Wrap trading is alive and well.
While is doesn’t get the fanfare of electronic or algorithmic trading, or program trading for that matter, wrap trading and the use of managed accounts is still big business today as it was six years ago.
As a refresher, a wrap account is a brokerage account where the brokerage agrees to conduct transactions for the client for a flat fee, usually assessed on a quarterly or yearly basis. This differs from most brokerage accounts where transactions occur in exchange for a commission on the size of the transaction. A wrap account exists to protect the client from overtrading, which is the (illegal but sometimes hard to detect) practice of a broker making transactions to extract commissions rather than to benefit the client. Because this can result in less profit for the brokerage, a wrap account often requires a minimum investment of anywhere from $50,000 to $100,000.
Also associated with wrap trading is the wrap fee – a comprehensive charge levied by an investment manager or investment advisor to a client for providing a bundle of services. Such services can include investment advice, investment research, and brokerage services.
Chris Hurley, Senior Vice President and Director of Institutional Sales at CAPIS, explained that trading away (wrap trading) from non-UMA (Unified Management Accounts) platforms has become more accepted as a regular business practice. With best execution always in the forefront, sub-advisors to wrap and custodial platforms have embraced executing aggregated wrap orders with the broker of their choice to alleviate the complexities and often detrimental effects of using a rotation.
“The regulators have also conducted audits on both wrap sponsor brokers and managers and their findings indicate that trading away is not an issue, but lack of disclosure is,” Hurley continued. ” Since then, sponsors have stepped up their efforts to provide annual disclosures to retail clients based on questionnaires sent to the managers.”
Both Mark Viani, Senior Vice President Institutional Sales at CAPIS and Robert McHeffey, in institutional sales at CAPIS, veterans of this specilized business and creators of trading software designed to streamline wrap trading, told Traders Magazine that one prominent sponsor is directing managers to use the explicit fee field on ACT to disclose broker commissions. The expansion of the use of this field was suggested to Nasdaq 10 years ago by CAPIS. CAPIS ARC, the firm’s wrap trading system, has already implemented the use of the explicit fee field and has been processing trades with the broker remuneration disclosed in this field on the confirm.
Also new since 2013, some sub advisors have been looking to outsource their execution of both institutional and wrap orders with using an outsourced solution. The Outsourced Trading desk at CAPIS has combined the functionality of outsourced trading with that of their ARC product to facilitate bunching institutional and wrap orders together to be cleared at a single average price, and while rightfully spreading the costs pro rata to all allocations in the block, in accordance with the SMC guidance issued by the SEC back in July of 2007.
This article originally appeared in the September 2013 edition of Traders Magazine
Wrap Powerhouse
By Alan Rubenfeld
The technology revolution has had an incredible and indelible impact on the institutional investment landscape for the past 20 years. While most of Wall Street (and this magazine) usually focuses on how technology has revolutionized the execution process and how trading has become faster, cheaper and more efficient, what is often overlooked is its impact on back-office processing, which in turn has enabled an explosive accumulation of assets by the wealth management industry. [IMGCAP(1)]
Up until about 10 years ago, clients of retail brokers, also known as wealth managers, were forced to maintain a separate account for each money manager that managed funds on behalf of their clients. This limited the customers’ investment alternatives, because a broker’s back office could not efficiently handle multiple accounts, thus limiting available investment alternatives.
However, the advent of the Unified Managed Account and model delivery system has enabled wealth advisors to create for their clients a diversified portfolio of stocks, bonds, ETFs and other vehicles by placing these assets into a single managed account, creating almost an unlimited choice of investment options for the average investor. Previously, if an investor chose to maintain a diversified portfolio of stocks, bonds and mutual funds, he or she needed to open separate accounts for each asset. The UMA removed this hurdle and combined all the assets into one account.
The introduction of the UMA platform, also known as a wrap account, has contributed to the massive asset growth by wirehouses, Registered Investment Advisors and other managers who predominately cater to individuals and high-net-worth financial investors. Today, a financial advisor can often choose from more than 100 different external managers, providing his or her client with a range of investment alternatives.
But what is often overlooked is how these portfolios are executed and where the trading is taking place. The UMA revolution has led to the creation of a group of trading desks that specialize in these large asset pools. Most of the major wirehouses now have dedicated trading desks to trade this outside manager flow. Where formerly the investment manager’s own trading desk would execute the order, today the trading responsibility is often outsourced to the actual owner of the assets. The largest of these desks resides in the Private Portfolio Group of Morgan Stanley Wealth Management.
Formed in 2009 as a joint venture between the wirehouse units of Morgan Stanley and Citigroup, the company was originally called Morgan Stanley Smith Barney, a retail brokerage juggernaut with 17,000 registered representatives. Citi announced shortly after the formation of the group that it would eventually sell its stake in the venture to Morgan Stanley. In September of last year, Morgan Stanley announced the joint venture would be renamed Morgan Stanley Wealth Management and that it would purchase the portion of the venture it did not own by 2015. Then, in June, Morgan Stanley completed the purchase after receiving approval from the Federal Reserve.
As an “Overlay Portfolio Manager,” Morgan Stanley oversees about $66 billion in assets managed by outside firms, according to the Money Management Institute. The PPG team of equity traders is headed by Scott Kravitz, who has spent his entire 27 years working for Morgan Stanley and the 10 predecessor firms that have evolved into what is now one of the most influential buyside firms on the Street-at least in terms of its trading volume and the liquidity it provides.
Today at Morgan Stanley, Kravitz leads a team of traders who execute orders of all shapes and sizes, in equity markets all across the globe, averaging approximately 1 billion shares in a typical year. But as Kravitz noted, “It is not the volume that makes things exciting here.”
HUGE RESPONSIBILITY
What separates Kravitz and his colleagues from other buyside desks is that he is predominately trading orders from more than 150 investment managers from across the globe. His business stems from the fact that the outside managers who reside on the Morgan Stanley platform don’t directly create and execute portfolio trades. Instead, these managers are in the model delivery business, placing their portfolio weightings for each strategy on Morgan’s internal platform and leaving the responsibility of execution to Kravitz’s PPG trading team.
“It is a huge responsibility, making sure we handle orders in a manner that satisfies each outside portfolio manager,” Kravitz said. “Undoubtedly, our performance is going to be judged against not only traditional transaction-cost analyses, but against the performance of the outside portfolio manager’s own trading desk. This is why we are constantly reviewing our own TCA performance, to ensure we are achieving what we consider to be best execution.” Kravitz is a voting member of Morgan Stanley’s Wealth Management Best Execution Committee and presents PPG’s TCA data to the committee.
What also makes the Morgan Stanley desk unique is the dollar amount in commissions it pays to the brokers it engages as counterparties: virtually nothing. Outside of a few international markets, Kravitz and his team always trade for zero commission. The reason behind this lies in the fact that the thousands of clients who participate in Morgan Stanley’s UMA program are charged an annual management fee that enables them to trade commission-free.
Despite the fact that brokers are not compensated for their efforts when trading his flow, Kravitz and his team are a highly coveted account for the sellside. “We are an account in high demand, as we can provide a significant amount of liquidity to the Street.”
Additionally, being an execution-only desk and not dependent on Street research enables the Morgan desk to concentrate its flow among a chosen few counterparties: “We have a core group of fewer than 20 brokers. We are able to leverage our orders and make ourselves a meaningful account to our brokers despite the fact that we aren’t directly ringing their cash register.”
Kravitz’s career path has taken him literally from ground zero of the UMA platform revolution to where he now runs the largest desk of its kind on Wall Street. Kravitz joined Morgan Stanley as part of the merger with Citigroup’s Smith Barney unit in 2009, where he was managing director and head trader for Citi’s managed account trading platform. Through mergers and acquisitions, he has held trading positions with predecessor firms Legg Mason, Smith Barney, Solomon Smith Barney, Shearson Lehman Hutton and Shearson Lehman Brothers. He began his career at Shearson Lehman in 1986, working as a purchase and sales clerk, where he had the chance to gain a complete understanding of the trade settlement process: “It wasn’t glamorous, but it enabled me to get a complete, front-to-back understanding of the trading process.”
In 1987, Kravitz joined the Shearson desk to trade for one of the firm’s top money managers. During his first years of trading, he balanced omnibus accounts and settled all trades. At that point in time, $1 billion was being managed in a single style strategy for Shearson clients, an almost unheard amount of AUM for a single portfolio manager.
Over the next few years, he moved up the ranks as he remained with the same investment management team, although it was rebranded with a host of new names (including Shearson Lehman Brothers, Shearson Lehman Hutton, Smith Barney Shearson, Solomon Smith Barney and others). In the mid-’90s, Kravitz joined the Citi Assets buyside desk, trading traditional SMAs, mutual funds and institutional accounts. In 2005, Citigroup Asset Management was sold to Legg Mason and Kravitz became the head trader for Legg Mason’s spin-off Private Portfolio Group, which was then sold back to Citibank’s Smith Barney unit in 2008. In 2009, Smith Barney and Morgan Stanley began their joint venture between their wealth management units, with Morgan Stanley becoming the sole owner this year. Although one might need a scorecard to keep track of the corporate movements, one of the few constants throughout the process was Kravitz and his team of traders, working together with a core team of analysts and portfolio managers since 2007.
Earlier in his career, Kravitz had some regrets about not following in his father’s footsteps and going into the family’s gold refining business alongside his brothers. However, after 27 years, trading remains his passion-and while the recent run-up in gold gives him cause for reflection, he says he knows that there is no business he would rather be in today.
Today, Kravitz is now part of the PPG team under the leadership of Roger Paradiso, managing director and head of investment solutions and portfolio development, and creator of the UMA. Kravitz notes the unique chemistry between all the groups within PPG, as all the department heads have been together as a team for more than 20 years. He believes this has created a unique synergy among operations, technology, implementation, compliance and trading, allowing the business to grow exponentially.
At least one of his brokers holds Kravitz in high regard. “I can readily see the respect that Scott receives from his portfolio managers and superiors. He has become a critical part of Morgan’s investment process. He is always level-headed and not easily rattled,” said Mark Morell, managing director in U.S. equity sales trading at Canaccord Genuity, who has covered Kravitz for more than 20 years. “That is not to say he is not a demanding account. He is quick to give me a hard time if he believes it is warranted. Unquestionably, Scott has become a major player in this business and is highly respected by the Street.”
MODEL CHANGE
Given the number of orders that cross his desk on a normal day, Kravitz says he places a priority on execution. Kravitz and traders Brian Stephens and Frank Viggiano work together as a team and collectively have more than 60 years of trading experience. That experience allows them to expertly work block trades and generate alpha for the client’s account, according to Kravitz.
The workload is manageable, but can be challenging when one or more of the managers makes a model change: “Some of our larger managers run over $1 billion on our platform, and when they make wholesale changes to their portfolio, they generate trades that can run into the millions of shares and produce hundreds of thousands of tickets for our back office to process. Before the advent of the UMA platform, this was an incredibly manual process prone to errors. But technology enables our back office to process several hundred thousand tickets, on a daily basis, with virtually no human intervention.”
The team looks to automate order flow to the greatest extent possible. Essentially all orders under 5,000 shares are traded in a low-touch facility. The desk uses three different venues: a DMA execution platform, along with an agency-only dark pool and one that commits capital. Depending on the order, they use a variety of algorithmic strategies, including TWAP, VWAP, percent-of-volume, market-on-open and market-on-close.
Again, all trades are executed with a zero commission. “We are considered a top user of each dark pool,” Kravitz said. “What helps this relationship is that we are also an important client of each broker’s high-touch desk-that and the fact that we don’t collect rebates.”
The PPG desk also has to face external issues that other desks never have to address. For example, when the PPG desk gets a model change from an outside portfolio manager, it is likely that the manager’s internal desk also will be in the market as well. Add to that the fact that the outside manager is also making the same modification at other firms and on many other platforms.
The whole process takes a lot of coordination to ensure that multiple desks are not simultaneously trading the same order and creating unnecessary market impact.
Kravitz and his traders also have an important advantage over their competitors: stealth. PPG’s holdings do not appear on the various industry holdings’ screens. Therefore, if his desk is trading a large block of stock, he does not have to worry about the manager’s holdings being revealed in the marketplace. This added level of anonymity adds an additional layer of security in trade execution.
However, where the Morgan PPG desk makes the biggest waves on Wall Street is with their ETF trading: “We are one of the largest investors and holders of ETFs in the market today,” Kravitz proudly noted. Morgan offers discretionary ETF-only strategies that have more than $10 billion under management. The managers periodically make wholesale changes to their portfolios that create rebalances that can run into over 60 million shares in a day.
When Kravitz’s desk trades these rebalances, sellside ETF desks take notice: “We usually do not get a lot of advance notice on rebalance days, but we quickly swing into action, determining how to trade each ETF and the appropriate counterparty.” For the most part, the desk attempts to access the liquidity that can be provided by the various market makers-known as Authorized Participants-in each issue. They are able to create and redeem each ETF and generally are willing to provide a lot of liquidity.
For example, if Kravitz has an order to buy 10 million shares of a single ETF, he will call one of his brokers for a two-way market. Simultaneously, Stephens or Viggiano will call another ETF desk and ask for the same market. The key point Kravitz acknowledges to both brokers is that they are in competition and the desk is seeking the best bid or offer. The traders then take the best market and, with just a phone call, trade a $100 million block of stock.
“You win or you lose, and, as they say on the desk,” Kravitz said, “no tears.”
For those ETFs with less-liquid underlying components, Kravitz will turn to a broker who has been active in the name and has the ability to efficiently trade the underlying securities. The broker will then create the ETF.
“We’ve enjoyed a great business relationship with the Private Portfolio Group at Morgan Stanley Wealth Management and particularly with Scott Kravitz for several years,” said Nick Wood, co-head of equities for Susquehanna Investment Group, a major trading partner of the PPG desk.
“The relationship expanded when PPG began utilizing ETFs in their product offerings, which increased their need for liquidity and market color, two of the areas where we can add value for customers. Scott’s willingness to collaborate and to leverage the tools we offer has made for a lasting, successful relationship.”
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