The buy side has been increasingly using passive scheduling-based algorithms due to lower volatility and volumes in equities markets, but still want to be able to trade blocks at the right levels. Introduced in late 2020, Liquidnet’s Smart Blocks hits that spot as it combines algo strategies with intelligent block seeking. 

Gareth Exton, Head of Liquidnet’s Equities Execution and Quantitative Services EMEA, said: “The firm is well known for block trading but has also been building an algo business for over 10 years. In response to feedback from the buy side, Liquidnet rolled out Smart Blocks which can monitor stocks throughout the day and automatically initiate block trades within defined parameters set by traders.” 

According to Exton, Smart Blocks intelligently looks at what is happening to a specific stock relative to a certain benchmark to find opportune moments to go into the block market, effectively fusing those two trading styles together. 

Due to continued margin pressures, the buy side is having to do more with less and Smart Blocks has proven to be an invaluable tool to traders when they do not have the resources to have eyes on every order or when they have to be away from their desks. Traders can adjust a large variety of parameters to fit individual trading styles. For example, Liquidnet has a proprietary relative basket that indicates whether a stock is overbought or oversold which Smart Blocks can use as a signal for a block trade.

Exton said: “This really resonates with traders because the algo behaves as they would and effectively allows them to take their hands off the wheel a little bit.”

Conor Diviney, Equities Execution consultant at Liquidnet, indicated that Liquidnet analysis has shown the use of Smart Blocks can improve performance against the VWAP benchmark by automatically seeking blocks when prices are most favorable, reducing slippage by 61%.

He explained that the sweet spot for Smart Blocks is an order that is more than 5% to 10% above average daily volume. Traders may struggle to complete the order in one day just using passive algo strategies, but the ability to use Smart Blocks to find liquidity could prevent the order from having to extend into a second day.

Liquidnet had a trial phase of approximately six months to calibrate Smart Blocks to ensure the algo went into the block market at the right time. 

“We have been slowly rolling Smart Blocks out and calibrating it with members,” added Exton. “We now have a good default setting that works for the majority of members, although they can still very much work with our team of execution consultants for added customisation.”

He described the take up of Smart Blocks by members as significant, but said others were waiting to see proof of performance and robust analysis. Therefore, the firm analysed all Liquidnet VWAP, POV, and Dynamic POV orders in EMEA between 1 January 2022 through 13 April 2023.  

The research found that orders with smart block executions, or where Smart Blocks was enabled, both statistically significantly outperformed orders where Smart Blocks was not used. The sample of orders with executed Smart Blocks saw lower spreads and order durations according to the study.

Diviney explained: “The block overlay is effective at removing the long tails of very high and very low-cost trades that would normally occur when using a scheduled algo.”

He indicated that this could be because limiting the order duration reduces price risk and also because Smart Blocks is most likely to execute during periods of volatility that would lead to high- or low-cost trades. Smart Blocks is most likely not to execute during benign markets as prices might not move enough to trigger the threshold.

The report said the data suggests using Smart Blocks can be thought of as an insurance policy that protects against highly underperforming, very costly trades. While this insurance is at the cost of limiting some large outperformers, on average the data suggests the benefits outweigh the costs, added the study.

Exton said: “The numbers speak for themselves and show that Smart Blocks reduces trading costs and standard deviation, which is important as one of the big things that traders want from their algos is consistency of performance. They want to know that any slippage versus their benchmark is going to be within a specific range.”