Hedge funds have had a torrid few months, and sudden drops in share prices due to misuse of trading algorithms have not helped matters, argues John Tompkins*, head of trading at Senrigan Capital, a Hong Kong-based event-driven manager.

Hedge Fund Research’s global composite index fell 2.81% in September, meaning they closed the third quarter down 5.5%. Asia ex-Japan funds have fared particularly badly, down 9.33% in September and 16.13% for 2011. Event-driven funds globally fell 3.28% in September and are down 4.10% for the year to September 30.

“In this stressed environment, much more flow has been going via direct market access and algorithms and a lot less through the normal trading desks,” says Tompkins. “So the ability to engage that liquidity has gone down quite sharply.”

One example he cites of recent execution challenges is an Australian stock that dropped 4–5% intra-day on light volume and no news flow.

“We were in the process of buying this name in the market via our brokers, but there was no sell flow in that size and shape coming from any broker we deal with,” says Tompkins. “So we routed part of our trade through a dark pool to see if we could access that flow and improve our price on the day.

“Unsurprisingly, we got filled on everything in the dark pool and the stock traded back up to previous levels once the seller was out,” he adds.

“That’s a good example of how misuse of an algo or not understanding micro-structure can have a negative impact,” says Tompkin, “but these types of things do happen and you need to be in a position to take advantage. “

He believes it is a learning process to determine what can or should be sent to a desk versus sending trades to an algo. “With the recent developments in the algo space,” he adds, “you need to do a bit more prep work to make sure you are accomplishing what you intended, in terms of configuration and set-up before sending to market.”

He feels traders should be spending a good amount of time analysing the markets they deal in and the potential effect of their activity.

“We have seen stressed markets before, so it’s increasingly a case of understanding how that market stress impacts what you’re doing, be it increased volatility, less predictable volume patterns, tighter limits, etcetera,” he adds.

“So you spend more time in the pre- and post market analysing what you’re looking at and how to best accomplish it,” notes Tompkins. “Currently that means using more points of access to flow and adjusting to accomplish what we want in the market.”

Senrigan’s trading team comprises Tompkins and one other trader, but it may add another next year, if its AUM continues to grow. The Senrigan Master Fund launched in November 2009 with $150 million, soft-closed at $750 million at the end of 2010 and has since exceeded $1 billion.

*For more on this interview with John Tompkins, see ‘Trader talk’ in the upcoming (November) issue of AsianInvestor magazine.