Sell-side firms must demonstrate a new skillset to compete effectively for execution business from the trading desks of institutional investment firms, according to a new report from research consultants TABB Group.
In ‘Execution consulting: the next-generation in sales trading’, TABB principal Laurie Berke asserts that brokers will service buy-side clients in “radically different” ways by 2013.
“What is now known as high-touch service is quickly migrating to the low-touch space,” said Berke. “This is creating a next-generation sales trading model defined as execution consulting, a differential skillset required to help buy-side traders navigate complexities in today’s equity market structure, to optimise the trading decision and preserve alpha.”
According to Berke, the wafer-thin differentials between the returns provided to end-clients by top-tier institutional investors is adding pressure to trading desks, because reductions in trading costs – or an improved ability to retain alpha – can make the difference between winning and losing mandates.
“More than ever, the implementation strategies of the buy-side trader must be designed to preserve and protect the investment decisions made by the PM,” said Berke. “If the buy-side trader doesn’t choose just the right algorithm, set just the right aggressiveness parameter, avoid just the wrong dark pools and select the right execution time horizon, the probability of alpha leakage is high.”
If the right algorithm saves 12 basis points on US$50 billion in equity turnover, notes Berke, US$240 million in savings drops straight to the bottom line of the fund. As such, suggests Berke, brokers than can help buy-side trading desks to navigate the increasingly complex securities landscape put themselves in a good position to win a greater share of wallet.
The report is based on interviews with heads of sell-side algorithmic trading desks and head traders at major US-based asset management firms. It covers the evolution of the sell-side electronic trading model as high-touch migrates into the low-touch space.
While high-touch coverage lays claim to 64% of the bundled commission rate, Berke found that buy-side traders currently pay less than 50% of their equity commissions for algorithms, smart order routers and analytics. Berke asserted that brokers need to know their customer, their algorithms and how to apply the optimal electronic trading solutions to each client’s trading style.
“Armed with transaction cost analysis reports, CSA (commission-sharing agreement) relationships and allocation tools to manage payments to research brokers and third-party providers, the institutional investors continue to eliminate trading relationships with providers that can’t compete on quality of execution on the trading desk,” said Berke.