Investment managers had plenty of reason for good cheer as they prepared to ring out 2013 and ring in the new year. A buoyant equity market saw the Standard & Poor’s 500 index soar by more than 26 percent as of December 10, to more than 1,800, while the Dow Jones industrial average breached the 16,000 mark late in the year for the first time.
The bull market has improved the fortunes of many managers, but it hasn’t fostered any complacency. Five years after the great financial crisis, demands for greater transparency and accountability in equity trading — and lower costs — are louder than ever.
“In years that you see a nice strong market, typically you don’t hear much about trading costs,” says James Bryson, president of Elkins/McSherry, a subsidiary of State Street Corp. That’s no longer the case, he adds. Transaction cost analysis “is now a part of the trading process — and it’s here to stay,” says Bryson.
Firms are having to sharpen their analytical tools, though. With market fragmentation continuing apace and concern about the impact of high-frequency trading worrying investors, the challenge of delivering best execution is getting tougher all the time.
U.S. TradingEquity investment managers
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | UBS Global Asset Management | -25.12 |
| 2 | Deutsche Asset Management | -22.45 |
| 3 | Timessquare Capital Management | -22.08 |
| 4 | Jennison Associates, LLC | -20.60 |
| 5 | Pzena Investment Management, LLC | -20.40 |
| 6 | Harris Associates LP | -19.94 |
| 7 | GMO, LLC | -19.51 |
| 8 | Dreman Value Management, LLC | -18.73 |
| 9 | Gamco Investors, Inc. | -18.69 |
| 10 | Davis Selected Advisers, LP | -18.26 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
“As commissions have declined,” says Foster, “there is now less to be squeezed out of the explicit cost side of the equation, so the focus continues to shift to the implicit side” — the cost of getting into or out of a position while the market may be moving against you. Bid-offer spreads have narrowed over the past several years, but market depth has also declined, especially displayed depth, he notes.
Global TradingEquity investment managers
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Marathon Asset Management | -31.16 |
| 2 | Brandes Investment Partners | -25.45 |
| 3 | Harris Associates LP | -22.53 |
| 4 | Arrowstreet Capital, Limited Partnership | -20.43 |
| 5 | Capital Guardian Trust Company | -20.15 |
| 6 | Franklin Templeton | -19.69 |
| 7 | Mondrian Investment Partners Limited | -18.11 |
| 8 | GMO, LLC | -16.49 |
| 9 | Acadian Asset Management, LLC | -16.28 |
| 10 | Numeric Investors, LLC | -16.27 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
Full-Service Brokerages — U.S.
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Cantor Fitzgerald | -19.63 |
| 2 | Jefferies & Company Inc. | -18.80 |
| 3 | Merlin Securities (A Wells Fargo Company) | -18.16 |
| 4 | BMO Capital Markets | -17.23 |
| 5 | BTIG | -16.73 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
Exchange consolidation has dominated the headlines in 2013. IntercontinentalExchange, the Atlanta-based upstart founded just 12 years ago, completed its $8.2 billion acquisition of the venerable New York Stock Exchange in November. Three months earlier, rivals BATS Global Markets and Direct Edge Holdings announced their own agreement to merge, a deal they expect to close in 2014.
Full-Service Brokerages — International
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Macquarie Securities | -21.39 |
| 2 | Nomura Securities | -17.10 |
| 3 | HSBC Securities | -11.63 |
| 4 | Raymond James Capital Markets | -6.50 |
| 5 | Macquarie Securities | -3.55 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
“I think the most important part of that is not which venues you deal with, but how you deal with them,” says Foster. “With fragmentation of the market, 13 — soon to be 12 — exchanges and a plethora of dark pools, you need to have open eyes about the liquidity that’s out there, knowing when to use it and, more importantly, when not to use it.”
Weeden looks to create close partnerships with its clients to better understand what their risk profiles are and why they are buying or selling a stock. A feedback loop follows all executions so Weeden can go back through a trade, with a client, to see how the firm fared and what it can do to improve execution.
Answering those venue questions requires data, of course, and once again market fragmentation poses a challenge. It’s difficult to obtain consistent data from different trading venues, says Jason Lenzo, director of equity and fixed-income trading at Russell Implementation Services, a brokerage arm of Seattle-based Russell Investments. “There’s a massive amount of differentiation,” he says. “Is it internal? Is it on a legacy system? Is it on the cloud? How do we extract it?”
Agency Brokerages — U.S.
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Liquidnet Inc. | -25.11 |
| 2 | Weeden & Co., LP | -20.74 |
| 3 | Bloomberg Tradebook | -20.29 |
| 4 | Fox River Execution Solutions | -20.15 |
| 5 | Agency Trading Group, Inc. | -18.85 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
For top-finisher Liquidnet, venue analysis requests can be more of a checks-and-balances exercise by investment managers seeking to ensure that the firm is on top of its game. “So we provide these types of analytics to our members,” says Akis Georgiou, head of quantitative sales and analysis. “And we not only provide them, but we actually use them to enhance our algorithms and ensure our members get best execution.”
Agency Brokerages — International
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Sanford C. Bernstein | -25.92 |
| 2 | Bloomberg Tradebook | -19.99 |
| 3 | Liquidnet Inc. | -18.23 |
| 4 | Pavilion Global Markets | -15.20 |
| 5 | State Street Bank (SSGM) | -3.12 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
One tool within some of the firm’s trading algorithms detects the extent and duration that orders are exposed to its liquidity pool. Liquidnet also employs safeguards like a fair-value model, which measures the extent to which a price stays within a fair-value band, to help prevent adverse executions at poor prices; and smart blocks, which adjust execution size to temper the inevitable high-frequency activity.
Bulge-Bracket Brokerages — U.S.
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | UBS | -19.17 |
| 2 | Bank Of America Merrill Lynch | -17.50 |
| 3 | CSFB | -15.66 |
| 4 | Citigroup Inc. | -15.57 |
| 5 | JP Morgan | -13.82 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
UBS communicates with its broker-dealers through the Fix Protocol and uses that to find out which venues its brokers are using, whether counterparties are making or taking liquidity and whether any rebates were involved. “If a counterparty was overly concerned with rebates, that would put liquidity and venue toxicity in the backseat, and potentially my overall execution would be inferior,” says Abellera. “And they wouldn’t be getting a lot of business from me in the long run.”
Bulge-Bracket Brokerages — International
| Rank | Manager | Difference vs. Survey Universe in Basis Points * |
| 1 | Citigroup Inc. | -24.80 |
| 2 | JP Morgan | -20.93 |
| 3 | UBS | -19.38 |
| 4 | Morgan Stanley | -17.54 |
| 5 | Barclays Capital | -17.02 |
| * - Based on full-day volume-weighted average price; data covers the 12 months ended June 30, 2013 | ||
“People are trying to understand: If all these bad things are happening in markets but we can’t see them, what tool will allow them to be seen more clearly?” says Russell’s Lenzo.
One such tool is the Market Information Data Analytics System, or Midas. Developed by the Securities and Exchange Commission and ?Tradeworx, a Red Bank, New Jersey–based high-frequency-trading and financial technology firm, Midas aims to provide an abundance of empirical data collected from consolidated tapes and proprietary feeds from equity exchanges. The system collects about one billion records daily from U.S. equity exchanges, according to the SEC’s Midas web site, which was rolled out in a user-friendly format in October. In a market devoid of sophisticated visualization tools, Weeden’s Foster sees Midas as a promising example of technology from which other tools could be derived over time.
“It’s incumbent upon everyone involved in the life cycle of a trade to make sure that the least amount of friction exists,” says Foster.
As regulation seeks to make the markets more transparent, the accumulation and consumption of data will only increase. Trading costs — the pennies on millions of dollars — need to be accounted for. The competition to improve execution looks set to intensify even further in 2014 as the U.S. equity rally matures and the prospect of an exit from the Federal Reserve’s quantitative easing policies threatens to increase market volatility.
“2014 could be a little bit more of a roller coaster, which will make transaction costs even that much more important,” says Foster. “The divergence of strategies between firms and traders will increase.” • •
