Progress toward unbundling of payments for execution and other broker services is gaining ground in Asia, but buy-side firms should not sacrifice quality of content or execution on the altar of cost reduction, says Jesse Lentchner, CEO Asia-Pacific of institutional broker-dealer BTIG.
“Asia is less unbundled than the rest of the world, and therefore the discretion of the trading desks in Asia is less than it is elsewhere,” he says. “In the US, our business model is primarily focused on talking to trading desks. In Asia, you can't only focus on the trading desk if you want your business to be very successful and very scalable. To reach the same level of penetration we have in the US, we have to cover fund managers and research analysts as well as the trading desks. But I do expect unbundling to continue apace in Asia.”
In Asia, the level of unbundling is generally low because the diverse nature of the region's markets has compelled portfolio managers and traders to form a closer link between research and trading. Moreover, institutional investors are more reliant on their sell-side counterparts than in western markets due to frequent difficulties in accessing sufficient liquidity and sourcing research across the whole region.
“We help people make money the way they did in old-fashioned stock broking, but we are a little bit faster and smarter. The market has become very competitive. If I see a client that we're not already trading with, almost without exception they will say they are over-covered and they have many brokers that they have to pay. But then usually within three-to-four months, we get our first trade with the client. October was a record month for us in Asia,” says Lentchner, who joined BTIG in March 2010 after more than 10 years as a senior executive at Goldman Sachs in Asia.
Unbundling is more established in some markets than others. A report published in April 2009 by the UK-based consultancy Oxera stated that the use of commission sharing agreements (CSAs) by UK-based investment managers had increased to 70% from 50% in 2005 and that a range of performance indicators were “consistent with the theory that the new regime has limited the use of dealing commission and permitted greater separation in the purchase of execution and research.” The current UK rules, introduced by the Financial Services Authority in 2006, were intended to provide greater transparency on costs to end-investors, confine the use of commissions to pay for research and execution services and encourage the use of payment mechanisms to enable services from brokers to be purchased separately.
Despite the higher levels of commissions generated, high-touch execution via sales trading desks is still in demand in Asia where integrated research covering the diverse region's economies and markets is valued at a premium to help generate alpha.
The latest annual ResearchFocus report by US-based investment research provider Integrity Research on CSAs, which polled 214 buy-side firms in the first quarter of 2010, found that nine out of 15 of the top-rated CSA providers were agency brokers. The remaining six places were filled by full-service investment banks. Around 38% of respondents also said they were most likely to trust agency brokers with their CSA pool, compared to 24% for bulge-bracket firms.In the previous study, conducted in the fourth quarter of 2008, there were no agency brokers among Integrity's top-rated CSA providers.
But Lentchner says the overall commission levels paid to the sell-side are less important than being able to combine the best research provision with the best in execution. “I don't think price is the most important thing. If you look at the performance of mutual funds or hedge funds, it's extremely rare that the commission they pay will make the difference between good performance and bad performance. The cost of execution across all markets in Asia is 25 basis points on average, but unless you turn your portfolio over 100 times a year, it doesn't make much of a difference. However, getting good information from your broker and using it effectively is important,” he says.
“The slippage on the execution can make a difference between a very good trade and a very mediocre trade. If your fund managers have alpha, capturing that alpha is the job of your trading desk. That doesn't mean you shouldn't pay brokers for research. For most of my career I was at full-service firms, and I think they provide a lot of value. But your traders should have the ability to call the person that they think is going to give you the best price.”