Union Investment’s development of a multi-asset trading team and segregation of high and low touch business is allowing it to focus trading resource where it is needed.
Christoph Hock is head of Multi-Asset Trading at Union Investment, an asset manager with over €250 billion in assets under management. He joined Union in April 2014 and, with his team, is responsible for all trading activities associated with portfolio management of cash equities, fixed income, fund and exchange-traded funds business, foreign exchange, listed and over-the-counter (OTC) derivatives, and securities lending.
He manages 17 traders working on the Charles River execution management system, and is based in Frankfurt am Main in Germany.
Hock has worked across the buy- and sell side for more than 20 years, most recently as the head of Execution Sales at Barclays Bank. Prior to this, Hock worked at Alpha Trading and was founder, partner and co-CEO/head of Portfolio Management and Trading at Tungsten Capital Management, a hedge fund company. He ran the proprietary equity derivatives desk at JP Morgan in London and Frankfurt from 1998 to 2004 having started his career at Dresdner Kleinwort Benson in cash equity trading.
What were the drivers that led to you setting up a multi-asset trading desk?
An initial one was regulation. Equities went through the changes of MiFID back in 2007-8. Now those changes are increasingly impacting other instruments. You can’t just copy and paste from the equity space into fixed income, but there are certain features where fixed income can learn from equities. In the FX space, we see ‘equitisation’ with liquidity pools that buy-side firms can use. We are using algos to work FX orders, so there are fairly big similarities between equities and FX.
How was fixed income affected?
After the 2008 crisis, Dodd-Frank meant in general that we saw proprietary trading accounts at the investment banks shutting down and we had hedge funds deleveraging massively, both of which were good providers of liquidity in the past. As a result, we definitely don’t have the same liquidity situation that existed in the market several years ago.
So there is a potential bottleneck. As a consequence the buy side must break up the traditional thinking of how market structure used to be set up. We have access to new market players, such as high-frequency trading (HFT) firms or electronic liquidity providers. These are adding beneficial liquidity for buy-side firms and we also see all-to-all platforms, who provide access to traditional brokers as well as a wider range of market participants from buy and sell side. When looking at the prevailing market structure it is really about helping to develop and also optimising existing venues for fixed income, equity and FX. Against this backdrop, it absolutely made sense to us to set up a multi-asset trading desk to deal with the changes in market structure, regulation and liquidity.
What is the main advantage of running a multi-asset desk?
Our ultimate philosophy is best execution; getting the best access to sources of liquidity in order to minimise the implicit as well as the explicit costs, and to maximise the benefit for the portfolio manager (PM) and our investors.
For the team it is an evolutionary process. As the head of trading you have to make your team fit for the new regime. That is another key feature of the multi-asset trading desk. We are not only an execution desk, we have developed into an internal sales trader role. Compared to the old regime, we are a dedicated service and solution function for our portfolio managers.
Do you have to educate the PMs on the changing trading function?
It’s a two-sided process. We are in continuous and very in-depth interaction with our PMs. They are our internal clients. Our job is to deliver best-in-class service to them as a sales trading team. In the past – particularly in fixed income – the PMs would often trade directly. The rationale behind it being that they wanted to stay in the market to have a better understanding of liquidity. And frankly, there was also the perception amongst portfolio managers that when trading on their own they got a better outcome. That is why we had to bring our traders to the next level in the first place in order to convince the PMs subsequently that they could trust the desk to deliver the very best results. Every single member of the team has to be smart and well-trained and educated in order to function as an advisor in liquidity-related questions to the PM.
What guided the structure you put in place for the development of the trading desk?
The multi-asset model was helpful in the process by allowing traders to see how business in other asset classes worked. For example request for quote (RFQ) is used in fixed income, FX, equities and derivatives markets, so the traders were able to learn from the way the processes work elsewhere.
Setting up a best-in-class trading desk in an increasingly complex environment is really about having an additional source of alpha for investment managers, and when talking to clients, showing them that part of a properly set up investment process is also to have a highly sophisticated trading desk.
Do you feel pressure from having a client facing role?
When we are involved with potential new mandates, investors increasingly ask how we as a trading desk are set up, how we achieve best execution or how we make sure we are accessing the best sources of liquidity. I don’t feel a pressure at all on us to deliver, I think we are ahead of the curve when we look at how we treat execution and how we define our role as a trading desk. However every day we are looking for further potential for improvement. Every single day.
Do you see automation replacing skills as part of those improvements?
Man versus machine? I am a believer that fully automated trading will never happen. We are currently moving to a new structure which will have a low-touch team dealing with flow and electronic trading. We expect to have two to three traders there, capable of trading every asset class. That requires electronic skills, tracking the various venues and liquidity, and improving broker algos together with them. These traders in our team will either handle smaller orders or orders in hugely liquid order books where there is no risk of high market impact. The question of becoming fully automated arises in this low-touch business. There will be an extremely high level of automation. At the same time, this gives us the opportunity to focus more intensively on the less liquid underlying with the high touch trading team.
How would you characterise the difference in skill-sets across those roles?
High touch requires a very high level of specialism. The trader working a 3% stake in a Spanish small cap in equities will not be the same one trading Ä20 million in a Brazilian corporate bond. There will never be the same work as on the low touch desk with every trader working every asset class. A part of this business is trading via voice.
Is that skill set delivering efficiency?
Let me give you an example. One of our PMs wanted to sell a 2.5% stake in a small Swiss pharma name and our pre-trade transaction cost analysis told us that when trading 15% of the volume this would take 147 days with a 12.5% market impact. That is an answer that is not acceptable, neither for us nor the portfolio manager.
How did you deal with it?
We had already developed extremely good relationships with syndicates and equity capital market teams at bulge bracket firms. We knew that the pharma company had carried out a capital increase earlier in the year, and that one of our Swiss contacts had conducted this increase; obviously with client interest in this name. We had discussions with them about where we might place this block; they made calls to three clients and in one and a half days we had placed it at less than a 2% discount. You cannot fully automate that.
Can you see buy-side firms moving to a price maker role?
Yes and no. No, because being a price maker typically means market making functionality, having bids and offers in most market environments and generating profits by getting lifted on the offer, getting hit on the bid, and then either capturing the full spread or closing out the position somewhere within the spread.
What is the case for price making?
Looking ahead, we will tell our counterparts where we are interested in buying and selling, especially in the fixed income space where we have this liquidity advisor role for portfolio managers. To cover the PMs effectively – “knowing your client is key” – we are participating for example in the morning meetings and their strategy meetings. Attending these discussions delivers us valuable insights: are the PMs more inclined to sell duration or to buy duration? Which sectors are they positive or negative on? By communicating with those broker firms we have a strong partnership with, we consequently have a much better dialogue. The advantage is evident: the dealers can approach us with more precision, since they know what we are actually interested in.
How are your relationships with the sell-side firms changing in fixed income?
The RWA (risk-weighted asset) charges make it significantly more expensive for dealers to keep inventory. This clearly impacted their profitability in the fixed income and the FX space. As a result a few firms are stepping back from certain areas. However that is a feature of the change we see in markets. New players and venues are coming up and we have to be active in developing and using them when we see they add value for our portfolio managers and to our investors.
You mentioned high-frequency firms earlier, how important will they be in the future?
We see these new liquidity providers playing a major role going forward. We are working with them, and in my opinion they are becoming in certain areas serious competition to traditional broker firms. In US treasuries, firms like Citadel have a decent market share on electronic trading platforms. So we are very active in talking to these firms.
You have to differentiate between electronic liquidity providers who I am happy to trade against, and some prop strategies at HFT firms where we have to avoid getting gamed. Don’t get me wrong; it is not that HFT is bad per se – there are some very beneficial elements as well as others that we clearly have to avoid, or prevent.
Do you see a change in the skill sets on your desk?
The clear answer is yes. Let me give you another example. I hired a new trader for our credit business not too long ago. Previously, he was a market maker at a sell-side firm and he is doing a great job in helping us to get to the next level. He has the DNA of a sales trader, covering portfolio managers, is a great communicator and as a former market maker he understands how trading works in detail, how to find liquidity rather than just executing business via traditional RFQ’s.
Will you have the tools to support the skills?
Post-MiFID II we will have a much higher quality of pre- and post-trade data. So when trying to find the best sources of liquidity, management of big data is a key topic for us. We are massively upgrading our IT infrastructure, and we have a new release of our EMS which is a next major step. We entered into a strategic partnership with our EMS provider to put all of the content in to their developer so we can get to the next level of fixed income EMS fairly soon.
How will you handle the increased level of transparency and availability of data?
We are developing a data engine in the fixed income space. The tool will enable us to feed it with broker inventory on a real time basis, historical axes and pricing data from the various venues (TRACE in the US and Trax in Europe), and post-MiFID II the greater level of European data, and of course our internal order flow. This big data engine will allow us to figure out pre-trade where the likelihood is highest of finding the best sources of liquidity and achieving the very best outcome for the order execution. Also it will indicate where a fair price should be on the illiquid instruments, so we are not relying only on dealer quotes for something that last traded maybe three weeks earlier.
Do you think the buy side is driving change or observing it?
A number of our peers are in a wait and see mode, especially with new venues. My approach is to help developing and then testing various venues, being innovative and in the lead in this process. You have to be proactive and not phlegmatically endure what is provided to you. The outcome for equities around MiFID years ago was not fully optimal for the buy side because of that habit. At the same time, it is important for us to have partnerships with brokers but also that we drive the process. This understanding and attitude has helped in the development of the multi-asset trading desk.