Bull Or Bear, Market Is A Cash Cow For These Traders

Posted: August 13, 2000

Think you can beat the stock market?

Sure, you might join an online trading network. Buy realtime data. Study mutual-fund managers. Collect research from rigorously skeptical Wall Street analysts, if you can find any.

You'll still be betting against armies of well-financed traders, computer experts and mathematicians at program-trading firms such as King of Prussia's CooperNeff - who watch people such as you in hopes of profiting from every misstep.

From banks of glowing terminals linked by half a million feet of cable, casually dressed CooperNeff traders buy and sell more stock than their counterparts at Lehman Bros., Goldman Sachs or Salomon Smith Barney, according to New York Stock Exchange figures.

They don't care what the companies make or who runs them. It doesn't matter if the Dow goes up or down. They lack the Wall Street broker's bull-market attitude.

"To me, the stock market is not an acceptable risk," said Andrew Sterge, chief executive officer and chairman. "It's way too risky for the return you get," compared, say, to bonds.

Instead, CooperNeff, and rival firms such as Bala Cynwyd's Susquehanna Investments, make their money from thousands of calculated buys and short-sales designed to exploit the small price movements that result from trades by mutual funds, professional money managers, and individual investors.

Sterge expects to make more than he loses whether stocks rise or fall - as long as other investors keep trading, inadvertently creating momentary bargains he can take advantage of, however small.

It takes a lot of volume to turn those little price gaps into big profits. CooperNeff, owned and financed since 1995 by France's giant BNP Paribas bank, ranks among the five most-active traders on the New York Stock Exchange, alongside global giants such as Deutsche Bank, Morgan Stanley and Nomura Securities. Last week, it closed more than 14 million trades a day - about one of every 70 recorded at the world's largest stock exchange.

While controversial for the way it can accelerate sharply rising or falling markets, and limited by stock-exchange rules, program trading is one of the few stock-market strategies that win even grudging respect from professional investors.

"If there's such a thing as a better mousetrap, they would be among the select few," said Ted Aronson, head of Philadelphia's Aronson & Partners. Aronson is a prominent critic of his fellow money managers' trading practices, which he views as overly active, inefficient and thus vulnerable to exploitation by the likes of CooperNeff.

"The average investor is wondering, 'Should I buy this stock?' The trading wizards at CooperNeff look at it from a variety of angles - 'Should I go long? Should I go short? What's a good options strategy?' " said Blake Banky, a former CooperNeff partner who with other veterans of the firm has set up Gamma Investments, which invests in high-tech securities-trading systems.

Mutual-fund and retirement plan investors "aren't thinking about risk in the market. And I'm not going to change their perceptions," Sterge said.

But what is changing - thanks to the Internet, industry consolidation, the rise of electronic trading networks, and stricter disclosure regulations - are the rules of this high-stakes game.

And program traders are wondering how to keep their edge.

Since the mid-1980s, program traders such as CooperNeff have enjoyed "data, computer firepower and investment [knowledge] that no one else had," Sterge said.

"But market data is more democratic than it used to be. You can feel the presence of day traders in the market as they trade," he added. "They're not just these guys out of a job. There are also some pretty savvy people who've figured out very sophisticated ways to trade and make the market more efficient."

CooperNeff was founded in 1981 by Silo Inc.'s heir Richard Cooper and Roy Neff, a Wharton- and MIT-trained pension actuary. From the start, the firm traded mostly its own money, eliminating the need for a fancy marketing effort to sell products to outside customers.

But technology and market pressures have pushed CooperNeff and rivals such as Susquehanna to start soliciting outside clients. They're trying to win new business and boost earnings at a time when securities-industry profit margins are shrinking - a problem that's been covered up by the increase in bull-market sales volume.

Two years ago, CooperNeff rolled out the Isosceles Fund, a hedge fund limited by law to investors with more than $5 million in financial assets.

Isosceles balances 350 long and 350 short investments drawn from the 1,500 most-heavily-traded U.S. stocks. With $70 million in assets, Isosceles reported audited returns of 36 percent last year and unaudited returns of 22 percent in the first six months of 2000, even after deducting CooperNeff's fee - one-fifth of the profits plus 1 percent of assets.

That's roughly 20 percentage points better than the S&P 500 did in each period. More important, to Sterge, is that Isosceles showed lower volatility, with its value fluctuating less than half as much as that of the S&P during that 18-month period, adjusted for return. "I'm a big reward-to-risk kind of person," Sterge said.

The firm is planning more investment funds and also offers big investors a new portfolio-management service, headed by Mony Reuven from BNP Paribas' New York office, a former D.E. Shaw & Co. executive.

Both CooperNeff and Susquehanna, which now employs more than 700 at offices around the world, started as tiny options-trading firms at the Philadelphia Stock Exchange in the early 1980s.

Both firms - especially Susquehanna - were repeatedly cited by regional stock exchanges over the next decade for exceeding position limits that were supposed to prevent individual firms from dominating trading.

The program traders, unlike traditional money managers, have little interest in a company's production problems, the quality of its management, or the market for its products.

But they are quite conscious of the psychological effect of financial and real-world factors on other investors' decisions. "Many of the things we look at are behavioral," Sterge said.

In a corner of Susquehanna's main trading room, tiled with replicas of crumpled PhilEx options-trading forms, Susquehanna maintains a staff of traditional stock analysts who pore over ponderous Wall Street brokerage reports.

"Susquehanna doesn't believe in fundamental research but [studies] it anyway to see how markets will react," according to Eric Noll, Susquehanna's head of strategy.

Lately, Susquehanna has been on a hiring binge. Recruits - including competitive chess champions, athletes and bridge players as well as Penn, Stanford and MIT graduates - are taught high-stakes poker, and sent to try their skills at the PhilEx and other options markets before working in one of the company's main trading rooms.

At CooperNeff, Sterge, a veteran of the professional tennis circuit, also likes to hire athletes.

He's the last of eight CooperNeff partners who has remained since the BNP Paribas takeover. Several of the others have formed Gamma Investors, a group of 53 investors who have taken positions in "e-finance" companies such as the Archipelago stock-trading network and a pair of derivatives-trading technology firms, according to Banky.

Sterge received a Cornell University doctorate for his thesis on factional voting in Congress.

He was working for the former Philadelphia National Bank in 1989 when he was recruited for CooperNeff by cofounder Roy Neff, who "saw me [on the Paoli local] reading books about stochastic processes and asked me what I did for a living."

For Sterge, the biggest challenge is staying a step ahead of the competition, or the mass of investors.

"Our models only have so much predictive power," he said. "As investors get tired of losing money, they figure out what's going on and change their behavior."

He added, "It's nice to be the biggest trader. But what really counts is the money you make."

Joseph N. DiStefano's e-mail address is jdistefano@phillynews.com

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