US fund house Matthews Asia has a strong focus on mid- and small-cap stocks in Asia, so dark pools are a useful extra liquidity channel.

However, like other asset managers, the firm is concerned about the potential impact of high-frequency trading (HFT) in such venues. Head trader Shane Neal’s team is working on a transaction cost analysis that can assess the "toxicity" of dark pools.

He views it as important to limit interaction with high-frequency traders if the orders they intend to trade represent a high percentage of that stock’s average daily volume. Otherwise, crossing in these dark pools will have market impact.

Neal prioritises block specialists over dark pools when executing a large position. “We need to trade with natural liquidity [flows from non-sell-side traders] and minimise market impact when trading small and mid-cap stocks. We think sales trading achieves better outcomes in this respect.”

Around half of Matthews Asia’s volume is done through high-tough sales trading; and one-third via direct market access and broker algorithms, which access both broker crossing engines and agency dark pools. Program trading makes up the rest.

The $25 billion firm offers only Asia strategies and trades 17 markets in the region. Over the 10 years Neal has worked at the manager, he has seen improvements in how exchanges in the region have compressed tick sizes to improve spreads for market participants.

Overall, however, he notes that trading Asian shares on local exchanges remains costly. “While trading costs have come down in Asia, it is still more expensive than the US.

“The insufficient depth of liquidity and trading volume has lent itself to higher volatility in many of these Asian markets,” adds Neal. “This is one key reason for the cost of trading in Asia always being higher than the US.”

* See the May issue of AsianInvestor for more from this interview.