Advances in the ability to measure the value of trading ideas can lead buy-side firms to increase commission levels and direct execution to brokers that supply better research.
“Brokers' trading desks are getting more flow because the other side of the business is creating more value,” said Adam Sussman, director of research at TABB Group and co-author of a new report, ”Alpha capture: The what, who and how much'.
Brokerage sales staff enter investment ideas into the front-end of a alpha capture system, giving portfolio managers at quantitative hedge funds and other buy-side firms the opportunity to review competing suggestions and then contact the relevant supplier to develop and implement the most attractive ones. TABB Group estimates that 4% of global commissions are currently accounted for by alpha capture, but the research consultancy predicts that this will rise to 10% by 2012.
Alpha capture systems, which include utilities such as Trade Ideas Limited, an industry consortium, or proprietary platforms provided by technology suppliers such as FactSet and youDevise, typically allow the direct supply of an idea to a PM, monitoring of its performance, measurement of market sentiment, ranking of ideas generators and the creation of an audit trail of communication ideas.
While quantitative funds tend to aggregate many ideas into a single feed, long-only funds are more inclined to use each idea for an individual trade. If the majority of ideas entered are short term, the information can still be used by long-only fund to time their trades. For example, if many people are bullish on a stock, the PM or trader may wait until the market is calmer before buying it.
The success of these ideas is either rewarded via a gentleman's agreement to implement an idea via the execution services of the broker that supplied it, or by use of the alpha capture system as a source of quantitative data for the broker vote. If widely adopted, alpha capture systems could replace the broker vote system.
“The performance metrics within alpha capture systems could be used universally to determine which brokers get paid and how much,” noted Sussman.
Although alpha capture systems can provide greater granularity on the quality of sell-side research and idea generation, brokers are typically paid via a relatively imprecise sharing out of order flow. Only 12-15% of US funds are currently using commission sharing agreements (CSAs) to segregate payments for services.
However there are signs that the use CSAs is growing. Westminster Research Associates, a commission management service provider and part of the ConvergEx Group, a trading technology provider and agency broker, has recently expanded its global execution network to over 150 broker-dealers, up from 90 brokers less than two years ago.