Getting to Grips With VWAP

TRADING STRATEGY Mark Buchanan + 44 207 888 0908 Ma rk.k.bucha na [email protected]

Liesbeth Baudewyn + 44 207 888 7988 Liesbeth.ba [email protected]

Trading Strategy

Xiang Lin + 44 207 888 0974 Xia [email protected]

Getting to Grips with VWAP Market Commentary

2 October 2013

“

Key Points  The VWAP benchmark is an industry standard approach to measuring trader performance. 

Performance versus VWAP is highly dependent on a country’s market microstructure.



Those markets with the most stable profiles and the lowest spread costs tend to have least slippage.



More aggressive trades tend to cost more relative to VWAP.



Dark pools exposure improves execution performance versus VWAP.



VWAP is highly sensitive to the closing print, as well as the venues and trade types included in its calculation.

How We Crunch the Numbers The transaction cost data used in this report is extracted from ExPRT, Credit Suisse’s proprietary TCA tool (see ExPRT for Dummies for further details). It represents trading by a broad range of institutional investors via the single stock, portfolio trading and AES desks over the period from Jan 1st – Aug 30th 2013. Our analysis is based on VWAP strategy tickets only, as these tactics explicitly target the VWAP benchmark. Limit orders, orders which are not fully executed, amended orders and trades impacted by extreme price moves have been excluded.

Getting to Grips with the VWAP Benchmark Love it or Loathe it, It’s Not About to Disappear from TCA The VWAP benchmark – which measures the difference between the average execution price and the market wide volume weighted average price – is well established as an industry standard approach to measuring trader performance. While there are various arguments against the use of VWAP as a measure of execution quality (see Why Be Average? for further details), it is not likely to disappear from transaction cost analysis (TCA) reports – including Credit Suisse’s ExPRT – any time soon. To help traders better understand their performance versus VWAP, this report looks at the relative cost of trading different European countries based on data from our ExPRT client execution database (see side box for further details). We also investigate how performance versus VWAP varies with respect to intra-day volume profile stability, spread costs, participation rate and exposure to dark pools. Finally, we consider whether the closing print has much impact on full day VWAP, and whether the absence of an industry-standard consolidated tape matters in the context of measuring performance versus VWAP.

One Region, Mixture of Microstructures Market Microstructure is Key Driver of VWAP Performance Some countries in Europe have very similar microstructures, while others vary significantly with respect to turnover, bid-ask spreads, top-of-book liquidity, trade frequency, volume profile stability and fragmentation (see Exhibit 1 and Algorithmic Trading in Europe Spreads its Wings for further details). Unsurprisingly, our analysis suggests that each country’s market microstructure is a key driver of execution performance versus VWAP. We find that those markets with the most stable intra-day volume profiles and lowest spread costs tend to have the least slippage and the lowest variation in performance. We also find that more aggressive trades tend to cost more versus VWAP and that exposure to dark pools improves execution performance. Is there much difference between the VWAP with and without the closing auction, or using primary market only versus consolidated data? Our analysis suggests that there is.

Exhibit 1: Bid-Ask Spreads vs. Top of Book Liquidity

(212 (

Source: Credit Suisse Trading Strategy, January 1st – August 30th, 2013

TRADING STRATEGY

VWAP Slippage Varies by Country Top Countries Have Similar Costs, Others More Variable Those markets with the lowest slippage versus VWAP are separated by fractions of basis points in terms of their performance (see Exhibit 2). The standard deviation of performance versus VWAP for these markets is also remarkably similar. Exhibit 2: VWAP Slippage & Variation in Performance vs. VWAP by Country

Worse performance

Higher standard deviation


However, as you move beyond the top markets to consider the smaller and less developed markets in Europe, both the average slippage and standard deviation of performance versus VWAP increase substantially. For example, average slippage in South Africa is 3.3x that of the UK, while Turkey is even more expensive and variable.

Profile Stability Matters Countries with Stable Volume Profiles Track VWAP Best VWAP tactics slice orders according to a stock’s historical intra-day volume profile. The more stable the historical profile, the more likely that the VWAP tactic will slice orders in line with the stock’s actual volume profile on the day of the trade. It is therefore not surprising to find that those countries with the most stable profiles also tend to have the lowest slippage versus VWAP (see Exhibit 3). Exhibit 3: VWAP Slippage vs. Volume Profile Instability by Country

Worse performance Source: Credit Suisse Trading Strategy, January 1st – August 30th, 2013

2

TRADING STRATEGY How We Calculate Spread Cost For each individual child level fill, we compare the execution price with the prevailing near touch quote on the primary market. Spread cost is the weighted average of the difference between these two numbers expressed in basis points.

How Important Are Spread Costs? Countries with Low Spread Costs Track VWAP Best Spread cost is another key determinant of performance versus VWAP (see side box). In order to maintain scheduling versus the stock’s historical intra-day volume profile, the trader is generally required to pay the spread on some portion of the order. The wider the bid-ask spread, the more costly this could be relative to VWAP. This pattern is borne out by the data (see Exhibit 4), with higher spread costs corresponding with higher deviation versus VWAP by country.

Exhibit 4: VWAP Slippage vs. Spread Cost by Country

Worse performance Source: Credit Suisse Trading Strategy, January 1st – August 30th, 2013

Exhibit 5: Distribution of VWAP Slippage vs. Spread Cost

Why does Turkey have such high spread costs? This is partly because the tick size structure in Turkey forces bid-ask spreads to be wide (see Exhibit 1 and Global Equity Markets Handbook - Feb 2013 for further details). The resulting high depth of book in Turkey means that a significant amount of volume can be taken from the near-touch without ever reaching the trader’s VWAP order. The trader is therefore often forced to pay the spread more often than he/she would like to relative to other markets. Poland is another interesting case. Although its spread costs are comparable to those of the lowest cost markets, the fact that it has one of the least stable intra-day volume profiles makes it challenging to match VWAP (see Exhibit 3).

Spread Costs Can Drive Extreme Performance 0bps Source: Credit Suisse Trading Strategy, January 1st – August 30th, 2013

Exhibit 6: VWAP Slippage vs. Volatility

Global Financial Crisis J.P. Morgan acquires Bear Stearns

We also find that spread costs are an important driver of variability in performance versus VWAP. Where spread costs are low (i.e. less than 10bps), the distribution of performance versus VWAP is fairly tightly distributed around the average (see Exhibit 5). In contrast, trades with high spread costs are more negatively skewed versus VWAP and exhibit much higher variability of performance.

Matching VWAP is Tougher during Periods of High Volatility

Greece Debt Crisis

Euro Crisis

Since bid-ask spreads and volatility are highly correlated (see Europe Chartbook (Aug-13) for further details) it is not surprising to find that matching the VWAP benchmark is tougher during periods of high volatility (see Exhibit 6). Anecdotally, it may also be the case that traders need to pay the spread more often in high volatility environments and that volume profiles are less stable (see Executing in Earnings is Extra Expensive for further details).

3 Source: Credit Suisse Trading Strategy, January 2007 – August 2013

TRADING STRATEGY

More Aggressive Trading Costs More

Exhibit 7: VWAP Slippage vs. Participation Rate

High Aggression Rates Have Higher Deviations vs. VWAP More aggressive trading typically incurs higher spread costs (see A New EDGE in Impact Cost for further details). It is therefore not surprising to find that, on average, trades with higher participation rates have higher slippage versus VWAP (see Exhibit 7). To ensure an apples-to-apples comparison between the participation rate buckets, we have normalised our data set with respect to trade size and bid-ask spreads.

Exposure to Dark Pools Makes a Difference Trades with Higher Exposure to Dark Pools Outperform


There are three main reasons why exposure to dark pools is likely to reduce slippage versus VWAP. First, dark pools help traders reduce signalling costs. In Measuring Dark Pools' Impact and The Cost of Primary Market Only Execution we found that posting even small orders on lit markets can cause prices to move against the trader (see Exhibit 8). Second, by facilitating execution within the bidask spread dark pools help traders reduce their spread costs. Thirdly, dark pool prints allow VWAP algos to slice orders into even smaller waves and therefore better match a stock’s actual volume profile.

Exhibit 8: Signalling Costs in FTSE 100 and Euro STOXX 50 Names*

Approach to Analysis To test this theory, we analysed the performance of Credit Suisse VWAP tactics during 2013 and split the sample into those exposed to the dark (i.e. Credit Suisse Crossfinder and MTF dark pools) and those not. We paired the samples so they are similar with respect to trade difficulty, as measured by %ADV, bid-ask spread and participation rate. We have considered only market orders that were fully filled and trades impacted by extreme price moves have been excluded.

Bid Imbalance Ask Imbalance

Results On average trades exposed to the dark outperformed on a relative basis versus VWAP across every trade size bucket (see Exhibit 9). Overall, the relative outperformance was 0.94bps and the difference in performance was statistically significant at the 5% level. We also found that orders exposed to the dark had slightly lower variability of performance versus VWAP. As the other meaningful factors were controlled for in the construction of the two samples, there is evidence to suggest a link between exposure to the dark and execution performance

Source: Credit Suisse Trading Strategy, November 22nd – December 17th, 2012 *Note: Our approach is to track the movement of the mid-point of the bid-ask spread from the point where the bid-size is greater than 5x the ask size (and vice versa) for 2 consecutive ticks, but the bid/ask size is no more than the average primary market trade size for the stock.

Exhibit 9: VWAP Slippage by Dark Pool Exposure

-15.2%

-18.7% -19.5%

-57.0% -30.8%

Worse performance Source: Credit Suisse AES Analysis, January 1st – August 30th, 2013

4

TRADING STRATEGY

To Include the Closing Print, or Not VWAP Benchmark is Highly Sensitive to the Closing Print In a previous analysis, we found that stocks in Europe tend to have the most stable closing volume profiles (see Exhibit 10 and EDGE Update:**NEW MOC Pre-Trade in EDGE** for further details). As a result, VWAP tickets in Europe typically include the closing print, whereas they are often limited to continuous trading in the Americas and Asia. Exhibit 10: Closing Volume Profile Instability by Country

Source: Credit Suisse Trading Strategy, August 21st, 2013

Exhibit 11: Distribution of Full Day VWAP vs. VWAP ex. Closing Auction

15.4% of prices are lower by >0.5bps

17.4% of prices are higher by >0.5bps

Since the closing print accounts for around 15% of average daily volume in Europe, it could reasonably be expected to have a significant influence on the market wide VWAP. Our analysis, which compares the VWAP price during continuous trading with the full day VWAP, suggests that is indeed the case (see Exhibit 11).

VWAP Analysis without a Consolidated Tape VWAP Benchmark Highly Dependent on Venue Selection The lack of an industry standard consolidated tape is frequently cited as one of the most important issues facing traders in Europe. As evidenced by the MiFID II discussions, all parties agree on the need for affordable, consolidated posttrade data. However, their views differ on how that might best be achieved (see MiFID II: Hail CESR! for further details).

Source: Credit Suisse Trading Strategy, August 1st – September 27th, 2013

Exhibit 12: Distribution of Primary Market VWAP Slippage vs. Consolidated VWAP Slippage

19.5% of notional has slippage >2bps worse

17.4% of notional has slippage >2bps better


In the absence of an agreed-upon standard, data vendors and TCA providers have devised their own proprietary consolidated tapes. Due to on-going concerns about the underlying content of over-the-counter (OTC) prints, most TCA products tend to focus on primary market and multilateral trading facility (MTF) prints only. However, different providers’ VWAP prices may still vary due to venue selection or the exclusion of certain trade types. In a TCA context, does it make a big difference what trades or venues get used to compute the VWAP benchmark? Our analysis suggests that it may. By comparing the VWAP price computed using primary market prints only to the price derived when MTF and primary trades are taken together (sourced from the ExPRT database), we find that there is a high degree of variation between the two (see Exhibit 12). With MTFs accounting for over 40% of FTSE 100 turnover and over 35% of Euro STOXX 50 turnover this is perhaps not a surprising result. However, it does demonstrate the importance of using the most appropriate measure when evaluating VWAP performance.

5

TRADING STRATEGY Credit Suisse Trading Strategy USA Phil Mackintosh Victor Lin Ana Avramovic Stephen Casciano

+1 212 325 5263 +1 212 325 5281 +1 212 325 2438 +1 212 325 0776

[email protected] [email protected] [email protected] [email protected]

Europe Mark Buchanan Colin Goldin Liesbeth Baudewyn

+44 20 7888 0908 +44 20 7888 9637 +44 20 7888 7988

[email protected] [email protected] [email protected]

Asia Karan Karia

+852 2101 6322

[email protected]

Market Commentary Disclaimer Please follow the attached hyperlink to an important disclosure: http://www.credit-suisse.com/legal_terms/market_commentary_disclaimer.shtml

This information has been issued by Credit Suisse Securities (Europe) Limited (“CSSEL”), which is authorised and regulated by the Financial Services Authority for the conduct of investment business in the United Kingdom. This material is provided to you by CSSEL or any of its affiliates solely for informational purposes, is intended for your use only and does not constitute an offer or commitment, a solicitation of an offer or commitment, or any advice or personal recommendation, to enter into or conclude any transaction (whether on the indicative terms shown or otherwise). This material has been prepared by CSSEL based on assumptions and parameters determined by it in good faith. The assumptions and parameters used are not the only ones that might reasonably have been selected and therefore no guarantee is given as to the accuracy, completeness or reasonableness of any such quotations, disclosure or analyses. A variety of other or additional assumptions or parameters, or other market factors and other considerations, could result in different contemporaneous good faith analyses or assessment of the transaction described above. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Opinions and estimates may be changed without notice. The information set forth above has been obtained from or based upon sources believed by CSSEL to be reliable, but CSSEL does not represent or warrant its accuracy or completeness. This material does not purport to contain all of the information that an interested party may desire. In all cases, interested parties should conduct their own investigation and analysis of the transaction(s) described in these materials and of the data set forth in them. Each person receiving these materials should make an independent assessment of the merits of pursuing a transaction described in these materials and should consult their own professional advisors. CSSEL may, from time to time, participate or invest in other financing transactions with the issuers of the securities referred to herein, perform services for or solicit business from such issuers, and/or have a position or effect transactions in the securities or derivatives thereof. Copyright © 2013 Credit Suisse Group AG and/or its affiliates. All rights reserved

6

Getting to Grips With VWAP

Recommend Documents