NEW YORK -- Program trading has emerged from the shadow of the 1987 market crash to find wide acceptance among institutional investors.
Already program trading amounts to more than 20% of New York Stock Exchange volume, meaning one of every five shares is part of an automated trade by any of two dozen major Wall Street trading firms, a proportion that some observers say underrepresents its true scope.
Program trading by NYSE members averaged 20.4% of trades this year through July 21, up from 18.3% in 1999 and 17.2% in 1998. The NYSE defines program trading as the purchase or sale of a basket of at least 15 stocks with a total value of $1 million or more.
As technology and operational efficiency have improved, institutions have turned to program trading as a low-cost method of adjusting stock portfolios with minimal impact on market prices.
According to the NYSE, 70.6% of program trading volume was executed by member firms as agents for non-member customers during the week of July 17. Only 26.7% of program volume was trading by members for their own accounts.
Of the five firms reporting the highest level of program trading during that week, three -- Deutsche Banc Securities, Bear Stearns Securities Corp. and Interactive Brokers LLC, all of New York -- executed most of their program trades for customers. The others, Credit Suisse First Boston and Morgan Stanley Dean Witter & Co., both of New York, executed most of their program trades for their own accounts.
After being widely blamed for contributing to the 1987 crash, program trading no longer is the playing field for arbitragers and is now nearly as common as online stock trades. In fact, index arbitrage accounted for only 10% of program volume by NYSE members between July 17 and 21.
Program trading is growing about twice the rate of overall trading, said David Hall, managing director at Plexus Group, Los Angeles. The increase reported by NYSE member firms doesn't tell the whole story, he said, because a sizable amount of program trading is conducted by third-market firms that aren't represented in the NYSE figures. Those firms include Instinet Corp. and Jefferies & Co., both of New York.
Rich Bartels, head of the program trading desk at Jefferies, declined to reveal volume. He said most of the firm's program trades are on behalf of money management firms rebalancing their portfolios or committing new funds to the market. Program trading, he said, has developed into "part of the tools of the trade, very much in the mainstream."
New participants are being drawn to the institutional program trading market.
CooperNeff Group, King of Prussia, Pa. -- already one of the largest stock trading firms -- recently launched CooperNeff Enhanced Portfolio Strategies, a unit that will offer institutional program trading services on a global basis.
According to Mr. Hall and other trading experts, program trading has prospered and gained acceptance because of technological improvements that make it more efficient. In addition, the movement of assets into and out of index funds, money manager hirings and firings, mergers and acquisitions, and portfolio adjustments have made program trading almost a necessity.
One of its most widespread applications, said Mr. Hall and others, is for "money manager transitions."
Most institutional program trades are elaborate. For example, when a plan sponsor replaces a small-cap manager with a large-cap manager, the programs require experienced market specialists to trade quickly without affecting prices in either market. Stocks must be sold and others bought, sometimes in different markets simultaneously and anonymously. The same process is used when money managers move out of one sector into another or when a large amount of new money is allocated to an existing manager.
One money manager with experience in program trading and who wished to remain unidentified said: "The whole process takes a matter of hours and avoids conducting a fire sale of securities which, under normal circumstances, would have traded over three or four days. You end up with market value for the sale of the portfolio, which is immediately invested in the new portfolio, also at market value. It's a very efficient and cost-effective way to transition between managers."
Although it remains complex, program trading is accepted as a tool that "reflects the movement of money in and out of the market," said Matt Carrara, managing director at Deutsche Banc Securities.
A "big part of our business these days" involves manager transitions, Mr. Carrara said. "These trades are often large in size and involve multiple markets. There may be lots of assets moving around involving multiple managers and portfolios, currencies and sometimes countries.
"We help our clients so managers are not buying and selling the same stocks. We work with the plan sponsor to gauge the transaction with them. . . . We get all the moving pieces together, then we go through the actual portfolio trading process."
Contrary to the usual assumptions about program trading being driven by speed, he said, that is not the motivation in these cases.
Rob Cavallaro, senior managing director at CooperNeff, said advances in technology and trading expertise have made program trading "more widely available and allow more players to benefit from it."
"At the portfolio level (program trading) can reduce the market impact," he said. CooperNeff plans to target the 200 largest institutional money managers for its new program trading service; "They are all familiar with (program trading) and the advantages and know the firms who can provide global portfolio trading capabilities. We consider this group our main customers," he said.