The battle for the diminished commission wallet of US institutional investors could lead to a greater integration between high- and low-touch services by the sell-side in 2011, according to a new study by TABB Group.
In the research consultancy's sixth annual study of US institutional equity trading, subtitled ”Outflows, Outrage and Balance', senior analyst Matt Simon forecasts for 2011 a combination of continued low levels of buy-side commission spend, reduced volatility and trading volumes, plus a lack of differentiation between brokers' low-touch execution offerings.
On the one hand, says Simon, these trends will lead to a more intense focus on “evaluating orders and analysing transaction cost analysis, adjusting to optimise trading decisions”. When asked what changes they had made to order execution in the previous 12 months, for example, 34% of study participants said they were placing greater emphasis on monitoring orders and understanding routing logic, 19% said they had imposed tighter controls and 15% said they had adjusted commission management processes. On the other, heads of desk will be expecting the sell-side toinnovate and invest to win market share. “The buy-side is not uniformly opposed to better integration between the low- and high-touch desks,” said Simon. “ could be the year that brokers begin to break down the walls between these silos and explore new ways to offer the benefits of both worlds.”
Just over half of US buy-side traders (53%) said they preferred low- and high-touch desks to remain separate, largely due to residual information leakage concerns, while 26% were comfortable with a mixed approach as long as they could exercise some level of control and 13% wanted better integration across sell-side services. “The idea that service and relationship are so critical to the value proposition of the low-touch offering forces the sell-side to rethink the strategy behind the separation of the electronic business and the cash desk,” observed Simon.
The study is based on interviews with 68 head traders at US institutional equity firms managing an aggregate US$12.9 trillion in assets under management.
A total of 53% of traders told TABB that commission wallets were at least 20% lower year-on-year. The firm predicts that pressure to consolidate brokerage relationships will result in the top 12 core brokers executing 71% of trading share volume in 2011. “Reducing the overall number of brokers remains an important way to leverage relationships. Determining who to allocate commissions to in 2011 will continue to be highly dependent on research, electronic trading capabilities and access to liquidity,” said Simon.
Despite the frenzy of market activity that led up to the flash crash of 6 May, volatility and volumes trended downward overall, with the VIX volatility index trending down 40% between May and November and average daily volume standing at 8.5 billion shares for 2010. Moreover, 52% of buy-side firms said there were no significant differences between the algorithmic offerings of brokers. Although these findings might suggest a tough 12 months ahead for brokers' profit margins, a greater emphasis on unbundling execution from research services is providing institutional investors with a clearer idea of where brokers are adding most value and therefore a willingness and ability to reward higher quality service.
In 2010, nearly all research-driven survey participants were able to break out the execution-only rate from the research component of their spend. Among asset managers that used sales traders and consumed research, 91% could provide both an execution-only and all-in rate, whereas in 2009 most firms were unable to separate execution costs from research with any degree of certainty. When asked to list the factors that determined how spend was allocated between core brokers, buy-side traders ranked relationship most important (28%), followed by research (23%) and electronic trading (17%).
“Electronic trading support and feedback are also key differentiators but,” said Simon, “brokers that continue to hire well-established sales traders who understand how to service client accounts will continue to gain market share in 2011.”
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