The Scenario: It is the afternoon of Tuesday March 6, 2012. The portfolio manager of a London based conventional asset manager has for some time been looking to increase the weighting of his portfolio towards the financial sector and in this regard has been tracking KBC for several months.
News for the bank has been mixed since late 2011. In October 2011, KBC disposed of its Fidea insurance subsidiary to JC Flowers for EUR243 million, having shortly before sold its KBL private banking arm for EUR1.05 billion to Precision Capital. While these disposals gave intermittent support to the stock price during October, November brought the unwelcome news of a Q3 underlying net loss of EUR248 million-contrary to general market expectations of a modest profit. Losses on Greek bonds, and loan impairments in Bulgaria, Ireland and Hungary were the main culprits. KBC announced that write-downs on Irish real estate loans were expected to run at around EUR200 million per quarter, for the next two quarters. Further market uncertainty arose from the revelation that the bank intended to repay EUR500 million of the EUR7 billion of state support it received during the credit crisis of 2008-2009-less than many commentators expected. After rallying slightly mid-month, the stock made new lows for the year at the end of November at just below EUR8 per share.
This ambiguous picture persisted in early 2012. January first saw good news with the announcement of the sale of the bank's Warta Polish insurance unit for EUR770 million, which saw the shares rally more than 10% on the day. Unfortunately, ten days later Fitch downgraded KBC to A- from A. However, since then the news has been rather more benign. For example, February brought the announcement of the sale to Santander of KBC's Polish unit Kredyt Bank.
The portfolio manager feels that KBC's recent underperformance of its peers is unjustified and also notes that recent BIBANKEC (BI EU Banks - Competitive) data suggests that the bank is trading on average 12% below the average analyst price target.
He accordingly decides to take a long position and instructs his specialist financials trader to buy 400,000 shares during the following day's session-March 7th, using an absolute top of 17.50. The order represents just over 30% of the average daily volume (ADV). The trader has discretion as to how the shares are acquired, but must complete the trade during the following day's session limit.
The Asset: KBC
The Challenge: To buy 400,000 shares in KBC (31% of ADV) during the current trading session, with a 17.50 top.
The Trader: The trader handles all trade executions in financial stocks for the fund, and uses a number of proprietary momentum indicators that he has developed to pick short term buying and selling opportunities.
The Algo: The execution algorithm is designed to trade opportunistically as and when liquidity becomes available. It incorporates rules-based components that will post orders in order to passively peg the bid or offer so as to maximise fill rates on both sides. It will not trade through the far touch. User-configurable requirements are limit price, start and end time, plus the trader has options to put a maximum volume limit on the order.
7am - (all times are GMT) - Pre-open European market sentiment is positive. The Dow and S&P have shown some gains and Asia has been strong overnight. Mortgage application data coming out of the US is positive and stocks are showing some strength after a long period of indifference.
7.30am - The trader puts the order into a VWAP strategy algorithm which has an additional, dynamic element built in to the code to capture and take advantage of unusual intraday moves. If the market starts bidding up, the trader has discretion to switch into a more aggressive strategy as he is aware how volatile this stock can be. Pre-market indications suggest European indices will open between 0.5% and 1% up.
8:03am - The European exchanges have opened on average 0.85% up with all main indices- FTSE, CAC, AEX and DAX-showing strength with the financials leading. The market is switching out of industrials and KBC has bounced off its recent support levels of 16.40 and is currently trading at 16.70.
8:24am - The VWAP order uses data from the 30 day ADV and has traded 35,000 on the open.
Figure 1: KBC 5 minute chart March 7th 2012
The sector is rallying and the trader is keeping a close eye on other stocks for a potential breakout. He is quite happy for the algo to participate at these prices whilst the market is still finding its levels.
10:00am - The stock had an initial sell off after the open which was against the sector trend but allowed the algo to pick up stock around the lower levels of 16.65. The stock is now trading back up at 17.05 and is still looking strong. The BEL20 is up 1.8% and European indices are following suit. 74,000 shares acquired so far.
10:56am - The BEL20 is 2.6% up with banks and financials leading the charge. French and UK banks remain strong and all indications point to a small rally.
11:12am - 146,000 acquired so far at an average price of 16.8142. The trader doesn't want to continue to run the VWAP strategy on this trade as he feels more alpha can be gained by finishing the order early (albeit more aggressively). He therefore switches the balance of the order into an opportunistic algorithm. This will post random passive dynamic slices pegging the bid whilst shooting IOC orders at the far touch, additionally sweeping dark venues for liquidity. This strategy will not walk the book and gives the trader peace of mind that although aggressive, the algo will intelligently participate when there is liquidity, whilst being involved in volume going through on the bid side.
12.50pm - The stock is trading in good size and 256,000 shares have so far been bought. The algorithm's passive bid element has taken advantage of dips in the price and the order is picking up volume on both sides including dark venues. The trader has set the aggression level to 'normal' which will only take up to 50% of the far touch volume.
2:24pm - The trade completes at an average price of 17.02. The US opens strongly with both the S&P and Dow rallying. Financials continues their run and KBC finishes the day at 17.58, with the VWAP benchmark at 17.12.