Who Provides the Lowest Transaction Costs?

In Institutional Investor’s 15th annual survey of trading costs, the broad results show that brokerages having been combining high-tech trading tools with a human touch to reduce transaction expenses.


Ray Tierney walks around the trading floor at Bloomberg Tradebook, surrounded by a sea of desks mounted with the company’s multiscreened Bloomberg terminals, technologically sophisticated boxes armed with a dazzling array of trading algorithms. On each of the patented machines is something decidedly low-tech: a foam “No. 1” hand of the kind used by college basketball fans emblazoned with the outfit’s “One Team, One Dream” slogan.

That contrast reflects the passion and the strategy of Tierney, the hard-driving boss who joined Bloomberg Tradebook from Morgan Stanley Investment Management 16 months ago. During his brief tenure, he has revamped operations to combine Tradebook’s prodigious technology with the skills and human touch of its traders. The moves have made the firm an efficiency powerhouse in both U.S. and global equity markets, according to the latest Transaction Costs Analysis survey conducted for Institutional Investor by Elkins/McSherry, a division of Boston-based State Street Corp.

All Trading Rank (VWAP) (Broker)
All Trading Rank (VWAP) (Manager)
All Trading Rank (AP) (Broker)
Order Size (Arrival Price) (Broker)
Market Cap (Arrival Price) (Broker)

Bloomberg Tradebook dominates this year’s trading costs analysis rankings, placing first among brokerages in U.S. equity trading, with an average cost of 20.86 basis points below the volume-weighted average price, almost 6 basis points cheaper than its nearest rival, Stamford, Connecticut–based Source Trading. Tradebook ranks second among international equity houses, behind New York–based Investment Technology Group. The firm also tops both the U.S. and international rankings for cost based on arrival price. The results are based on more than 24 million trades by 1,900 brokerages and 1,000 investment managers covering a universe of more than 16,000 individual stocks, during the 12 months ended June 30. Among investment managers, Capital Growth Management, BlackRock, Jennison Associates, Jacobs Levy Equity Management and Robeco Investment Management provide the lowest transaction costs in U.S. equities, according to the rankings; Dimensional Fund Advisors, Genesis Investment Group, Acadian Asset Management, GMO and Mondrian Investment Partners lead in international equities.

Tradebook is hardly alone in harnessing technology to gain a trading edge. The rankings show that the continuous refinement of high-tech tools keeps lowering transaction costs. The average overall cost of equity trading in the U.S. fell to 23.90 basis points from 34.20 basis points.

Bloomberg Tradebook’s rise in the rankings has been meteoric. Five years ago the firm didn’t muster so much as one appearance in any of the categories. Tierney says Tradebook has increased its market share by 50 percent over the past 18 months and now claims 1 percent of U.S. equity trading volume. “If you were to talk to the bulge-bracket trading firms about their traditional, high-touch cash businesses, they aren’t doing much more than 1 percent,” he says.


The firm’s rise isn’t just a product of technology, though. Traders know how to utilize timely research in ways that can give a desk an advantage over rivals in an otherwise automated industry. Tierney says that when he was global head of equity trading at Morgan Stanley Investment Management, trading firms were more interested in pitching him products than services. At Bloomberg Tradebook he refers to his traders as execution consultants. “The trading world is more complex than ever, with regulations, competition and fragmentation,” he says. “So clients are looking for us to provide them with a level of knowledge that can align them with their algos. They’re looking for service and not just products. And the human being is still an important part of this equation.”

When he arrived at Tradebook, Tierney found an operation that was based largely on selling trading algorithms to supplement the Bloomberg terminal. The sales team was on one floor of the company’s Midtown Manhattan headquarters, research and development on another. Tierney brought them together in one room on the fifth floor, placed a “One Team, One Dream” foam hand on each desk and told everyone to collaborate and communicate. That meant taking an algorithm-writing quant jock who could conceivably go days without speaking to anyone and putting him on the front lines with the sales team.

“I want our execution consultants talking with clients about the microstructure of the markets they are trading,” says Tierney. “In the U.S. you’ve got 13 different exchanges and 40 dark pools. Gone are the days you can take an algorithm and throw it at all markets and sectors and see what happens. You have to take this technology and understand the nuances of how it works in relation to the market.”

Tierney says that because traders are making real-time executions, they need to have real-time conversations with clients, touching base with them throughout the day about execution and strategy and how it all relates to volume. “In the broker’s hunt for volume, everybody’s stepping all over each other, and the prices are indicative of that trend,” he says.

Declining commission averages have contributed to the frenzied search for volume. According to Elkins/McSherry, the average equity commission in the U.S. dropped to 7.66 basis points in the second quarter of 2011 from 11.35 basis points a year earlier. And costs are tightening across the globe: In Luxembourg, the lowest-cost country in which to trade, the average commission fell to 6.25 basis points from 9.19 basis points in 2010; in Japan it dropped to 8.64 basis points from 9.56 basis points, and in Germany it fell to 9.93 basis points from 10.33 basis points.

The technology that the largest firms can afford to employ is continuing to widen the gap between competitors when it comes to dominating the volume of the most heavily traded securities. Half the daily volume of State Street’s SPDR S&P 500 exchange-traded fund, for example, is traded by just four firms: Bank of America Merrill Lynch (17 percent), Goldman, Sachs & Co. (12.8 percent), Credit Suisse (10.7 percent) and Knight Capital Group (10 percent). “All these offerings, which need superior technology and, at times, principal trades, lend to their high percentage of the average daily volume,” says James Bryson, president of Elkins/McSherry.

A perennial top performer in the Elkins/McSherry rankings is one of those large firms: Jersey City, New Jersey–based Knight. The brokerage’s managing director, Joseph Wald, says that his firm’s status as the largest trader of New York Stock Exchange–listed securities, Nasdaq Stock Market securities and ETFs gives it an edge in finding liquidity. That’s the key to keeping costs low, he says.

A big brokerage like Knight uses trading algorithms that will track where sources of liquidity have turned up in the past when it goes to trade a particular security. Based on that record, it can target certain venues where traders have already had success. Brokerages without the size or technological sophistication of a firm like Knight will use the shotgun approach: Pinging different venues with small orders to test for liquidity. The problem with pinging is that it alerts other traders searching for liquidity that someone else is looking for that particular security, and that competition increases the cost of an order. Add to that the fragmentation of the market — there are more exchanges, dark pools and other trading venues than ever before — and the search for alpha becomes an expensive proposition.

Wald says that there’s little wonder that fewer small firms can compete. The player with the best technology almost always wins the game. Even an issue like co-location matters. The closer a firm’s computers are to an exchange’s system can cut nanoseconds off execution times. “It’s not unlike the old days, when traders jockeyed for the best placement on the floor of an exchange,” notes Wald.

Still, Wald says, it’s the traders he hires that give his equity desk its edge. “You can have a great algo and a terrible trader and not get a good outcome,” he explains. “You can have a great trader and a mediocre algo and most times do better.”

Richard Breck, founder of Source Trading, says that although algorithmic trading dominates the industry, the human behind the trade can still be a powerful force: “If everything in the market were marginalized, then we certainly wouldn’t have hedge funds, would we? A smart trader can add to how effectively a trade is executed.”

Trading costs also go hand in hand with volatility. The wild swings of the Chicago Board Options Exchange market volatility index during the global meltdown subsided in the first half of 2011, with the VIX averaging less than 19 during the period. But volatility has been roaring again because of the European debt crisis, and that trend threatens to drive trading costs up, according to Elkins/McSherry.

Back at Bloomberg Tradebook, Tierney says that uncertainty about the impact of new regulations, including the Dodd–Frank Wall Street Reform and Consumer Protection Act and its so-called Volcker Rule, as well as the European Union’s struggle to contain the bloc’s debt crisis are prompting many investors to sit things out for now. Still, he sees plenty of opportunity ahead. Bloomberg leases 310,000 terminals around the world, and just 5,000 of those boxes currently use Tradebook. “I’ve got 305,000 opportunities to add value to the terminal experience that’s already in place,” he says as he reaches for a foam hand. • •