Can post-trade TCA help redefine the relationship between traders and PMs?

This article was written by Zoravar Bakshi and Mike Googe,  Product Managers – BTCA at Bloomberg.

With the ever-increasing competition for mandates and greater depth of scrutiny across all aspects of investment performance, there has been a growing buzz around the potential of Post-trade Transaction Cost Analysis (TCA) to gradually transform relationships between traders and portfolio managers (PMs). The goal? To achieve the best possible outcomes for their investors.

To get there, it is fair to say that a desk’s performance hinges on nurturing relationships and refining outcome-based strategies that tend to succeed more when a trader deeply understands a PM’s approach and, conversely, when a PM can predict a trader’s actions. Surely, excellence is more likely when both groups take advantage of each other’s strengths through consistent feedback and tight partnerships?

So, what are the considerations for using TCA?

Improving outcomes

What are the features of improved collaboration? The days of segregated responsibilities seem to be on the decline with success increasingly sought through unified approaches. But specifically, how?

When traders understand a PM’s investment goals and bias, and conversely when a PM can rely on a trader’s judgment to take actions in support of that goal this builds trust which allows both groups to consciously identify, qualify and take advantage of opportunities discovered through consistent feedback on processes.

For example, a trader aware of the investment intent can take advantage of fleeting liquidity opportunities or, during periods of significant momentum or volatility, can advise on that market color to assist on timing decisions. All reasonable but how does one measure those outcomes?

TCA as strategic insight

TCA documents trade performance by presenting execution results and costs. The insights add a useful perspective to everyday conversations – proof of what worked and clear improvements to achieve better outcomes.

Using a data-driven approach and capturing context across a fully decomposed order lifecycle from decision to final execution allows traders to explain the narrative of an order within the context of the order characteristics and market conditions. This allows the conversations to isolate and distinguish between execution challenges, unforeseen market movements and internal routing and order handling impacts.

Let’s imagine a common scenario: measuring the opportunity cost from the time an order is created to the time it arrives on the trader’s pad for execution can reveal insights that could improve internal process, or calculating slippage in the context of related index moves can provide valuable relative performance perspective. Such observations can highlight issues of adverse selection. Looking at pre-trade momentum bias across orders can reveal clues to a trader about optimal aggression levels in their implementation of a strategy.

Repeated exposure to TCA data can empower a PM to better consider the trading implications of the investment goal and engage in realistic implicit costs rather than paper returns. They can therefore provide more plausible input to traders.

Conversely traders can gain data driven insights that can help them to provide appropriate market color at the right time potentially leading to better selection of trading strategy to meet the bigger picture of the investment goal. TCA as a discipline can therefore provide a common frame of reference for constructive discussions between both groups, increasing trust in each other’s contribution to the overall outcome. Sounds appealing but is it always a plausible method?

Beyond TCA

When applied too rigidly or without considering context, TCA can strain the relationships it’s meant to enhance. A prevalent concern would be pedantry and scrutiny – if every trade is analyzed beyond reason, traders usually feel unnecessary pressure, micromanaged with less autonomy and therefore inhibited from natural decision-making.

Ultimately TCA is constrained by the ability to observe and reconstruct the lifecycle of a trade and compare it to the view of accessible liquidity and price. For much of the analysis there are solid data points to use but there are obvious limitations. For example, intra-order changes of sentiment leading to changes in trading strategy or things that cannot be captured electronically such as conversations between Traders/PM which impact activity that go unrecorded.

It is therefore appropriate to use TCA in conjunction with good judgement and acceptance that it can only be part of the answer. It allows traders to anticipate a PM’s momentum bias for given conditions, which can be controversial if not handled sensitively. For both traders and PMs, there is a risk that over-reliance or inappropriate use of TCA may result in developing a short-term focus rather than a long- term plan.

TCA, when also considering a desk’s DNA and vision, can transform relationships between stakeholders. What is important is to derive suitable patterns and information from its data driven insights and to equip communication between traders and PMs with storytelling and a quantified muscle memory that makes every transaction seamless and well understood.

To learn how Bloomberg TCA can help strengthen your trader-PM relationships click here or request a demo here.
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