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THE THEORY OF EVERYTHING – AND TCA

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THE THEORY OF EVERYTHING – AND TCA

By Michael Sparkes, Director of Analytical Products and Research at execution broker ITG

The current Oscar winning movie The Theory of Everything has its lead character Stephen Hawking laying out his vision of a single equation that explains all physical aspects of the universe. The scientist explains in lay terms the two broad areas of theoretical physics that have emerged over the last century – general relativity (as famously developed by Einstein) and quantum field theory (analysing the properties and effects of sub-atomic particles) – and the challenges of integrating both approaches in one over-arching set of theories. One approach looks at very broad aspects of the universe and space and time, while the other focuses on infinitesimally small objects as the basis for broader theories and interpretation. In a way this rarefied scientific debate has echoes in the more prosaic world of Transaction Cost Analysis (TCA) in financial markets, where the availability of more granular data coupled with pressure from regulators has combined to drive a whole new wave of research and analysis.

Typically the analysis of trading costs has focused on the big picture, identifying the implicit costs incurred in the investment process. But now a much more granular level of analysis is also both possible and required. There is a risk that these latest tools may be thought by some to be able to answer all the questions on trading costs and best execution. This is clearly not the case, and a combination of methods of analysis is vital.

Traditionally TCA was conducted at a relatively high level, focusing on the outcome of orders and looking at the implicit costs incurred by price movements caused by market impact or by delays in the execution process (as distinct from explicit costs such as commissions). This “implementation shortfall” can be calculated and analysed to determine where and when inefficiencies occur in the investment process. Fine tuning can lead to significantly improved investment performance within the context of an underlying process. Most leading institutions continually monitor their TCA data for trends, and aim to identify opportunities to make improvements. If left unaddressed, such hidden costs of trading can and do have a major impact on investment returns and rankings in the performance tables.

‘Investment DNA’ Should Be Reflected in TCA Methodology

Every institution has an investment process, which forms a sort of investment DNA for everything it does. It is reflected in activities such as portfolio construction, stock selection, decision timing and trading strategies. Some firms are value-oriented and incur relatively low transaction costs, as they are typically trading against the consensus. Others are more event-driven and momentum-oriented; inherently they need to trade more quickly than others, incurring higher impact costs in order to capture as much alpha as possible before others do so. Similarly some portfolios are made up of many small positions which can be easily and cheaply traded, while others consist of fewer positions which may be highly illiquid, and cannot be readily and quickly traded without severe loss of value.

All of this should be reflected in the approach to TCA which a firm employs, and the metrics which are used to monitor efficiency in achieving optimal outcomes. There is no one-size-fits-all in this respect. There have been calls in some quarters for a standardised approach to TCA. Such thinking should be firmly resisted, given the wide range of needs and types of analysis. The high level analysis must take into account many aspects of the underlying process, since the costs will be highly linked to factors beyond the control of the trader.

Greater Market Complexity Requires Forensic Analysis

But then a whole new level of complexity was introduced to European financial markets. This reflected a number of developments over the last decade, starting with the fragmentation of trading that resulted from the first MiFID set of regulations in 2007. This led to several new trading venues emerging in Europe, reducing the market share of the traditional exchanges and making the trading landscape considerably more complex. At the same time new generations of trading systems allowed asset managers to record and analyse details of every single fill that is generated by their orders. With algorithms often slicing a large order up into very small pieces, this can literally mean thousands of separate executions for just one order. The final element of complexity – albeit a welcome response to the need for better information – has been the increased use of data tags to track and report information on these individual fills.

Together these factors have driven a rapid evolution in analytical approaches which have recently taken on added urgency as a result of the publication of the FCA’s Thematic Review on Best Execution and the final draft of the proposed MiFID II regulations. These stipulate that investors must not just monitor the venues on which their trades are being executed, but require them to describe the steps they undertake in the choice of those venues and their execution strategies to achieve best execution. While more traditional approaches to TCA tended to look at the context of the investment process and at high level trading data, the new requirements entail much more precision and forensic analysis of the tactics used at the most granular levels in terms of sizes, timing and venues of trades.

Analysis of Venues Must Be Linked to Execution Strategies

The linking of venues to execution strategies is more than coincidental, and indeed is crucial. The way in which an algo is designed to route an order is inextricably linked to the execution strategy selected. This may for instance be a fixed participation strategy, or liquidity-seeking, or aimed at trading only in the so-called dark pools or crossing networks. Each strategy will tend to execute in different venues, or in different sequences, or in different volumes at different times. Hence it is essential for the latest applications of TCA to link the analysis of venues to that of execution strategies as it drills down into these details.

With this new granularity of data, new metrics also come into play. Looking at simple average price or implementation shortfall calculations is not necessarily as relevant in determining the efficacy of one venue versus another. Shorter term statistics on reversion or spread capture may be more revealing. Similarly the number and sequence of venues used can be analysed (basically the more venues used, the higher the overall cost), as can the costs or benefits of trading in lit or dark venues (with dark in general achieving better outcomes, particularly in larger sized trades). Traders now regularly use such data to monitor the ways in which their brokers execute their orders, for instance in the differing patterns of behaviour of smart order routers or algo strategies. And using this data it is also possible to predict what is likely to be the most efficient way to execute a given type of order. As with more traditional approaches to TCA, the post-trade data can become a vital input to pre-trade decision making.

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Sterling rises above $1.37 for first time since 2018; UK inflation rises

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Sterling rises above $1.37 for first time since 2018; UK inflation rises 1

By Elizabeth Howcroft

LONDON (Reuters) – A combination of heightened risk appetite in global markets and UK-specific optimism lifted the pound on Wednesday, as it strengthened to its highest in nearly three years against the dollar and five-month highs against the euro.

The dollar weakened against major currencies for the third straight session, helped by U.S. Treasury Secretary nominee Janet Yellen’s urging lawmakers to “act big” on spending and worry about debt later.

The pound rose above $1.37, hitting $1.3720 — its highest since May 2018 — at 1045 GMT. By 1136 GMT it had eased some gains and changed hands at $1.3687, up 0.4% on the day and up 0.2% so far this year.

Versus the euro, the pound hit a five-month high of 88.38 pence per euro, before easing to 88.51 at 1137 GMT, up around 0.5% on the day.

The pound’s recent strengthening can be attributed in part to relief among investors that the impact of Brexit has not caused the chaos some feared, as well as a lessening of negative rates expectations, said Neil Jones, head of FX sales at Mizuho.

“Going into early 2021, there was a bearish sentiment building into the pound on the Brexit deal, in terms of maybe it had a limited reach, and then secondly an expectation of negative rates and so to some extent the market has been cutting down on sterling shorts because neither of those things have been quite so apparent as they were,” he said.

Bank of England Governor Andrew Bailey said last week that there were “lots of issues” with cutting interest rates below zero – a comment which caused sterling to jump.

The UK’s progress in rolling out vaccines is also seen as a positive for investors, Jones said.

Currently, the United Kingdom has vaccinated 4.27 million people with a first dose of the vaccine, among the best in the world per head of population.

“Further progress in vaccinations (a pick-up in the daily rate) by the time the BoE MPC meeting takes place on 4th February may prove enough to hold off on any additional monetary easing,” wrote Derek Halpenny, head of research for global markets at MUFG.

Inflation data for December showed that prices in the UK picked up by more than expected in December, to a 0.6% annual rate.0.6

Inflation has been below the Bank of England’s 2% target since mid-2019 and the COVID-19 pandemic pushed it close to zero as the economy tanked.

(Graphic: CFTC: https://fingfx.thomsonreuters.com/gfx/mkt/oakpeyayxpr/CFTC.png)

(Reporting by Elizabeth Howcroft, editing by Larry King)

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Euro sinks amid broader risk rally against dollar

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Euro sinks amid broader risk rally against dollar 2

By Ritvik Carvalho

LONDON (Reuters) – The euro struggled to join a broader risk rally against the dollar on Wednesday as analysts said the risk of extended lockdowns in Europe to combat the spread of COVID-19 and the continent’s lag in a vaccine rollout were weighing on the currency.

Down 0.1% against the dollar at $1.2117 by 1130 GMT, Europe’s shared currency had only the safe-haven Swiss franc and Sweden’s crown for company in resisting a broad rally against the greenback by the G-10 group of currencies.

“We’re getting more headlines that the current lockdowns will be extended further, which could mean that the euro zone would be flirting with a double-dip recession before long,” said Valentin Marinov, head of G10 FX research at Credit Agricole, noting Europe’s lag in rolling out a coronavirus vaccine compared to the United States and Britain.

“So all of that plays into the story that tomorrow’s ECB meeting, while uneventful in terms of policy announcements, could convey a relatively dovish message to the market. On top of that, President Lagarde could once again jawbone the euro, so the euro is kind of lagging behind.”

Marinov also noted price action in the pound, which hit $1.3720 – a 2-1/2-year high – and 88.38 pence – its highest since May 2020 against the euro – as a contributing factor to euro weakness. [GBP/]

There was also focus on a story by Bloomberg News, which reported the European Central Bank was conducting its bond purchases with specific yield spreads in mind, a strategy that would be reminiscent of yield curve control.

Elsewhere, the risk-sensitive Australian dollar gained 0.4% to $0.7727. The New Zealand dollar, also a commodity currency like the Aussie, gained 0.25% to $0.7133.

DOLLAR WEAKNESS

While the world will be watching Joe Biden’s inauguration as U.S. president at noon in Washington (1700 GMT), traders were more focused on his policies than the ceremony.

U.S. Treasury Secretary nominee Janet Yellen urged lawmakers at her confirmation hearing to “act big” on stimulus spending and said she believes in market-determined exchange rates, without expressing a view on the dollar’s direction.

The index that measures the dollar’s strength against a basket of peers was up almost 0.1% at 90.510. The euro forms nearly 60% of the dollar index by weight.

It also fell 0.1% against the Japanese yen to 103.81 yen per dollar.

While the dollar has perked up in recent weeks on the back of a rise in U.S. Treasury yields, investors still expect the currency to weaken.

“We remain bearish U.S. dollar, and expect the downtrend to resume as U.S. real yields top out,” said Ebrahim Rahbari, FX strategist at CitiFX.

“Continued Fed dovishness remains important for our view, in addition to global recovery, so we’ll watch upcoming Fed-speak closely.”

Positioning data shows investors are overwhelmingly short dollars as they figure that budget and current account deficits will weigh on the greenback.

(Graphic: Dollar positioning: https://fingfx.thomsonreuters.com/gfx/mkt/oakveyombvr/Pasted%20image%201611132945366.png)

UBS Global Wealth Management’s chief investment officer Mark Haefele reiterated a bearish view on the dollar, saying that pro-cyclical currencies such as the euro, commodity-producer currencies, and the pound would benefit “from a broadening economic recovery supported by vaccine rollouts”.

The cryptocurrency Bitcoin fell 4%, trading at $34,468.

(Reporting by Ritvik Carvalho; Editing by Angus MacSwan)

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England soccer star Rashford nets younger buyers for Burberry

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England soccer star Rashford nets younger buyers for Burberry 3

By Sarah Young

LONDON (Reuters) – Burberry stuck to its full-year goals on Wednesday after a media campaign fronted by high-profile English soccer star and social justice advocate Marcus Rashford drew a younger clientele to the British luxury brand.

Higher full-price sales would boost annual margins and Asian demand remained strong, Burberry said, while warning that it could suffer more sales disruption from COVID-19 lockdowns.

Manchester United striker Rashford, 23, has won plaudits for his campaign to help ensure that poorer children do not go hungry with schools closed during the pandemic.

A first coronavirus wave last year cut Burberry’s sales by as much as 45% before a bounce back on strong demand in mainland China and South Korea, which continued in the last few months.

Shares in Burberry were up 5% to 1,825 pence at 0905 GMT, with Citi analysts saying that improved sales quality from fewer markdowns would drive full-year consensus upgrades.

Burberry’s 9% sales decline in its third quarter was worse than the 6% fall in the second, and the company said that 15% of stores were currently closed and 36% operating with restrictions as a result of measures to curb COVID-19’s spread.

“We expect trading will remain susceptible to regional disruptions as we close the financial year,” Burberry said, adding that it was confident of rebounding when the pandemic eases given the brand’s resonance with customers.

In the third quarter, comparable store sales in Europe, the Middle East, India and Africa declined 37%, hit by shops shut in lockdowns and a lack of tourists visiting Europe, but in the same period, it posted sales growth of 11% in Asia Pacific.

Burberry said that Britain’s new relationship with the European Union would cause headwinds, warning of a modest increase in costs to comply with new rules and also the impact of an end to a scheme for VAT refunds for non-EU tourists.

This would make Britain a less attractive destination for luxury shopping when tourism returns after the pandemic, Burberry said, adding that it would try to mitigate the effect.

(Reporting by Sarah Young; Editing by Kate Holton, James Davey and Alexander Smith)

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