Analysis - T Rowe Price, others peer into Virtu's high-frequency world

By Herbert Lash

NEW YORK (Reuters) - Asset management firm T. Rowe Price Group conducted a trade last year as an experiment that a top trader at the firm said underscored the shortcomings of a U.S. stock market dominated by high-frequency trading.

Andrew Brooks, the firm's head of U.S. equity trading, said T. Rowe (TROW.O) used a reputable broker-dealer algorithm to buy shares of a heavily traded stock. He was surprised that in order to purchase 2.5 million shares, the firm had to indicate an interest in buying 750 million shares, or 300 times that amount.

"It's dysfunctional," Brooks told the audience at a Baruch College conference on financial markets in New York in October 2013.

But this year, the fund manager is taking a fresh approach to understand high-frequency trading. A group of T. Rowe's traders paid a visit in September to Virtu Financial, a firm known for its technological prowess.

The visit was described by two sources, one from T. Rowe and one from Virtu. Other firms have also made the pilgrimage to the company as investors try to get a handle on what makes the market-making firm tick, a source at Virtu said.

These trips, along with other industry developments, suggest some money managers know they are ignorant about much of what happens to orders once they are sent to be executed.

Last spring, Virtu was vilified after divulging in March that it had posted only one losing day in five years of trading. Critics pointed to that revelation as a sign high-frequency traders were getting away with murder.

Then came the best-selling book "Flash Boys," in which author Michael Lewis said the market is rigged in favour of high-frequency traders. Virtu was forced to delay plans to go public.

Asset holders have been pressuring their money managers to learn more about how their orders are routed. They want to understand whether cost, liquidity or trading strategy were the best available, and whether the routing process budged a security's price. Finding that information has not been easy.

Investors know the price, size and where a trade was executed. But it is hard to find information about where an order was routed before it was filled, or why some shares were executed on one venue and not another.

"When you get at the most granular level, the routing strategy and how they approach the market, it's just impossible to find information," said Larry Tabb, founder and chief executive of TABB Group, a capital markets advisory firm.

Clive Williams, global head of trading at T. Rowe, and six other traders travelled to New York in September to watch Virtu trade 50,000 shares of an unnamed stock, the sources told Reuters.

Williams wanted to learn about how Virtu routes trades across asset classes and markets, a key concern for T. Rowe, a global firm with $731.2 billion in assets under management as of Sept. 30.

Brooks, who has been critical of the market's structure, has urged an exhaustive audit of order routing. The source at T. Rowe said few investors have tried to get to the bottom of why Virtu or other high-frequency firms are so profitable.

"Why aren't you asking the question, 'What are they doing that we are not?'" said the T. Rowe source, adding that Virtu traded the 50,000 shares "very efficiently."

The T. Rowe source acknowledged Virtu has great technology. Still, it remained hard to compare the small trade that T. Rowe traders witnessed with the larger, experimental one that was conducted using another firm's algorithm. Details of that earlier trade are lacking: for example, how the algorithm was programmed to buy 2.5 million shares, and the market's condition at the time.

At the heart of Virtu's operations is an order management system that measures many key risks: Whether a trade is the right amount at the right price, if too many shares have been sent to a venue where they may not all get executed, and how price will be affected.

The system and the technology behind it are key for Virtu, which trades in more than 210 markets around the world, in stocks, foreign exchange and commodities. Order management systems are not novel, and knowing which is best is subjective.

Brian Lees, the trading applications manager at Capital Group Cos., the parent company of American Funds, is leading an initiative of about 20 asset management firms to better understand what happens to orders by gleaning routing and other information on order tickets. The effort is organised through the FIX Trading Community, which sets global trading standards.

After more than four years of effort, information is still lacking because of different vendor systems and broker reluctance to provide the data.

"There's an expectation that we understand what's being done on our behalf when we go into the market. It's not our algorithms that we wrote but it's our order that's out there, and we're expected to understand how it's behaving. If we don't have this information how are we going to know that?" Lees said.

(Reporting by Herbert Lash; Editing by David Gregorio)