Every BEEP matters
“Picking up pennies in front of a steamroller” is an investment term attributed to Nassim Nicholas Taleb, a renowned author on risk and randomness, describing investments that have both a high probability of a modest gain and a low probability of a huge loss in any period. Simply put, it’s about the existence of asymmetric payoffs and risks. Taleb hypothesized that the negative outcome would eventually outweigh any modest gains. It’s a common expression that many people can relate to in their business or investing life—how many accumulated pennies are worth potentially getting steamrolled for?
On the trading desk at Mawer, however, we use this analogy a bit differently. That asymmetry might work the other way: as opportunity costs, if we’re unable to implement our investment decisions in a timely fashion. We focus on best execution (avoiding the steamroller), but also try not to lose sight of the knowledge that a penny lost might be worth dollars of return should our investment thesis be correct. We can’t be so focused on capturing liquidity (the degree to which a stock can be quickly bought or sold in the market without affecting its price) that we leave an order unfilled and have the stock move dollars away from us—hence, the asymmetry of payoffs and risks.
We work hard to hold ourselves accountable to the long-term thinking that is at the crux of our investment philosophy and that can stand in stark contrast to the short-term feedback loop the market provides. Admittedly, it is the trading desk’s job to manage both the implicit and explicit costs associated with day-to-day trading, such as commissions, bid/ask spread, and market impact. This makes it easy and almost natural for traders to become focused on the minutia: every decision has immediate and measurable return impact. Therefore, we’ve built a process-driven framework that helps us to reconcile both the short-term and long-term demands of our trading desk.
We call this framework “Every BEEP Matters.” The acronym stands for Best Execution, Education, and Process and is also a cheeky reference to the term basis points (often abbreviated as bps, pronounced “beeps”).
Best execution is the glue that binds our long-term investing thesis with the short-term implementation of those ideas. We view best execution as an ongoing and iterative process, essentially aimed at obtaining both the best all-in price for a trade and for our investment thesis in its entirety (see: Education section below). It involves analyzing and learning from past executions, limiting market impact through technology, and maintaining key brokerage relationships. It’s about maintaining anonymity for our clients’ orders, and entails the security, ease, and surety of settlement amongst other things.
We view a partially completed order—where the long-term thesis wasn’t honoured through the implementation—as much of a violation of best execution as many of the other short-term and more micro items that are typically the focus. In other words, there can be long-term opportunity costs if we don’t fill our orders.
In our framework, education doesn’t refer to a formal degree or accreditation. Rather, it’s a concerted focus on the process of continual learning. That includes market knowledge (macro and market structure) and portfolio knowledge. We spend countless hours as a team understanding how the markets work, how the technology on our desk interacts with the markets, and how can we best optimize the routing of our orders. This type of education has become a requirement of our role as we fulfill our best execution obligations.
We have focused on items like behavioural finance, habit formation, and history (just to name a few) in hopes of expanding our personal knowledge and increasing the tools at our disposal. We aren’t macro investors, we build our portfolios from the bottom up; however, the macro environment impacts everything we do, and influences equity prices based on the flow of funds around the world. As a result, we strive to have a diverse knowledge base in all areas of capital markets, and as a team we share these individual learnings at our weekly global traders meeting.
In addition, a critical focus of our desk is on the understanding of the research team’s thesis behind an investment idea. Recently, we’ve started writing a trader’s version of research reports on each of our portfolio companies in which we highlight the key reasons we own a stock, the risks and opportunities, and tips/tricks or patterns for trading. This not only improves our individual knowledge of a holding but is a quick and easy resource for the other traders. This education sets the stage for better execution of our investment ideas because every investment has a different implementation strategy based on the expected return profile, time frame of that expected return, and expected weight in the portfolio. Without this knowledge, we might miss liquidity opportunities that could impact long-term outcomes for our clients.
The final piece of the framework is process. I would argue that everything we’ve highlighted to this point is all part of the overall process, so this section is more around the documentation of the processes and procedures we follow to fulfill our roles on the trading desk. A lot of this isn’t the value-add exciting stuff, but more about making the desk systematic to comply with all the rules and regulations and minimize operational errors. It’s about setting this framework, reviewing its effectiveness, and implementing improvements.
An important aspect that we have included in our process is communication. We are attempting to systematize the communication on the desk, both with our brokers and internal research team. Much of the systemization comes from using a common language (as we’ve discussed in previous blogs), information sharing, and common mediums of communication. For example, we have a traders update that goes out daily firm-wide that has input from the entire trading team (news and pertinent market and portfolio thoughts), we participate in weekly asset class meetings (individually or as a group pending who’s awake during those meeting hours), or we may even just have scheduled check-ins with portfolio decision-makers to discuss what’s on their mind. All these data points are then shared amongst the trading team.
Managing and understanding liquidity is an important part of our role, and we are required to communicate our thoughts to the investment team so they can better understand the complexity or expected timing around an implementation of an investment idea. The goal here is to make the research and implementation of our investment ideas as seamless as possible.
Ultimately, the purpose behind sharing the “Every BEEP Matters” framework is to take trading, which has been glamorized by Hollywood and stereotyped as fast and reckless, and demonstrate to our clients that they can rest assured we are systematically doing our best to implement the investment decisions they’ve hired us for. The metaphorical steamroller isn’t always a negative—oftentimes if you are aware of its existence and have a framework to avoid stepping in front of it, it can be the very thing that paves the way to good long-term investment outcomes.