The Art and the Science of SSgA

No matter the number of technology conferences you’ve attended, this is a refrain you’ve surely heard before: Business and technology are closely aligned!

Technologists want to believe this, or at least portray this air of teamwork to others. Sometimes they’re being honest, sometimes they’re delusional, and sometimes it’s a bald-faced lie.

To get the opposite side of this equation, I sat down with the business leaders of State Street Global Advisors (SSgA), the asset management arm of the $2 trillion Boston-based financial behemoth. SSgA is the second largest index manager in the world in assets under management, slotting in between the industry leader BlackRock and Vanguard Group in third place. The index game is one of scale and extreme data sets: Scale of that size and data sets of that heft can’t be managed without significant investment in technology—an investment that State Street has been forced to make.

Scott Powers joined SSgA as its president and CEO in May 2008. He also serves on State Street’s management committee, the firm’s most senior team of strategy and policy makers, as well as its major risk committee. While he may not be comfortable connecting servers or writing code, he’s a student of whiteboard tutorials and recognizes the value and necessity of technology.

Richard Lacaille serves as SSgA’s chief investment officer—the other kind of CIO that usually gets more mainstream media play than the chief information officers often covered in Waters. He told me our interview was very different from any of his other media interviews because of the technology component, but investment managers have to understand the trading platforms running an electronic organization, and Lacaille does.

“Electronification has definitely had a huge influence, and familiarity with technology is helpful to move from one part of the organization to the other. Our goal is to retain good people and to stretch them. We’re not running a processing operation where we’re just trying to minimize cost. We’re trying to maximize the quality of the output.” Richard Lacaille, SSgA

Christopher Rice is SSgA’s global head of trading. He joined the firm in 1996 when SSgA had only a very small equities trading desk. While far from a technologist, he’s tethered himself to the technology team and now knows enough to be dangerous.

Spread over three individual meetings, Powers, Lacaille and Rice laid out SSgA’s vision and how exactly they use technology to deliver on that blueprint.

The Mothership
“I think of our business as being art and science,” says Powers, who is sitting in his corner office located in Boston’s Financial District. “The art of buy-side asset management tends to be on the more active side. The science is SSgA’s huge index fund business we have that basically replicates the return of a benchmark.”

He says that scale is needed to compensate for the low fees of the beta-driven business of indexes. Index management means single-digit basis-point fees, while alpha strategies generate fees of 115 basis points on average.

“Scale is really important on the quantitative side because if you’re not doing this business at scale and you don’t have really, really effective infrastructure and technology, you can’t make money at it,” he says.

Where technology plays a crucial role in the business is its ability to support efficiencies. It becomes a mathematical equation of how many accounts your portfolio managers can juggle without being overwhelmed.

Indexes are fairly commoditized. Vanguard, BlackRock, and State Street are all tracking the S&P 500 and other popular benchmarks. Every client gets the same number of stocks, the same weightings and the same positions. So it’s about making portfolio managers efficient.

“Technology plays a huge role at SSgA and we have built a lot of infrastructure for our portfolio managers and traders so they can manage more portfolios, on the same platform, with the same number of people as five or 10 years ago,” Powers says. “When you look at the productivity of our teams, in terms of the amount of assets that we manage today compared to five years ago, the assets are up significantly, the number of portfolios are up and our teams have been remarkably stable. That’s operating leverage that we get from the platforms we use—its technology-driven.”

SSgA also has an advantage in that it can tap into State Street—the “mothership”—to leverage certain back-office platforms.

“I came here six years ago and my question for the firm was, how are we leveraging the parent company’s investment in technology? The answer was, ‘Probably not as well as we could,’” Powers says. “My view is that we’re in the business of managing client’ assets and I need the intellectual capital and talent to do that. I want to spend my discretionary budget and expense on the people and the talent and the skills necessary to satisfy our clients. I don’t want to be in the technology business or the software business.”

Smart Beta
Index—or passive—strategies tend not to get the same attention as active strategies do, but after the financial crisis of 2008, many investors fled to the relative safe haven of passivity in order to shed risk. Active managers were having a hard time outperforming passive strategies, although they didn’t stop charging fees.

It was a case of investors moving from the art to the science. According to State Street’s Q4 2013 Analyst Package, total assets under management (AUM) at the end of 2013 stood at $2.345 trillion, up 12 percent from the previous year. The firm saw double-digit growth from 2012 to 2013 in EMEA and a five-year compound annual growth rate in Asia of 13 percent, showing that its London and Hong Kong desks were providing significant value. In North America, AUM growth was up 13 percent in 2013 over 2012.

When it comes to SSgA’s sweetspot of passive equities, the firm experienced growth of 27 percent from 2012 to 2013. And it should be noted that on the alpha side, the firm saw five-year compound growth of 20 percent with its active multi-asset strategies. So the firm is showing impressive growth on both sides of the active–passive divide. Meanwhile, in 2010, State Street’s annual net income was $1.556 billion; in 2013, it was $2.135 billion, a noteworthy increase of 36.5 percent.

Still, in recent years the market has begun to once again find its appetite for risk. While firms will always look to hedge using passive strategies, Lacaille says it’s important for SSgA to evolve its index business and to work with clients to develop new strategies. In recent years, this has led SSgA to take the lead on advanced beta products, something of a middle ground between active and passive instruments.

“Years ago, the adage was that indexing was beta and everything else was alpha, and only specific, skillful people could deliver alpha,” Lacaille says. “We have great alpha teams, make no mistake about it. However, the change is that now there’s an evolving area in the middle where the world is not as black and white—indexing or alpha—because there are systematic approaches that you can use to provide better outcomes—maybe low volatility, higher returns. You wouldn’t describe these systematic approaches as alpha because they’re not dependent on skill; they don’t depend on someone rolling into the office every day and having smart ideas and doing research—they’re a little bit more systematic than that,” he says.

“This is an important change because it challenges, on a value-for-money basis, what’s happening at both ends of the spectrum,” Lacaille continues. “I think SSgA’s role is to provide good products but also to challenge some of the thinking that exists out there and see if we can’t do things a little bit differently.”

Passive or Active, It’s Electronic
As SSgA looks to adjust its passive capabilities, it has also significantly matured its trading operations. Rice, the global head of trading, notes that the firm has invested in scalable technologies in order to create a more flexible trading architecture. Rice started at a time when SSgA didn't have a centralized global trading desk across asset classes, so he’s seen the blank slate grow both technologically and geographically over the last 18 years.

As the firm expanded globally, SSgA has also extended its multi-asset-class reach. In 2009, SSgA added currency to its portfolio, and in 2010 it added fixed income. Rather than having disparate systems for equities, foreign exchange (FX) and fixed income, management looked to compress its technology functions under one platform in a way that would also connect upstream to the portfolio management systems.

“The vision was, if you’re accessing liquidity in a specific way—there’s a framework where you can trade electronically or you can pick up the phone—by and large if we can access the liquidity electronically, it’s more efficient,” Rice says. “Also, there are benefits for anonymity in an equity market. For example, we almost doubled our index book between 2006 and 2014 for US equities while retaining roughly the same number of traders. So we’re using technology where we can to add scale.”

Rice says the firm’s view toward investing is to say liquidity is liquidity. A high-yield bond is different than an equity exchange-traded fund (ETF), but from SSgA’s perspective, it’s all driven around client demand, so understand the microstructure of the instrument and then go into the market and access it.

“It’s all a market-structure solve,” he says. “You have this Rubik’s Cube. You might twist it a little bit differently for equities or fixed income, but you still have to get the same colors on all the sides to meet the client objective, which is getting the trade done. You have to solve for ‘How do I extract that unit of liquidity at the lowest frictional cost?’’ For all of our strategies, why wouldn’t you think about one method of accessing liquidity? Again, the market structure is going to make each approach different, but as you think about how to connect all the points it becomes a lot easier when you organize the trading organization this way.”

But, he says, a key component to that is the ability to access the market electronically, wherever possible. “That applies equally to fixed income, as it does to currency, as it does to equities,” he says. “That’s where the strategy has evolved.”

Fungible v. Specialized
Moving forward, SSgA will continue to trade electronically and increase its own capabilities as well as help other regions—such as Asia and Europe—to push forward and grow their own electronic trading environments. While index management will be at SSgA’s core for the foreseeable future, Rice says clients will continue to lead how traders and portfolio managers adjust their strategies. They built a team and an investment platform that are at times fungible and at times highly specialized.

“It’s like the equalizer on your stereo. You like bass; I like treble—you just tune it a little bit differently. For an active fund, turning up the treble means getting your active fill-rates up more and thinking more about implementation shortfall versus the price where the stock entered. Over here, with the bass, let the liquidity hit your catcher’s mitt. But you’re using the exact same algorithm, the exact same electronic approach to gather that liquidity, and it’s the exact same approach if you want to trade in a dark pool. It’s the exact same formula; you just mix up the ingredients differently,” he says.

Lacaille says market conditions and demand will always dictate just how flexible or specialized the SSgA team needs to be.

“There are many things we do that are incredibly specialized and you need to develop a deep level of talent, such as fundamental analysts that specialize in certain sectors. There are other areas, like futures trading, which has become more homogenous across the asset classes than it was 10 years ago, so a good futures trader can have a talent development program to extend into a different asset class,” Lacaille says. “That won’t be available everywhere, but the technology definitely helps in that regard to homogenize areas of asset management that previously would’ve been very specialized. Electronification has definitely had a huge influence, and familiarity with technology is helpful to move from one part of the organization to the other. Our goal is to retain good people and to stretch them. We’re not running a processing operation where we’re just trying to minimize cost. We’re trying to maximize the quality of the output.”

Top IT Projects at SSgA

• Completed project: Global order management system (OMS) consolidation: SSgA consolidated its fixed-income trading and compliance systems onto one global vendor platform, already in use for equities and currency. SSgA is now running on a single, global, OMS for trading and compliance operations—excluding the money market business—resulting in operational improvements ranging from consistent workflows to continuity.
   
• Current projects: SSgA is rolling out a centralized analytical data platform to its quantitative equity teams.  By leveraging big data technology, this system integrates a broad range of financial data across global markets onto a single database accessible to all its researchers and portfolio managers.
  
  SSgA is also implementing client relationship management and information management platforms to enable client servicing and engagement of the highest quality.
   
• The future—2015: As institutional investors continue to increase their allocations to alternative products, SSgA is focused on further expanding its alternatives capabilities and improving its trading operating model to support increasingly complex demands.