Quality of pricing and efficient execution have again been voted as the two most important aspects for selecting bank counterparties in this second Profit & Loss/Parker Global Strategies Fund Managers’ Report. But ecommerce is beginning to make inroads with this community, as more and more turn to online services for execution. Colin Lambert reports.
In an environment in which banks are falling over one another in their efforts to offer more and more services online, fund managers are generally impressed with the new range of services; however, the majority are still most interested in the nuts and bolts of trading: efficient execution and quality of pricing. Likewise, 80% of respondents continue to use the telephone as their primary means of communicating with their banks. Nevertheless, e-commerce is beginning to make headway with this market sector, as the accompanying table shows (see page 18).
The 2002 Profit & Loss/Parker Global Strategies Fund Manager’s Report surveyed 35 North American and European fund managers. Almost half of the respondents invest the majority of their portfolios in the currency markets; however, many of the managers cite a range of investment vehicles, ranging across fixed income, energy, commodities, equities and interest rate contracts, in both the OTC and listed derivatives markets. The report was conducted by Profit & Loss in conjunction with Stamford, Connecticut-based Parker Global Strategies, a manager of managers and consultant specialising in alternative investment strategies. The Parker FX Index covers $10 billion in currency assets under management.
The defining factors that determine which banks a fund deals with haven’t changed much with regards to traditional services – with speed of pricing, quality of pricing, efficient execution leading the field. However, this year’s survey showed some important changes in terms of the Internet. Two years ago when the survey was launched, Net-based execution was “unimportant” to 91% of respondents, while today, it is deemed “very important” by 40% of those surveyed, while 33% view it as “important”. Additionally, the prospect of straight-through processing (STP) and pre-trade account allocations are beginning to make this market sector sit up and take notice.
E-commerce has made obvious inroads in fund managers’ day to day business. This year, the fund managers surveyed say they now use the Internet for trade confirmation, which scored highest with 46%, followed by execution (33%), news (33%) and communication (33%). In 2000, research was the only category in which managers said they always turned to the Net, and that was for 27% of respondents. Then, only 18% said they “sometimes” turned to the Net for execution, while 64% used it for news and communication purposes.
Speed of execution is the main concern about Internet-based trading among fund managers, 87% of whom say it is “very important” to them. This is followed by 80% of which are “very concerned” about the speed of pricing, and 54% “very concerned” about the ability to deal in size. In 2000, the main concerns were security and the ability to deal in size, as well as speed of execution.
Back office services also scored highly this year, with 60% saying this is an important function in considering bank counterparts, versus just 27% in the 2000 survey. This surge in interest is probably a reflection of the greater interest shown in prime brokerage. Research on the other hand lost some ground, with 73% calling it “unimportant”. In 2000, 54% at least deemed it “important”.
Liquidity remains the single most important aspect for funds when asked about concerns over the FX market generally, followed by credit quality and banking consolidation. Two years ago, funds were much more concerned with diminished personal relationships and exchange rate risk by comparison.
With 100% of respondents saying efficient execution determines which banks they deal with, exactly what determines efficient execution largely depends on the size and nature of the business. At the top end of the scale, Edinburgh-based Standard Life Investments, which has £80 billion in assets, prefers to execute its business over a multibank portal.
Murray Gunn, investment director at the investment house, says 80% of the company’s FX business is related to the settlement of equity and fixed income transactions elsewhere in the group, and that he is looking to the portals for execution. Standard Life Investments is about to commence operations on FXall, but Gunn says that in the interim (it had initially traded over the now defunct Atriax portal), the group has reverted to telephone-based execution. “We decided not to execute over single bank platforms,” he says, “Primarily because of the work that would have entailed linking them to our internal systems. It simply would not have been worth the administrative cost for such a short space of time. We are waiting to go onto FXall which is our portal of choice.”
One of the benefits of a portal to a company such as Standard Life Investments is, says Gunn, that the group can prove best execution to its regulators. He also cites the “great deal” of efficiencies that STP brings to the front and back offices, and the fact that the group can meet its fiduciary requirements, as well as break trades down across multiple accounts on one platform.
At the other end of the spectrum, Summit, New Jersey-based Plimsoll Capital, which commenced business in May with $20 million under management, is already executing about half of its business electronically. “The best part of online execution has definitely been the rolls,” says partner Randy DuRie. “It is much easier keeping them in line – before it could be a time consuming business.”
Notwithstanding the great benefits of online trading, there is much business that simply does not go online because it is too sensitive in terms of the size of the market being traded. It is this business that really gives a bank a chance to shine – to demonstrate its worth and, some would argue, to provide the only true value added service. The advance of e-trading, and strides taken towards full STP by the multitude of vendors and portals means that one bank’s online services are pretty much like another’s. Offline is where the banks – even at the top end of the market – can truly differentiate themselves.
“We recognise that there is a dual market in the era of e-commerce,” says Gunn, “Some business is not suited to a platform because of its size or market sensitivity. We highly value a bank that can execute these orders in a difficult market quietly, discretely and without leaving a footprint.”
He adds that Standard Life Investments works some orders internally, and that whilst they can be worked through a platform, their very size means it would have to be through one bank. The benefits of online trading, especially automatically allocating trades, are real, but he stresses that most of the time there is more value in getting the order done as quickly and efficiently as possible. “We take the view that the interbank market has a better feel for how the market as a whole is positioned, therefore it is better for us to work in partnership. You cannot work an order of real size online to the same degree, therefore I can’t see us ever changing this methodology.”
Gunn does accept that there is a hybrid solution to this issue, executing on the telephone with the sales dealer and then receiving the benefits of STP by actually booking the trade online. “Executing on the phone and processing online is something we would have no hesitation in doing,” he says, “In effect, it amounts to using the portal as a deal capture system.”
In addition to efficient execution, quality pricing was also voted as the top determinant in selecting banks among all the respondents.
While the speed and quality of pricing are, as they always have been, key factors in deciding and maintaining banking relationships, they are not seen as areas of concern for most respondents when it comes to trading over the Internet. DuRie says that occasionally prices over the telephone are better than online, which is not the first time Profit & Loss has been told this by those on the buy side. In October 2001, Profit & Loss ran a survey of corporate treasurers, which showed there was some doubt about the speed and quality of electronic pricing. At the time, a trader at a large multinational told Profit & Loss that his company had tested a series of single- and multi-bank sites, and found all of them wanting when compared to the telephone.
Doug York, SVP of trading at Campbell & Company, a Towson, Maryland-based CTA that currently manages around $3.5 billion, adds that when it comes to executing large ticket size, picking up the telephone is still currently the best option. “To execute online – including matching platforms (see sidebar) certain criteria has to be met in terms of time sensitivity and the size of an order. You can overwhelm a platform with high volume trades,” he says. “For larger trades, we prefer to work closely with our bank providers – liquidity management by means of risk transference – we still see the banks front and centre when it comes to significant trades. Our time-proven bank providers have the superior liquidity pool based on their order boards and global outlets. We rely – and will continue to rely strongly – on our bank counterparts.”
While the issue about trading in size is not on the near horizon lfor Plimsol, DuRie also prefers a hybrid of online and offline services. “As a new company, we need to leave orders with banks for 24-hour coverage. The thing I like about our banking services is that I can place and manage my orders in real time. Currently I can’t do this with all of our bank providers and I would like that to change, but the fact that I can access my orders at any time and change them if necessary is a very efficient way for us to do our business. The added value from managing our orders offline is the market information we get from the salesperson,” he says.
The importance of relationships should not be overlooked; however, the importance of these seems to be slipping. Sixty per cent of respondents deemed these as very important, with the remaining 40% calling relationships important. However, in comparison with those who answered our survey in 2000, relationships were “very important” to 82%, while 9% said they were “important”.
Although all the banks it has relationships with are rated AA long term and above, to a large institutional investor like Standard Life Investments, value added services largely determine which banks it deals with. “Three or four of our relationship banks see a greater proportion of our business because of the extra services they give us,” he says, “These services may be advice on currency management or research, but in reality it is a subjective decision – there is no easy way of quantifying it.”
For the smaller fund, DuRie says it is important to maintain a personal relationship. “Sometimes people work harder for you on the phone,” he says. “It is not about the market information they pass you – our programme is 90% systematic so we do not necessarily need it – but it is about information they can give you that impacts on your business. We can repay this service by giving the banks some of our friendlier business; it is not all about leaving orders.”
Research has always been something of a tricky subject for the buy side as a whole. Many participants feel they are overloaded with research and rarely have time to read all of the information they are sent. In this year’s survey, a whopping 73% deemed research “unimportant”, as compared with 2000 when 54% thought it at least “important” and 18% as “very important. This swing in opinion is likely the result of the increased interest evident in systematic currency programmes.
Gunn believes that research has to be specific to get read. “We are looking at specific issues, be they economic, strategic or involving technical analysis,” he says. “To meet these needs, we like to get our banks to conduct bespoke research for us. We like to think of our banks as a resource we can use for ad-hoc work in this field.”
Advice on currency management as a value added service is not, Gunn stresses, about who is doing what in the market. “The advice we value very much is information about how our contemporaries are managing their currency risk – whether they tend towards a quantitative or ad-hoc system – what they are thinking about currency management issues.
“We also value insight into what the pension managers are thinking,” he continues, “Although we speak to them on a regular basis, so do the banks. We are aware that the banks may have a different perspective on their thoughts that may be of interest to us. We recognise that there is still a debate over active or passive currency management, so any insight we can get on this debate is valuable to us.”
DuRie says Plimsoll does receive research but that it is for interest-only purposes. Sitting in the camp that promotes active currency management, he sees little reason to read research other than for reference reasons, because of the systematic approach the company takes. The programme has a small discretionary element, but he says that Plimsoll is more likely to react to market information than “official” research provided by a bank.
Despite the improvements that initiatives such as STP and online trading are bringing in terms of reduced costs and error rates, liquidity and credit quality are the two biggest concerns about the future of the market, with 66% “very concerned” about the former and 54% about the latter. Consolidation among banks also proved a major concern among 46% of respondents.
York acknowledges that banking consolidation is likely to continue, but is confident that it will not have a major impact on the liquidity pool. “There will always be capable banks to step into a void if you lose a bank provider due to consolidation,” he says. “Admittedly a company like Campbell needs diversity and variety among its bank partners, so in those terms consolidation can be a scary thing. If we lose 20% of our banking providers in a very short space of time – big banks – that is not good, but I look at my dealing board and see 16-plus great banks. By contrast, I can name four or five great energy players, but there are more than 20 great banks, so we can lose a few more and still have a great stable of providers.
Another issue that is of growing concern to fund managers is liquidity. Two years ago only 36% of respondents were “very concerned” over liquidity, this year the number stands at 66%. For the buy side, this issue has not yet become truly problematic, although it could well do so in future, especially for the larger players. Gunn says that he has the impression that banks are finding it more difficult to transact the big tickets, and adds that he himself feels that efficient execution of a big ticket cannot be assured after 4:00 pm London time. “I think we now have pockets of liquidity whereas before you could pretty much guarantee liquidity all day, especially in Europe. Whether that is a reflection of the reduced risk taken by market makers I am not sure, but it is a concern,” he says.
Further banking consolidation could well open the market to greater access for the buy side to influence liquidity. The fund management community is having an increasing impact on the FX markets, and with more banks reducing proprietary operations, this influence can only grow. For the managers themselves, there appears to be something of a paradox in their thinking. The majority are all for the efficiencies that online trading can bring in STP and error reduction terms; however, they still prefer to put the biggest tickets down the telephone line. This will keep the “traditional” telephone sales role alive to an extent, but as managers become more confident in the execution capabilities of their banks online, this may not always be the case.
Notwithstanding that, it seems as though the vast sea change seen in the FX market is not yet over, and that further adjustments will be needed. The corporate relationship may shape a bank’s overall profile, but it seems inevitable that the fund management community will have a greater say in shaping a bank’s FX services in years to come.