Alpha - September 2007 - (Page 60)

Marshall Wace sumption was that brokers would be totally bullish, despite the bear market, and cost us lots of money. The real discovery we made in those early years was that — even as the markets were still going down — some of the advice we were getting was truly valuable.” The system that Clake, Marshall and Wace developed does far more now than simply automate and systematize classic phone-call interactions between the buy and sell sides. It captures, sorts and prioritizes tens of thousands of stock recommendations by geography, industry sector, market capitalization and contributor accuracy, among other metrics. The result is a multidimensional database of investment opportunities: In 2006, for example, the Marshall Wace TOPS (Europe) fund polled 1,796 individuals from 343 teams at 77 brokerage houses and collected 86,000 ideas in real time. That information was then processed and subjected to a multifactor optimization model that uses complex algorithms to filter, evaluate and weight investment ideas. No single investment idea is allowed to dominate the TOPS funds, and single-stock positions are restricted to 3 percent of net asset value in any given portfolio (external risk factors, such as sector or country exposures, are also tightly constrained so as not to exceed 15 percent of the total risk). Although Marshall Wace trades heavily — usually in $1 million blocks, making about 800 to 1,000 trades a day, according to Clake — its traders are not chasing short-term momentum. In 2006 the average holding period for a single stock in the Opportunistic TOPS pool was 89 days; it was 173 days in the Fundamental TOPS pool. Through the ﬁrst seven months of 2007, the holding period in Opportunistic TOPS had grown to 117 days; for Fundamental TOPS it was 206 days. At its core TOPS is a massive investment-optimization engine. From a broker’s perspective, however, it simply looks like a personalized Web page: Each broker is granted a certain amount of notional capital for virtual investment purposes and then asked to allocate it to his or her most compelling investment ideas — long or short — and provide a 200word rationale for each. Some small, single-sector portfolios may have as few as six positions; larger, generalist pan-European portfolios may have as many as 25. Total notional capital can range from E10 million to E250 million. Although none of these individual totals have any connection to Marshall Wace’s capital base or real asset allocations, they do allow participants to track how well their portfolios are performing relative to a given benchmark, such as the MSCI pan-European index. “TOPS is a bit like fantasy football for salespeople,” says John Millar, head of the hedge fund advisory busi60 • INSTITUTIONAL INVESTOR’S ALPHA • SEPTEMBER 2007 ness in London for Merrill Lynch, whose private clients have invested more than $100 million in MW TOPS. “The most clever thing about the system is that Marshall Wace made it exciting — they set up various inducements to participate and turned it into a competition. Having a chance to compete — and get compensated for winning — is what every alpha-oriented individual on Wall Street and in the City of London wants to do.” Every month, Marshall Wace sends its contributors a report that reﬂects how much money their virtual investments would have made and ranks them according to their absolute and relative performance. Based on that cumulative data, Marshall Wace then allocates commissions to its contributors’ ﬁrms on a time-lagged basis. Contributors to the TOPS system get compensated for the quality of their ideas regardless of whether Marshall Wace has actually traded on them, effectively reducing the pressure on brokers to do anything but generate winning suggestions. For those ideas Marshall Wace does adopt, the ﬁrm parcels out trade orders based on its assessment of the banks’ trade-execution quality and services, regardless of where the idea came from, further reinforcing the culture of performance-based compensation. “I think TOPS taps into the psyches of many frustrated salespeople who would secretly like to be hedge fund managers themselves,” says Daniel Squires, a director of equity markets at Merrill Lynch who has contributed to TOPS for the past three years and is responsible for the bank’s European hedge fund coverage. “We’d all like to think that we could do a great job if someone would just give us several million to run. For many brokers this is as close as they’ll get to managing a real portfolio.” Currently, TOPS receives recommendations from roughly 5,000 brokers, half of whom are based in Europe. Anyone on a sales team can contribute, but Marshall Wace looks for those who provide the best information: The ﬁrm adds about 200 contributors a year. The average broker has been in the system for more than two years and some as long as five, says Clake. The Marshall Wace team performs its own assessment and optimization of the investment ideas — looking at more than 30 performance metrics, including duration, turnover and alpha generation — before allocating any of the ﬁrm’s capital. The detail that TOPS captures about its participants is mind-boggling. Clake can tap into the system and find out, for example, which brokers shine in a bear market or at what hour of the day they make the most accurate calls. Marshall Wace looks at the combinations of stock pick and broker to identify the best stocks to buy long or short. “The contributors are their raw material,” says Squires. “And these guys put a lot of time and effort into managing us. They are constantly refreshing the pool.” Marshall Wace’s focus on self-improvement is driven in part by its London rivals. In September 2006, GLG Partners began marketing its own dedicated alpha-capture strategy — called the Esprit fund — which the ﬁrm seeded with $400 million of its own capital and listed on the

Table of Contents Feed for the Digital Edition of Alpha - September 2007

Contents Letter from the Editor Longs & Shorts Pension Corner: Keeping the Faith The Good Guys: Going Public Interview: Barry Bausano - A Delicate Balance Cover Story: Cruel, Cruel Summer Profile: Phil Cooper - Alternative Flight Plan Strategies: Marshall Wace - TOPS in Its Field Profile: Fortis Investments - Banking on Alternatives Research Center: Top Equity Trading Firms Alpha Bytes: Desktop Duel Unhedged: Commentary - The Taxman Cometh

Alpha - September 2007

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