Buy Side Zeroes In on Execution Cost

Terry Flanagan

Asset management firms are adopting transaction cost analysis to guide short- and long-term portfolio management decisions and measure the performance of traders.

Transaction cost analysis (TCA) is increasingly being integrated into the institutional investment process as a means of assessing and improving trade performance.

Within the institutional investment space, organizations that have found TCA most beneficial are large asset managers with multi-currency, multi-country and multi-day portfolios.

Other big users are broker dealer transition desks managing large, complex transactions, where they need to track costs and provide transparency to clients.

“A big IT expenditure on our part in the past five years or so is to reduce our dependency on brokers, and give our fund managers and, therefore their clients, much better visibility, service, execution performance, market insights and liquidity analysis,” said Paul Squires, head of trading at Axa Investment Managers, a French-headquartered buy-side institutional investor.

Paul Squires, head of trading, Axa IM

Paul Squires, head of trading, Axa IM

In 2011, 35% of the institutions participating in Greenwich Associates’ annual U.S. Equity Study said their compliance departments used TCA systems to ensure best execution.

Almost 40% of the institutions taking part in that research said they use TCA systems to assess broker performance on internal trading desks, 38% said they employ TCA to identify outlier or problem trades and 37% said they use TCA to measure active trading results against a benchmark.

“The buy-side trader has taken on much more responsibility than in the old days when we’d just ring up a broker and use their resources and insights to decide on an execution strategy,” said Squires. “By the time you reach a broker now, even if you ring them — about 95% of our flow goes through FIX—the execution decisions have largely already been made.”

The asset management industry has also lacked effective controls over commission costs, which can often add an additional 30% or more to the asset management fee.

UAT, a financial technology company, has partnered with Bloomberg Tradebook to release a commission recapture program, called Bloomberg Tradebook Boomerang, which generates commission savings for asset owners and enhances trader productivity and execution quality for asset managers in the sub-advised and externally managed industry.

“Capturing alpha outside of portfolio risk is important,” said Tom Warren, president and co-founder of UAT. “Compression of returns on large cap growth companies has created little disparity between the first and last quintiles, so that anything you can do as an asset manager to give yourself more efficiency in trading, even if it’s as little as a few basis points, is significant.”

A central component of Bloomberg Tradebook’s commission recapture system is the Boomerang algorithm, which incorporates UAT’s iPerX commission savings technology.

Traders at money management firms can adjust the algorithm settings to identify low-touch orders from high-value order flow, said Warren. Orders identified as low-touch are automatically executed without further involvement from traders.

Trading performance is central to the investment process at Axa IM, where liquidity must be found across all asset classes and market conditions.

Axa IM’s trading desks use straight-through processing, a protocol that optimizes electronic trading and lessens, but does not eliminate the need for high-touch execution.

Axa IM’s experience “has enabled us to launch our full-scale algo capability with venue analysis and more granularity on how we are trading—why we are trading on certain venues and how that is impacting execution performance”, said Squires.

Responding to calls from clients and regulators for more and better trade data, big institutional investors are applying to asset classes beyond equity investments, where its successes have been tested.

Among the world’s largest institutions—those managing more than $20 billion in assets— 41% of institutions that employ TCA use it in their FX investment process, according to Greenwich Associates.

The lack of proven third-party systems is apparent in FX, in which only about 30% of TCA users employ a third-party vendor and 72% use in-house systems, according to Greenwich.

Such is the case at Axa IM.

“By the end of the year,” said Squires, “I’ll have moved FX on to the EMS [execution management system], which will give us some TCA capability on FX execution, which we’ve never had, and also give us the ability to use algorithms on vanilla FX trades and also listed futures across asset classes.”

Although equity market TCA has seen the emergence of several leading platforms, no definitive leaders have yet emerged in FX.

Institutions participating in Greenwich Associates’ research use a wide range of third-party providers in FX, including Bloomberg, Elkins/McSherry, ITG, MarketAxess and TradingScreen.

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