For institutional equity investors, transaction cost analysis is largely de rigueur, as assessing and quantifying the efficiency of transactions is seen as critical to better understanding markets and improving trading performance over time.

A more recent development essentially pulls forward TCA for the largest block trades, which are most often executed in pieces rather than all at once. The idea is that TCA can be less of a rear-view-mirror exercise; rather, ‘Big Data’ can be harnessed intra-trade, information is learned from each transaction, and the next piece of an order is traded better than the one before it.

“There are tools out there now that really can help buy-side firms make more informed routing decisions and venue choices,” said Steven Glass, chief executive of Zeno Consulting (formerly Plexus Group). “Sort of overnight, I’ve seen some quant tools that allow you to look at your trades and ‘child orders’ from where your blocks are broken up, and see if they were picked off or executed on venues with HFT.”

“We’re starting to see these tools develop, but I don’t know if the buy side has wrapped their arms around it in any significant way,” said Glass, whose firms analyzes trading costs for pension plans and other institutional asset owners. “Some managers are using these tools today, but most aren’t.”

Aside from moving toward real-time, the cutting edge of TCA seeks to incorporate broader swaths of information in helping block traders transact more efficiently. The new developments hold promise, but for now much of the utility still lies in the accessibility and usability of TCA’s core capabilities.

“Pre-trade is evolving to be less and less about just understanding execution statistics, and more about understanding a holistic picture of order intent,” said David Johnsen, head of equities electronic trading business development at Barclays.

“I don’t think anyone’s really there yet,” Johnsen continued. “We’re still in the relatively vanilla world of understanding impact models and execution schedules. In today’s TCA world, I think it’s more and more about distribution of our pre-trade models, and making that really convenient to clients — how do we deliver to them our pre-trade data in an efficient way that then allows the client to do whatever they want with? It’s not ‘one size fits all’.”

Increased scrutiny on trading costs, and a higher bar for TCA, comes amid a challenging market where every basis point of outperformance needs to be protected. The stakes are especially high for public pension plans, which may have tens of billions of dollars allocated to active equity and a less-than-full understanding of what money is going out the door in those strategies.

Recent academic research, including a 2013 piece by renowned Stanford University Professor William Sharpe, have suggested that transaction costs, and by extension active-management fees, are higher than many people realize and that makes it extraordinarily challenging to beat passive indexes consistently.

“More asset managers are recognizing the challenges they face trading block orders, and the pitfalls in today’s market,” Glass said. “All this talk about high-frequency trading and latency ties in with the problem of block orders. If you’re not going ‘upstairs’ (to negotiate privately)  you’re going to get broken up, and you really have to pay attention to the different venues.”

Added Glass, “managers need to have a well-thought-out strategy and approach for getting in and out of these positions efficiently, given the fragmented marketplace.”

Featured image via magann/Dollar Photo Club