Instinet Secures Its Place On Desks Of Money Managers As Volume Hits Critical Mass

Instinet, the electronic brokerage system operated by Reuters Holdings PLC, posted a 70 percent increase in trading volume during the first half of 1992, compared with a year earlier.

Including daily volume of two million shares on its Crossing Network, Instinet has recently been trading more than 15 million shares a day and more than 20 million shares on peak days, says Peggy Rappaport, senior vice president of Instinet.

Instinet's strong volume growth this year, and its ability to attract such a large portion of the equities market, represents a coming of age for the system, which was acquired by Reuters in 1987.

Rappaport attributes the dramatic growth in volume to several factors. One is the growing number of subscribers worldwide, now more than 1,700, including 300 on the buy side. Another is the expanding coverage of equities on the system, which gives subscribers the ability to trade more than 14,000 issues.

The introduction of an order management system six months ago (IMT, May 15) and the recent acquisition of Bomar Securities L.P. (IMT, Aug. 7)--now known as Instinet Analytics--have both served to increase the functionality available to Instinet users, says Rappaport. But Instinet's main drawing card, she says, is the anonymity that it provides subscribers. This reduces market impact and ultimately leads to lower transaction costs.

To learn more about how institutions are using Instinet in their trading strategies, IMT interviewed three money managers that use the system on a regular basis.

Fred Hughes, Capital Guardian Trust Co, Los Angeles. Hughes has been the head of trading at Capital Guardian, an arm of Capital Group Inc. that manages about $30 billion, for 12 years. However, he and his staff did not become Instinet users until eight months ago.

"The volume that was trading in OTC stocks on Instinet had reached a point where we felt like we could get things done effectively," he says. Capital Guardian occasionally uses Instinet to trade listed stocks, but most of its activity is in OTC issues, Hughes says.

Capital Guardian's investment philosophy has a three- to five-year time horizon. As a result, it does not have the same need for immediacy that many other investment management firms do. Capital Guardian does not take a quantitative approach to investing. "We buy companies, not stocks," says Hughes.

Hughes and other traders at Capital Guardian agree that Instinet is user-friendly. Coded keys, a mouse and a menu-driven format make the terminals easy to use, says Robin Zooker, who often monitors the action on Instinet for Capital Guardian.

Capital Guardian doesn't use Instinet's order management system. "We've only tapped half the capabilities of the machine," says Zooker. The firm's main emphasis is not on electronic trading, Hughes says. Still, he finds a place for Instinet, the Crossing Network, and the Arizona Stock Exchange (AZX) on his trading desk. Developed by Steve Wunsch, the AZX uses a single-price auction to trade stocks.

Harold Bradley, Investors Research Corp., Kansas City, Mo. Bradley is director of equity trading at Investors Research, the investment manager for Twentieth Century Investors Research Corp. His firm has $18 billion under management in equities and fixed-income securities. Bradley has been using Instinet for four years. With Instinet, the firm can reach "200 brokers without taking 200 phone calls," he says.

Investors Research uses a wide variety of alternative markets in its trading. In addition to Instinet, Bradley uses the Crossing Network and the AZX. He prefers the AZX to the Crossing Network because of its price discovery function and its advertised trades.

"On the Crossing Network, trades are not advertised," Bradley says. "They are reported to the consolidated tape and show up only in monthly statistics."

Most of the trading that Investors Research does on Instinet is in over-the-counter stocks. "I consider Instinet the specialist book for the OTC market," Bradley says.

Although the National Association of Securities Dealers has been trying to use technology to improve the efficiency of the OTC market, Bradley says more institutions have been moving to Instinet since Nasdaq introduced its SelectNet system two years ago. That's because dealers are doing transactions among themselves between the spreads that they are quoting on SelectNet, he says.

If a dealer is willing to buy an issue at 261/2 and to sell it at 263/4, interdealer trades may take place at 2610/16 on SelectNet, Bradley says. "Institutions have begun to investigate how to get trades done in a tighter market," he says.

Although he is an Instinet fan, there are some features Bradley doesn't like about the system. "Instinet has a problem," he says. "Because the orders entered by dealers are tagged with ampersands, dealers can tell whether it's an institution or a dealer that wants to trade."

Ken Levy, Jacobs Levy Equity Management, Roseland, N.J. Along with partner Bruce Jacobs, Levy founded Jacobs Levy in 1986. Both veterans of Prudential Insurance's asset management unit, Levy and Jacobs spent the next three years developing systems for stock trading. Their firm officially opened for business in December 1989. Today, Jacobs Levy has $1.5 billion under management.

Jacobs Levy has been using Instinet's electronic execution system almost since the day it began trading. "We really like the whole Instinet approach of anonymous, electronic trading," says Levy. "It enables us to trade large programs of stocks efficiently." Since it is not unusual for the firm to be active in several hundred issues during a single day, Levy finds Instinet's order management system to be particularly useful.

Although Jacobs Levy uses a variety of trading styles, it is best known for its "long-short" strategy. This calls for buying issues that are expected to outperform the market while selling those that are expected to underperform. "If we have a portfolio where we want to keep the same dollar amount in our short position as in our long position, Instinet's order management system allows us to account for where we stand in real time," Levy says.

Levy also likes the fact that Instinet permits him to peg the price of an order to the market. The price of an order in the Instinet system can be automatically adjusted as the market rises and falls, eliminating bad fills.

Most of the trades that Jacobs Levy executes on Instinet are in over-the-counter stocks. "Instinet is very good for OTC stocks," Levy says. "There is an awful lot of liquidity."

For listed issues, Jacobs Levy will sometimes use Instinet, but most orders are executed on exchanges. The firm is electronically linked to the order-routing systems of three New York Stock Exchange members, including Bear, Stearns & Co., allowing it to gain quick access to the NYSE's SuperDot system.

In addition to the regular Instinet block trading system, Jacobs Levy uses Instinet's Crossing Network. "We try almost everything that wasn't executed on the exchanges, Nasdaq and Instinet during the day on the Crossing Network at night," Levy says. The firm also uses the Posit crossing system operated by Jefferies ITG.

However, Levy is more selective about trading on Posit because orders in the specialist's book on the exchange must be withdrawn to be executed on Posit, which, unlike Instinet's Crossing Network, crosses trades during the day. If an order in a listed issue isn't filled on Posit and Jacobs Levy has to send it back to the exchange, it goes to the bottom of the list in the specialist's book.