Patient trading

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Grant Wentzel 29 March 2015 Est. reading: 4 min read

Stock market trading is often portrayed as a frenzied, urgent activity. The reality is very different – and it’s a lot calmer than you may think.

Technology has driven equity trading from the stock exchange floor into trading rooms serviced by highly-powered computers. The book ‘Flash Boys’ by Michael Lewis brought the world of high-frequency trading (HFT) into the public eye, so too has the rise of alternative trading venues. These alternative venues are now a large part of the market liquidity and can lower the cost of execution for investors.

Getting the best possible price for the block of stock we are looking to buy or sell is obviously a key factor for a dealing function, but so too is sourcing liquidity.

There are various ways we can access different pools of liquidity and block trading via brokers remains a pivotal function. The ability of brokers to discretely source blocks of stock on behalf of traders is essential. The value of strong relationships with a trusted group of executing counterparties cannot be overestimated.

Being patient is not a virtue typically associated with trading. The perceived objective is to deploy capital as quickly as possible without making a market impact. We are able to move quickly when we need to, but much of our activity takes place at a more measured pace. The concentrated nature of the Woodford Equity Income portfolio means that we have large stock positions and, unless we are careful, our trading activity can move the price of stocks in which we are trading. We have to be patient.

Building our initial position in Cranswick, the food producer, is a good example. The original order was to buy 400,000 shares worth c. £5m. Although this appears to be a relatively small position, Cranswick is a very illiquid stock. The average daily volume on the London Stock Exchange (LSE) in the year prior to the fund’s launch was just 45,000 shares. Cranswick may manufacture premium pork products, but we were determined not to pay a premium for the shares. We began buying the stock on 20 June and finally completed the order on 15 August1.

Another illiquid stock example, is 4d Pharma, where we have been able to build a meaningful position by being patient. The Equity Income Fund now owns 8.78m shares with 2.7m of those bought in the market at an average price of 325p2. To put that in perspective, the total number of 4d Pharma shares traded on the LSE for the whole of this year to date is less than 1.5m.

Working closely with the investment team and highlighting market inefficiencies is also an important part of the trading function. The profit warning by Game Digital on 13 January provided us with an opportunity to buy stock, which we believe offers long-term value, at a hugely discounted price. The warning saw the stock halve in value within hours of the announcement and it closed the day down 30%. We took advantage of this weakness and bought 2.27m shares at an average price of 227p.

Our investment approach is all encompassing: it is disciplined and focused on the long term. It starts with the initial company research through to the investment decisions made by the fund managers – and ends with the execution of the stock trades. This is why dealers have to be patient too.

Triple-witching casts its magic

The CF Woodford Equity Income Fund raised £1.6bn during the offer period in June 2014. When the fund went ‘live’ we wanted to put that money to work quickly.

Given the amount of money raised there were significant challenges in deploying the capital without having an impact on the prices of the stocks we were buying. We started trading for the fund after midday on Thursday 19 June but by the close of business on Friday 20 June, we had invested £1.2bn. We were close to fully invested within a week.

Despite the challenges, many people were surprised at what we managed to achieve in a short period of time. Some assumed that by investing so quickly we must have moved share prices detrimentally. In fact, our market impact was actually positive during the period.

Bloomberg has a system for monitoring dealing activity that uses a theoretical model to calculate expected market impact based on the volume of shares traded across the entire portfolio. When we compared our actual trading activity to the results of this model, we saw that we actually traded with an average execution price 114bps (1.14%) better than Bloomberg’s estimated market impact. That translates into ‘trading alpha’ or a ‘saving’ for the fund of £18.24m.

We were helped by the timing of the fund’s launch, which coincided with two significant liquidity events in the UK stock market. On Friday 20 June 2014, ‘triple-witching’3 and the FTSE index rebalance resulted in a large increase in traded volumes on the LSE – £6.25bn worth of FTSE shares traded on the LSE versus a daily average of £3.5bn.  Some of my peers suggested that perhaps they weren’t the only factors that helped us get the money away under the radar. Many brokers may just have had other things on their minds. After all it was June – the sun was shining, England were still (only just) in the World Cup and Ascot was in full-swing.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address: 27 Old Gloucester Street, London, WC1N 3AX.

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