Howard Tai, a longtime trader turned consultant, believes that if a money manager is vigilant with its FX trading, it will do its clients right with higher returns.
FX is very integral once a firm has assets beyond its borders, because exchange-rate fluctuations will affect the value of its portfolios," said Tai, a 25-year trading veteran who joined the consultancy Aite Group one year ago. "A reasonably active hedging strategy has the potential to add 1 percent-plus in returns on the fund level."
That’s significant, said Tai, who joined Aite from mutual fund giant American Century, which he joined in 1995 as a senior FX trader. There, he implemented the firm’s hedging strategy for equities and fixed income. By the time he landed there in Kansas City, Mo., he already had nine years under his belt working at banks, trading currency options and futures. At American Century, Tai would trade FX, as well as equities and convertibles for 16 years.
Through his research reports, Tai hopes to shed light on an industry that is dealer-dominated and not known for its transparency. In March, he completed a survey of 30 buyside firms that highlights their FX trading attitudes and practices. Titled "Buyside FX Outlook: In Search of Best Practices," the report offers his first glimpse of how the business is evolving.
The buyside survey was important to Tai because he wanted to examine trading practices for the asset class that he spent most of his career trading, he explained. "FX is something that the buyside has historically treated as an afterthought, and until recently, has been looked at from more of an operational standpoint than from a markets perspective."
During Tai’s tenure at American Century, the mutual fund was among the most vocal critics of the market structure of the U.S. equities market. Under the leadership of Harold Bradley, who headed trading in the 1990s, American Century was one of the biggest proponents of electronic trading and fair dealing. Although he was influenced by his former firm’s philosophy, Tai says he doesn’t plan on being as vocal about changing the industry as his former firm was. But he doesn’t plan on biting his tongue, either.
"I won’t be afraid to voice my opinion and offer my honest observations of where I think the industry is headed," said Tai, who plans to continue speaking on industry panels, something he’s done over the last 10 years. "I want to be part of the discussion to find new solutions for the industry."
Aite Group principal and founder Sang Lee told Traders Magazine it was a win-win getting a former buyside trader with FX experience on staff. "Howard speaks our client’s language and has a firsthand understanding of the issues traders experience every day, across a range of asset classes. His recent FX report proved to be one of our most popular reports this year," Lee said.
A few of the conclusions from the survey include: 1) Electronic trading will continue to grow, as will the overall FX trading volume for most of these firms. 2) For those firms that still use the phone, it remains important not only for execution but also for market color and strategy. And 3) defining best execution will become increasingly important, particularly as firms begin to wrestle with measuring their trading costs.
Tai believes his survey is the first research piece on the buyside and its FX trading practices. The 30 respondents needed to qualify for the survey, so he said the results are representative of firms that are more proactive and ahead of most buyside firms in their handling of currency trading.
Overall, Tai said he was pleased with the insights the survey offered, but he would have liked to have had more respondents from a wider range of FX users, particularly high-frequency trading firms. Only one of the 30 respondents identified itself as an HFT.
Still, he believes the buyside is looking more closely at execution quality for FX. The new mind-set began in the last year or so, after pension funds sued custodial banks State Street and BNY Mellon on their execution quality for captive orders. Pension funds claim they received inferior prices. The banks have denied the allegations and defended their trading practices.
Tai said the majority of buyside firms have a way to go to improve their FX trading practices. "A large group of firms are still doing the handoff and letting the custodian do their trades, but they’re learning they can’t do that anymore in the current low-return environment," Tai said. "Firms that have very junior traders or operations people doing the trading are leaving a lot of money on the table."
The survey included some heavy hitters: Half the firms interviewed had more than $100 billion in assets under management, while another 7 percent of the respondents ran between $50 billion and $100 billion in assets. Another 20 percent managed between $10 billion and $50 billion. The 23 percent balance managed less than $10 billion.
The firms surveyed were mutual funds (40 percent), institutional asset managers (27 percent), hedge funds/CTAs (17 percent), pension funds/endowments (10 percent) and emerging markets asset managers (3 percent). Just the one high-frequency trading firm participated, representing 3 percent of the survey. Tai had hoped for a larger showing of HFT firms.
For FX, electronic trading accounted for 72 percent of the "aggregate weighted volume in the study." The study broke down electronic trading into three groups: single-bank and multi-bank platforms, as well as ECNs (52 percent of the aggregate weighted volume); via a direct API connection like FIX Protocol from an OMS (14 percent of the weighted volume); and instant messaging or chat (6 percent). Seven out of the 30 firms surveyed were totally electronic and traded 100 percent of their FX flow through single- or multi-bank systems or an ECN.
Still, the phone is important, as 43 percent still use it to some degree. The phone accounted for 18 percent of the weighted trading volume in the survey. Exactly 10 percent of the participants, or three firms, do all of their FX via the phone. Four firms traded from 26 to 50 percent of their FX volume on the phone, and six more firms traded from 1 to 25 percent by voice.
Tai said the phone is a good way to execute sensitive trades, typically size. But it is also a good way to receive spot market commentary, as well as a tactic to reward certain brokers and to enhance the relationship.
On best execution: For 80 percent of those surveyed, their firms already have a best-ex policy in place. The balance of respondents, 20 percent, said their firms are thinking of developing a policy.
It should be noted that best-ex is more than just best price. To have trades settle cleanly avoids additional costly errors. Also, a firm that provides good research and trading strategy on FX trades should be part of the discussion of best execution, according to the report.
What is important when choosing a trading partner? In order of importance: 1) ease of custody and settlement (43 percent); 2) one-stop shopping, when the client already trades other asset classes at the broker/bank (43 percent); 3) a lending relationship already being in place (30 percent); and 4) best execution (23 percent).
"It is somewhat surprising that achieving best execution came in as the fourth most important criteria when choosing a bank or broker," Tai said. One reason behind that might be that firms are still grappling with a definition of best execution in FX.
