionally speaking, there are four main ways to access the marketplace, each possessing its own unique sets of benefits and disadvantages. First is electronic access. This method is the most convenient alternative, but it poses significant risks, from unfilled or partially-filled orders to orders that receive fills but adversely impact the market.
Second, the marketplace can be accessed through a custodian or prime broker. While operationally convenient, the risks here could range from limited control over the order (i.e., how the order is executed) to limited visibility of the marketplace as a whole (i.e., minimization of price discovery opportunities).
The third type of access, reserved for principal transactions, is achieved through a Liquidity Provider (LP). The LP can provide immediate liquidity; however, because the provider will be internalizing your order, the markets reflected will be risk-adjusted based upon their inventory levels or positions, and this adjustment may or may not necessarily reflect fair value.
Finally, agency brokers can provide marketplace access. Such brokers represent your order as if it were their own; however, the agency broker’s quotes will only be as competitive as those liquidity providers in their network.
There are several money managers who might not realize that they have many trade execution choices. In the coming months, we’ll take a closer look at each alternative and examine how forward-thinking money managers are deciding where and how to execute.
About WEX:
Headquartered in Chicago, WEX specializes in value-added execution, enabling clients to trade equities, options, futures, and ETFs through our proprietary electronic trading platform (WTP), algorithms, floor access, and agency brokerage desk.
This is intended for informational and discussion purposes only and does not create any legally binding obligations on the part of Wolverine Execution Services, LLC and/or its affiliates. Without limitation, this document does not constitute an offer, an invitation to offer or a recommendation to enter into any transaction or investment advice of any kind. For general information regarding the nature and risks of investing please go to www.tradewex.com.