Generating Alpha in the Information Age: A Process in Need of Refinement

In today’s Information Age we often hear that data is the new oil. Yet in institutional asset management and trading, one of the most sophisticated industries in the world, the process of extracting data, turning data into information and information into action remains untapped.

There are good reasons why the investment idea generation and execution processes are, for the most part, separate functions, handled by different people using different systems.  The issue is that these two functions have a communication problem, meaning that processes often run independently from one-another, often to the detriment of alpha generation.

This is made more acute by the complexity of the markets themselves and the number of participants interacting. The execution of an investment idea, driven by fundamentals, may generate different alpha when you take into account market information which may not be available to portfolio managers, e.g. short interest, option volumes, volatility, upcoming corporate actions, non-deal roadshows, conference schedules, share of the stock owned by ETFs and passive funds. A more complete picture will provide a better framework for decision-making and a more informed and opportunistic implementation strategy, which can help generate alpha in addition to protecting alpha.

In short, the more the traders know about the thinking behind the investment strategy, the more value they can add to the implementation of those ideas, including understanding liquidity profiles and opportunistically taking advantage of liquidity spikes when they come.

In an age where information flows are almost seamless – think of your shopping experience with Amazon for example – you would be forgiven for thinking that an industry which trades billions of shares daily would have created systems that anticipate and disseminate necessary information systematically. Alas, this is not the case. The poor quality of information exchange between the portfolio managers and traders is a key barrier to a successful implementation of an idea. And an idea with poor implementation equals lost alpha.

If this is the problem, then what are the solutions? Outsourcing has become the go-to solution to every problem in the Information Age.  However, in trading, which relies precisely on integrating complex information flows into the investment process and relies on a real-time view of the market, outsourcing to a third party may have the opposite effect. It can slow the information flow between investment idea and implementation thus resulting in lost alpha. Only traders who spend their days in front of computer screens and have access to various data flows can add value by monitoring the orders and the existing positions for potential market moving information that they can filter and provide to the portfolio managers.

I am not suggesting that portfolio managers become traders or traders become portfolio managers, but both sides of the investment process can benefit from technology to create a seamless process of information sharing which could help improve overall fund performance.

There are many advantages to having an integrated platform to help generate ideas, monitor existing holdings, and implement the strategies. First, there is the potential for cost reduction by streamlining the use of technologies that must be evaluated, paid for, resourced, integrated, and maintained by each firm. Second, the ability to systematize the sharing of information based on user entitlements and role responsibilities. Third, centralization of information within an integrated platform enables technologies like artificial intelligence to consume vast amounts of internal and external data to be monitored and analyzed in real time all to the benefit of the existing portfolio and orders. 

At Liquidnet we have spent the past two decades giving traders the tools they need to generate alpha. We are now taking this commitment further by helping them become part of a more integrated value chain which seamlessly connects the entire investment process from idea to implementation. We are creating a powerful investment platform that combines our liquidity sourcing and execution capabilities with our new artificial intelligence and data capabilities added through our acquisition of OTAS and Prattle. Finally, it further integrates these systems with one of the largest online marketplaces for research from our RSRCHXchange acquisition.

Why are we doing this and why now? The economics of institutional asset management are changing and so the technology must evolve to do the same. To maximize the opportunities granted by the Information Age, institutional asset management firms will need to make use of all the data and tools which allow for a more seamless dialogue between idea generation and execution. Only by integrating the entire investment process can asset managers unlock this untapped source of alpha.

Seth Merrin, CEO and Founder