07 Oct White Paper – The Impact of Equity Market Fragmentation and Dark Pools on Trading and Alpha Generation
By Voya Investment Management
When trading equities, institutional investors seek “best execution” — by understanding prior to execution 1) the characteristics of an order and how that will impact its costs and 2) the expected alpha from the trade, investors can optimize the trading frontier (i.e., how long to trade) and attain the best available price for the order. In the context of an institutional portfolio, this implies that a trading desk seeks to identify the optimal balance between market impact and volatility exposure over time in order to realize the alpha forecast by the portfolio manager. Anything short of best execution suggests that a trade may have been executed at an adverse price (due to trading too aggressively or too passively) and that there is the potential for an intermediary to realize an almost risk-free profit at the expense of portfolio performance.
Making informed decisions about what constitutes best execution depends largely on interpretation, which has become increasingly more complicated in recent years as markets have shifted to a dynamic, constantly evolving system.