A long-time specialty painter at the General Motors plant in Linden, N.J., learned a while back that machines can't do everything. They make mistakes, too. This 30-plus-year veteran, now in retraining classes at the factory idled since May, is terse in describing his job: "I had to fix what the robots messed up." He also handled the more intricate painting that the machines couldn't do. Once the union contact runs out in September, 2007, this member of the United Auto Workers will be retired and find that his past and future are oddly tied to the trading desk at General Motors Asset Management (GMAM), less than 20 miles away in New York City.
The money that will pay for his retirement will pass through the GMAM trading desk. But professionally, this painter may never realize how similar his old job is to what the GM trading desk does daily: Work the outliers, the tough stocks that cannot be traded by machine.
"Sometimes you have to be ready to interject human judgment into a trade," said George Bodine, director of trading at GMAM. Bodine, who considers himself a traditional trader at heart, executes about 70 percent of the volume that flows through his desk via programs, or packaged trades. The balance-the trickier and less liquid stocks-is worked the old-fashioned, manual way. It's worked through crossing networks and traditional brokerage.
"Sometimes you have to be ready to interject human judgement into a trade."
This has served the pension fund well, since the equities managed internally are quantitatively driven. It would be impossible for the four-person staff to deal with hundreds of trades at a time. Add the fact that commissions are in the 1-cent range, and program trading is even more attractive.
Big Player
GMAM employs roughly 75 outside managers in all asset classes. It manages about $150 billion overall, with about $70 billion-47 percent-in equities. Exactly 15 percent of its assets are internally managed. About $8.5 billion in equities are managed at 767 Fifth Avenue, its headquarters.
The $150-billion pension fund, which manages $90 billion of its own money, will certainly be called to the test to deliver the benefits that it promised to employees. According to a GM spokesman, recently announced plant closings and layoffs-expected to affect 25,000 workers-will not put additional strain on the pension fund. The layoffs will equal normal attrition rates, he said. (See "GM Pension Fund Challenge.")
Bodine acknowledges the challenges ahead for the pension fund and the responsibility that his trading desk faces in its effort to add basis points to performance. Still, after 30 years in trading, the Auburn, N.Y., native has seen the evolution of institutional trading, with its basics essentially left intact. Trading is about making market calls and decisions, regardless of the increasing use of electronics. The life cycle of a trade may shrink, as the number of steps in the trading process is reduced because of technology. But ultimately, there still needs to be decision-making along the way. "I don't think a machine can interpret how the market will react when Alan Greenspan speaks," Bodine said.
High of the Day
The greatest feeling in trading, Bodine said, is making the right call on a stock. "That's why they pay us," Bodine said. From a management standpoint, the challenge is getting the desk to achieve a camaraderie and chemistry. "Having a desk that really flows and operates as a team is really important," he said. "That's what makes the day fun." He's also of the opinion that it adds to performance.
Traders on the GM desk have specialties: Zesa Gewertzman, single-stock trading, Steven Ulbrich, futures and international equities and Mark Dupuis, who oversees programs.
Traders Magazine caught up with Bodine last month, wanting to know the story behind trading at the largest corporate pension fund in the USA.
Hub and Spoke
It starts with the process. Bodine called the investment process-both the stock picking and the trading-a "hub-and-spoke model." Aptly named for a car company, it's not universally called that internally. But it does describe the interaction that takes place between GMAM's investment professionals and its outside managers, with GMAM staff acting as the hub and the external managers, the spokes.
"We're basically all like player-coaches," said Bodine, a former linebacker at Syracuse University in the early '70s. As players, GMAM's portfolio managers are picking stocks, and its traders are trading them. As coaches, both portfolio managers and trading oversee the external managers' activity.
But there is a huge benefit: Stock pickers can also take the best big-picture ideas from the external managers. In other words, the GMAM portfolio managers can pick the brains of its outside managers and incorporate the investment ideas that they like best.
The breakdown is simple. Within each asset class is a portfolio manager who monitors the outside managers, while running his own portfolio. It should be noted that all stock picking is quantitatively driven, so GMAM is not in competition with the outside managers. One example Bodine gave would be a sector rotation that an internal portfolio manager might begin to see from the outside managers.
"Having a desk that really flows and operates as a team important."
That manager, for example, might then adjust his model and change the weighting in chemicals from 3 percent to 4.5 percent, he explained. From there, it's a bottom-up exercise with the portfolio manager choosing the stocks that would get the heaviest weighting.
At the end of each day, the GMAM trading arm puts any cash at the outside managers to work. It's called a futures overlay program. The desk purchases S&P 500 futures for additional market exposure. Internationally, the same strategy is employed. No leverage is used to juice performance.
Bird's-Eye View
Bodine, as the head trader, also has a bird's-eye view of what the external managers' trading desks are doing. "Obviously, as a good student, I try to pick up information that is valuable," Bodine said. "Nothing proprietary, but if I see a system that looks good or a process that looks worthwhile, I will come back and share it with the group here."
Bodine wears both a plan sponsor and a money manager hat. Each morning, Bodine reviews the previous day's commissions paid to brokers by the external managers. The reports only show the particulars of the trades allocated to GM, but there is tremendous value in seeing daily reports from between 40 and 50 managers.
Besides the size of the trade and the commission paid, Bodine sees which broker executed each trade. That info, aggregated over time, can demonstrate clear trends that often provide an edge in running his own desk.
Insights
But there are other benefits to reviewing daily manager reports. "I can see how much traction a new system or broker is getting, and it might prompt me to look into it," he said. It is a good way to double check on claims that sales people might be making, he added. "That's an advantage when I can see something happening among 20 or 30 managers whom I respect."
Two trends have jumped out at him over the last couple of years: Declining commission rates and usage of soft dollars. "The soft dollar decline seems to have stabilized," he said. This decline of soft dollars was quantified recently in a study released by Greenwich Associates, which concluded that soft dollar usage was down about 10 percent over the last year. Bodine said there should soon be more clarity on soft dollar rules, as the industry awaits U.S. Securities and Exchange Commission guidelines.
"Open lines of communication to trading often translate into better performance."
"The question we ask ourselves as a plan sponsor is, 'Are we getting value for these dollars that are being spent on research?' We think we do," Bodine said. "There is a strong feeling that the General Motors pension fund is getting these commissions back in the form of performance."
In the Beginning
When Bodine joined the firm nine years ago, he looked at the morning commission run. His goal was to find a way to cross trades internally among GMAM's external managers. That would lessen market impact, which benefits pensioners. But that initial thought died when there just weren't enough opportunities, and the few that existed, were made even more difficult to achieve because of ERISA rules. When Bodine joined GMAM, he spent a good deal of time traveling. He held quarterly meetings with the head trader of each outside manager, but that grueling pace has slowed down in recent years, as he's become more familiar with each shop's process. Still, Bodine keeps tabs on each manager, primarily through the daily commission runs, an occasional phone call and his quarterly trade-cost analysis reports from Elkins/McSherry. When Bodine had heavy contact with outside desks, he came to the realization that there was often a correlation between performance and the relationship between the portfolio managers and the traders on the desk. Bodine looks at the chemistry between them, as well as the respect the desk is given. Consequently, the better the trading desk communicated with portfolio managers and the freer the traders were to do their jobs, the better the firm's overall performance. "It really showed when a lot of the decision making was put on the desk," he said. "It helps in the performance, because [portfolio managers] are brought into the process much sooner."
Discounted Commissions
GMAM also participates in commission recapture – the rebating of commissions paid back to a plan sponsor by broker-dealers. The commission recapture business has come of age, maturing to the point that just about every major broker now participates. GMAM uses the brokerage affiliate of consultant Frank Russell. Bodine pointed out that its list of participating brokers is a 'Who's Who' of Wall Street. "We'd be using these brokers anyway, so it's just a way for the pension fund to trim its commission costs, and it's worked out well," Bodine said.
Setting recapture targets-a percentage of trading volume-is worked out with the external manager. Bodine is mindful that setting parameters too high, in an inappropriate asset class, could negatively impact performance. Having traded many of these stocks himself, he knows the burden that can be placed on a manager with unreasonable demands for direction. Only certain strategies are in the program-external quantitative managers are not. The targets are set up by Bodine, Frank Russell and the manager. They range from 30 percent direction on a large-cap value, for example, down to 5 percent for a small-cap growth. James Bryson, President of Elkins/McSherry, N.Y., GMAM's trade-cost analysis vendor, said plan sponsors need to be in recapture programs. "It doesn't make sense to leave that money on the table," Bryson said.
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A Certified Financial Trader? When commissions were deregulated in 1975-May Day-George Bodine was a greenhorn. He had three months experience trading at the large insurer, The Equitable. The business today is hardly recognizable compared to then, according to Bodine. He pointed out that there has been an evolution in how traders have learned their trade over the years. He now wonders if buyside traders shouldn't be accredited or certified. Two factors have pushed him toward that thinking are: 1) The rapid change in the industry; and 2) Conversations between the buyside and the sellside have dropped dramatically with the increasing use of electronics. Outlining the development of how traders learned their craft, up until the early- or mid-'90s, there was an apprentice-like transition into the business, Bodine said. Brokers were still considered 'customers' men', and traders on the buyside and sellside learned the job by talking to each other and by trial and error. "A lot of the old interaction and information flow is diminished," Bodine said. "I'd say it's about 25 or 30 percent of what it was just 10 years ago." But he also believes that more experienced traders would benefit from such an accreditation. "The business today is much more challenging," he said. "It's just not just about trading." |
Long Live Block?
As more trades are blended into the market-i.e., fewer blocks-the trader's job is made more difficult in judging supply and demand. There's less information in the marketplace, so traders do not have a comfort level to make pricing decisions regarding larger prints, Bodine said.
Right now, Bodine is of the opinion that one of the impediments to a resurgence in block trading is the lack of pre-trade analysis. He mentioned that several brokers are hot on the trail in developing pre-trade for single stocks. Interestingly, pre-trade has been a staple on the program trading side of the business for years. But it has proven elusive for single stocks.
"I think once you get more sophistication and predictability with pre-trade analysis, and you put that on the desk of traders, that will give them the confidence to commit to a price sooner."
"Block trading is not going to die," Bodine predicted. "It's going to come back more than we've seen as of late." But it is not likely to be as prevalent as it used to be, either, he pointed out. Bodine drew an example of a stock that traded 200,000 shares a day. If the pre-trade analysis showed a market impact of 15 cents per share, a trader could justify to a portfolio manager that it's OK to execute up or down 8 cents or a dime. Bodine said that each year machines have taken increasingly more orders from the trader's hands, but he now believes that sophisticated pre-trade analysis for single stocks should stem that tide.
VWAP Mentality
"I think that skill of knowing where supply and demand is has been lost a little bit, and we've delegated that to machines." Overall, Bodine likes VWAP (value-weighted average price) as a benchmark. "It's a pretty tough measure to beat," he said. But it needs to be tinkered with. He offered an example of a trader receiving a buy order at 3 p.m. Instead of being aggressive, the trader keeps the order out of the market because VWAP would be hard to beat or come close to. "Who wins if the stock moves up a point?" he asked rhetorically.
Yet, Bodine would like to see traders get away from a VWAP mentality. It lessens the so-called 'value proposition' that traders on the buyside bring to the table. "Where is the value? You're letting someone else make a pricing decision," Bodine said. "You're not initiating, you're reacting, and that's what I'm philosophically opposed to. It undermines what a trader is paid to do."
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The GM Pension Fund Challenge The future of roughly half a million Americans is depending on the success of the pension fund at General Motors. GM's money management arm, General Motors Asset Management, which oversees a total of $150 billion in assets, has no shortage of challenges. First, retiree benefits eat up about $6 billion a year, making it necessary for the firm to meet a bogey of 7 percent annually just to stay even. Its target is actually higher, at 9 percent. That magic number of 7 percent might seem a tall order when taking into account the current low-return investment environment with factors such as retirees living longer and the increasing cost of health care. Interestingly, and contrary to the dire fundamentals at the parent car manufacturer, the story at General Motors Asset Management (GMAM) has been a bright one. For the last 15 years, GMAM has delivered a blended return of 10 percent annually. And the last two years, performance has been an eye-popping 22 percent and 14 percent, respectively. "We are pleased with the results," said Allen Reed, president and chief executive officer of GMAM. "But we deal in very competitive markets and never stop looking for new and better ways to generate returns and to manage risks." Managing a pension fund is a "long-term game" that brings "new and greater challenges" everyday, Reed added. Indeed, there's no minimizing the challenges that lie ahead for the nation's largest private pension fund, as GMAM looks to earn the greatest return that it can for the $90 billion that it oversees for its own retirees (GMAM also invests for other plan sponsors like Xerox and Delphi.) But the issue of earning enough through investments is a national one for both public and private defined benefit pension plans. Although GMAM is not underfunded as of the end of 2004, according to a GM spokesman, many plans are. Nationally, corporate plans alone were underfunded to the tune of $354 billion at the end of 2004, according to the Pension Benefit Guarantee Corp. Public pension funds covering state and municipal workers are in the same fix, many believe. Is there an answer for these struggling private and public plans to wrestle with all of these issues? Certainly they need to be fully funded. But they also need consistent investment returns. Could the answer to their problem partially lie in how these plans are structured and the investment process itself? Might GMAM, with its hybrid model of investing with external managers and internally, be an example for others to follow? (About 85 percent of its assets are invested with external managers. Its asset allocation is 47 percent equities; 35 percent bonds; 8 percent real estate; and 10 percent others investments such as hedge funds and private equity.) GMAM made an asset allocation call recently and increased its weighting in real estate and hedge funds, which raised the firm's risk profile. As the head of one public pension fund said, "What GM's doing isn't radical, but they are ahead of the curve. One way or another, you will see more plans-especially public ones-moving in the direction of what GM is doing right now." But GMAM's Reed pointed out that each plan is different, and thus has different needs. "There is no single solution to pension management. Each plan sponsor needs to decide on an investment strategy that meets specific requirements." The public fund head agreed, saying that a plan sponsor needs to figure out where its expertise lies. "Plans sponsors need to know where they can add value, what they are really good at," he said. Reed praised his investment team and offered up a big-picture philosophy. "When you look at the impact the pension fund returns can have on GM's financial results, it is obvious that this is an area that GM must manage as effectively as the rest of its business," he said. "We view pension fund management as a core competency." |
Outside managers are about to participate in a new program to measure their trading costs, Bodine said. The plan is to evaluate how much value the trading desk at each external manager is adding to the process. The goal is to time stamp each incoming order received by the desk. Then, capture the last sale in the marketplace of that stock, and have that trader do a pre-trade analysis of the expected market impact. From there, after adding the market impact to the last sale, it will be easier to judge how the trader added value, he said. "If someone decides to stay out of the market, that's a trading decision," he said.
"Block trading is not going to die."
Bodine believes that traders need to understand the market and their stocks. He is a proponent of algorithms. Namely, they reduce commissions for a plan sponsor, but also free up a trader to monitor supply and demand for the tougher stocks. "We use them when we feel a trader can't add value," he said. "Once you get into the mid-cap and small-cap names, it gets difficult to find that liquidity."
"I like algorithms, but it's a tool, not a substitute for a trader," Bodine said. "Once we hit a period of stress, and emotion takes over, then you might as well take [the algorithm machine] off the autopilot, because you've got to be the decision maker again." When it comes to trading, there's no such thing as one size fits all, he said. Asked if he had concerns that his algorithmic orders were read by opportunistic traders in the marketplace, Bodine said there was no evidence of that. "It might be happening, but I haven't seen it or been able to quantify it."
Program Trading
There are about 10 major transitions a year that GM's desk executes, Bodine said. A "major" transition is defined as either the firing of an external manager or a major reallocation of assets internally, he said. "These can take about two weeks, from start to finish, " he said. "It's very intense."
Still, the desk doesn't begin trading until a series of administrative steps are completed, primarily making sure that stock from the fired manager is available and the settlement is completed. Other issues like matching CUSIP numbers and symbols can also be major headaches. "Just trying to get the administrative part completed, before we even analyze the portfolio, is pretty difficult," Bodine said.
Fortunately, GMAM has outsourced its back office to its custodians, JP Morgan Chase and State Street. The two firms have employees working on-site at GMAM. This is a huge advantage before, during and after a transition, Bodine said. "They are really acquainted with the process."
But trading doesn't begin until a final sign-off from the custodian is received. Once all the assets of the fired manager are reclaimed, and a list of the new manager's stock selections is in Bodine's hands, he then does his first trade-cost analysis of the transition. If, for some reason, a new manager has not been hired, the desk will convert the cash from the sells into the purchase of S&P 500 futures, keeping exposure to the market.
For pre-trade analysis, GMAM uses Citicorp Stock Facts Pro III. Bodine is impressed with the accuracy of these market impact measurements. In fact, he said that impact models for individual stock are on the way, and they may make traders more comfortable to trade blocks if they become as accurate as the ones in the program trading arena. Experience is often the best teacher, and Bodine said that the GM desk has become adept at doing these transitions. "Our experience and comfort level in doing this really benefits us," Bodine said
Programs offer the pension fund efficiencies as far as manpower, but also provide cheaper commissions.
A transition could be valued anywhere from $100 million to $1.5 billion. However, most are in the $200 million to $600 million range.
For programs greater than $500 million, it becomes very difficult to find a broker willing to accept the risk for a portfolio that large, he said. Most of the programs are done on an agency basis, but Bodine pointed out that there are times when brokers are looking to buy market share and using their capital is advantageous.
