Alpha Profiling in Focus

December 02, 2013

Markets Media

Buy-side traders have reams of data and information at their fingertips of varying utility toward helping buy and sell stocks more efficiently. One largely untapped, but potentially actionable trove of information exists in human form, i.e. in the profile of the portfolio manager (PM) who hands the order to the trader.

Some practitioners believe that tapping into the past decisions of the PM and quantitatively applying the findings — a process known as alpha profiling — is part of a next frontier of ‘smarter’ trading that embeds business intelligence into trading.

“Typically, traders understand generally what the PM’s characteristics are in terms of are they more likely to be a momentum or a value manager, but they don’t really have the ability to discern that on an order-by-order basis,” said Dr. Henri Waelbroeck, global head of research at Portware. “The main idea of alpha profiling is to create a model that assigns an execution strategy to a trade at the time of trade creation and then very importantly, as the trade executes, monitors whether that strategy assignation was correct or not.”

The relationship between the portfolio manager and the trader at an investment firm is a vital one. PMs need traders to execute, buy and sell orders as efficiently as possible so as to not lose precious basis points of investment return; to accomplish that, traders need the fullest possible understanding of what’s behind the trade and how that translates into urgency or lack thereof.

Alpha profiling is breaking new ground on the trading desk, but the broader notion is not new. “Models have existed for years for knowledge management, and for neural networks to try to create expert systems and try to predict how individuals were thinking and how the expert might act in a particular situation,” says Dr. Andrew Urbaczewski, chair and associate professor of business information and analytics at the University of Denver’s Daniels College of Business.

“We see this with healthcare quite a bit, trying to mimic what a doctor might do, trying to take various sources, journals and medical information to assist a physician in making a diagnosis,” Urbaczewski says. “Anything we can have to integrate more sources of data is going to allow a decision maker to make a more informed decision. Where it starts to get goofy is when we start to turn it all over to the computers.”