Does the growth of algorithmic trading render high-touch services more, or less, vital for the buy-side?
The story of algorithmic trading is well-known: computerised trading decisions are made in micro-seconds to aide buy-side firms clear their blotters of simple orders. Growth in institutional investor use of algos, and brokers’ offering to keep apace with technological innovations and the buy-side’s appetite shows little sign of slowing.
The ability to break down trades and execute across markets instantaneously is clearly of great value, but for more complex, delicate orders – including block trades – the buy-side is ever-reliant on high-touch services from brokers.
A key issue in the discussion that has emerged in recent years revolves around information leakage linked to broker routing decisions. The sell-side has a commercial imperative to route orders through their own pools to mix with internal flow, then to pools where they are either offered rebates or cut-price execution fees. Interacting with this flow can lead to compromised execution quality, many buy-siders urge, especially with block trades that are hard to break down. For this reason, the skills of a specialised, high-touch sales trader will remain in high-demand to the buy-side.
What trends will dominate high-touch service offering in the near future?
As algorithms incrementally increase in advanced functionality, the buy-side will utilise brokers’ high-touch services in more precise, pointed ways. The development of specific sector expertise for brokers and a trend away from ‘me-too’ research and execution offerings from major sell-side houses will be key to this trend.
Further integration between high- and low-touch services may also occur in some houses, and overall execution offerings are tailored to fit specific buy-side needs.
Will the growth of independent research payment though commission sharing agreements (CSAs) benefit bulge-bracket brokers at the expense of the mid-tier?
Use of CSAs is set to blossom in Europe, and especially the UK, where they were initially developed. These agreements give asset managers the execution benefits of large, bulge-bracket brokers with diverse connectivity, and the niche research offerings of specialised brokers, or independent research providers.
The growth of CSAs has, and will continue, to have a profound impact on the overall buy-side-sell-side relationship, as asset managers pull away from the traditional supply of research. In this area, institutional investors have widely claimed, brokers have relied too heavily on a favourable model of execution supporting research, which has limited innovation to research offerings, or indeed the production of high-quality research.
Buy-side needs are evolving, and central to this transformation will be the ability to source the highest quality research through commissions paid to the bulge-bracket, where execution will remain consistent. Mid-tier brokers must meet this challenge head-on by crafting bespoke research offerings or staking claim to niche areas of research.
As with high-touch offerings, brokers – whether mid-tier of bulge bracket – must anticipate buy-side demand before competitors, as greater choice and flexibility will define these areas in the future.