One of the great challenges when executing a transition management event (or any portfolio-based trade) is when to start.

Several issues are intertwined here, including benchmarking, volume, cost, and volatility and how those factors can impact overall performance.

Choosing when to start is not a new phenomenon. Performance measurement has been around since the inception of the markets. But, as a community, we still struggle with its complexities and
determining the best benchmark for each trade.

Now, I’m not saying I have the solution – the simple answer is there is no one best benchmark. It all depends. However, some benchmarks are better for certain types of trades.

Please do not mistake this for an academic paper (as I am surely not an academic). However, my perspective as someone who has traded and managed transition events for more than 17 years may be helpful.

Historically, transition (or TM) events were almost always benchmarked versus Prior Day’s Close (PDC). PDC was seen as an unbiased measure of the TM event. Since this benchmark could include overnight risk (including news or macroeconomic events), TM providers had to be active at the market open. It was the first opportunity to trade and the closest execution point versus the benchmark.

While PDC does provide an unbiased benchmark (relative to the TM trading), it also creates potential noise for both the TM provider and the client. Overnight portfolio movement is often unmanageable (a hedge can defer but not completely eliminate this risk), so the start of trading is not a zero point for performance – it can be higher or lower. This defeats the purpose of a trading benchmark since this artificial bias creates pressure for the TM trader to make trade pace decisions based on that artificial performance bias and not necessarily the volume or risk in the market.

If we look past the potential bias of this benchmark, the data supports my theory here. If we look at the S&P 500 during 2021, the overnight gap was greater than +/- 10 bps relative to the closing price about 68% of the time.

Now, maybe a 10 bps doesn’t seem significant to you. But, the trend exists even if we expand the gap to +/- 20 bps where we see this happening 42% of the time. The data highlights a considerable risk that a trader would need to manage. Statistically, the overnight gap would likely generate undue and unintended risk for a transition or program trade.

The trend here isn’t only seen with US equities. We looked at the iShares Global 100 and found the same pattern but to a greater magnitude. We saw a +/- 10 bps move 82% of the time and a +/- 15 bps move 71% of the time.

So, is there a better benchmark? We think there is – Arrival.

At CAPIS, we define the Arrival benchmark as the midpoint when trading begins. Based on our strategy and analysis, this starting point is determined before the transition begins. Equally important, the benchmark is set with the client (to align expectations and be transparent). We start trading after the benchmark is struck, so there is no situation where we influence it or the event’s performance measurement.

Be aware there can be variances in this definition, including “bid/ask midpoint price at the time the order is submitted” (Craig Niven, Societe General, 2018). Note the idea of “submitted” versus “begins” can vary depending on the trade type and instructions.

Using Arrival, we ignore what happened before and can accurately measure and analyze the TM strategy and trading performance more accurately, removing potential performance bias from the process. When we provide a post-trade, we compare all our performance to the selected benchmark (e.g., Arrival); however, we include other benchmarks (such as PDC) as part of the post-trade. The variety of benchmarks may help the client understand the performance of markets around the transition trade.

A final caveat – there are times when other benchmarks may work. But, that will always be the case. I believe Arrival will provide better and more transparent results around the TM event execution for most events. Take from this what you will.

Our next article will discuss when to start a trade (it’s more complicated than you may think). If you have thoughts, questions, or want to say hi, reach out on LinkedIn or email me at [email protected].

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