Trading Value – Pursuit of Best Execution and Innovation

This edition of the Brandes Quarterly Commentary offers an inside look at our trading team, and how its commitment to efficient, positive change in the marketplace helps serve our clients’ long-term interests. An important part of the firm’s commitment to best execution is our investment in The IEX Group (IEX), which we describe in detail below i .

More investors are now aware of the industry challenges created by high frequency trading, mostly due to the intense interest in the new book by best-selling author Michael Lewis, Flash Boys: A Wall Street Revolt .

The book outlines how one company—IEX—almost single-handedly combats what it calls a “rigged game” that has siphoned billions of dollars from the investing world. We are proud to be an inaugural supporter of IEX, as it reflects our interests in promoting a fair and transparent trading environment that we believe will benefit our clients and the industry. This commentary highlights:

• The “Electronification” of Markets and What We’re Doing: Why it is now more complex to execute effective trading strategies and how Brandes has efficiently and pro-actively navigated the trading arena.

• Our Investment in IEX: Brandes took an early lead in supporting the formation of IEX, whose primary purpose is to address the challenges created by a fragmented and fast market. We consider trading a means to an end, and not an end in and of itself. While Brandes will always focus on value at the company level, best trading execution is a critical part of our investment process as well.

• Client Benefits: The Brandes commitment to best practices and innovations in technologies, processes and team development that help benefit our clients. A Fragmented and Fast Market Depicted in Exhibit 1 is our current, fragmented U.S. equity market, electronically connected via high-speed networks and computers. According to research, by the end of 2013 the U.S. stock market was comprised of 13 exchanges and 40+ additional venues for trading—referred to as Alternative Trading Systems (ATS), as well as “dark pools.” 1

• For both parties—buyers and sellers—orders enter the market through a broker-dealer, which then places them in one of several algorithms (computer programs). The algorithms then slice large orders into smaller ones (called child orders).

• Another layer of computer programs, named Smart Order Routers (SOR), contains rules that are used to determine where to send the child orders, typically a myriad of venues (exchanges and dark pools).

• The SOR sends child orders back and forth until they are filled. This process increases the opportunity for what is referred to as “information leakage,” where one’s intention to trade can be inferred, and it can ultimately have a negative impact on the price.

Brandes fragmentation

In this environment, a new class of short-term oriented traders (or participants) also evolved, practicing what is commonly referred to as High Frequency Trading (HFT) 2 . While the term HFT is broad, many HFT strategies now have replaced the traditional role of the specialist and market makers 3 as liquidity providers, but without the same obligations.

As HFT gained influence and access, it wasn’t long before buy-side traders witnessed its impact by patterns of “unexplained” changes on their screens. Usually, any of the buy-side’s attempts to lift 4 the offer on certain stocks would result in frustration, as the displayed liquidity vanished and implicit costs increased. Not wanting to rely solely on their brokers, some buy-side firms have had to spend a considerable amount of resources to understand this new game and its rules to help protect their clients’ orders.

Unraveling the Complexity

In order to effectively serve clients in this new environment, we believe that an investment manager’s trading desk must master market structure—the regulatory, competitive and technological “plumbing” of stock markets.

Since the first day the firm took its trading capabilities in-house in 1991, the Brandes Trading Group has kept vigil to identify and understand industry trends, while simultaneously retooling, educating and training our personnel for the constantly changing and ever-complicated investment landscape.

Brandes and The IEX Group: Advocates of Change Today the time it takes to buy and sell stocks is measured not in minutes but in microseconds, 5 thanks to evolution in technology, high-speed networks and increasingly sophisticated trading algorithms. While this trend isn’t necessarily bad for traditional investors in general, we believe it can be increasingly problematic over time. It wasn’t long before we discovered that many of our peers shared our view, and eventually we pooled our resources to do something about it.

Brandes is one of the initial investors in a company called The IEX Group, the first Alternative Trading System (ATS) funded exclusively by a group of mutual funds, hedge funds, family offices and individuals. An ATS is an electronic trading venue that matches buyers and sellers of securities. In our initial talks with IEX, its innovative and potentially industry-changing model became clear, so we stepped up along with other institutional investors to help IEX get started.

Our finding IEX, as the company was sketching out a business plan two years ago, was no coincidence or accident. It was the result of our trading desk proactively seeking out the best and the brightest that the industry can offer to ensure our clients’ experience is world class. We’ve known the core team behind IEX for years, dating back to when its members worked for the Royal Bank of Canada and had proved themselves a talented and reliable resource for the Brandes trading desk.

How does IEX help? IEX seeks to provide a more balanced marketplace via a simplified market structure design and its own proprietary, cutting-edge technology. With its fair-access platform available to any qualified broker-dealer, IEX aims to neutralize predatory high-speed strategies.

IEX Technology

IEX’s patent-pending Anti-Colocation Architecture (IEX POP) separates its matching engine (where IEX buys and sells are matched) and Access Layer (where brokers connect to the IEX platform) by 350 microseconds. IEX’s smart order router captures nearly 99% of displayed liquidity. These two features, which are unique to IEX, can benefit orders in two ways: a) Prevent Slow Market Arbitrage – The IEX POP creates a critical latency buffer, slowing down the HFT, and which allows IEX to accurately price trades in relation to the most up-to-date National Best Bid and Offer (NBBO).

6 b) Prevent Electronic Front-Running – When routing orders, the IEX POP ensures they arrive at all designated locations before predatory strategies have a chance to pick up a signal at IEX and race the order to other markets. What would otherwise result in “fading liquidity” has been largely eliminated by the IEX routing methodology.

Requiring no changes to our existing trading systems, Brandes traders can direct a portion of orders to rest in the IEX pool and leverage IEX’s proprietary routing technology. Combined with other IEX features, the ultimate result is increased control of our orders, reduction of information leakage and less opportunity for electronic front-running 7 and other forms of unnecessary intermediation. Therefore, as liquidity congregates in one location, there is less need to slice orders, creating an opportunity to improve the quality of each trade execution. This ultimately should be reflected in the price our clients receive over the long term. Our decision to support IEX is

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