A significant evolution in transaction cost analysis has taken place in conjunction with the maturation of algorithmic trading and smart order routing.
“In the not-too-distant past, many consumers of TCA analytics predominantly utilized TCA for compliance or client reporting purposes,” Tom Conigliaro, managing director and head of trading services at Markit, told Markets Media. “More recently, clients are recognizing the value that TCA can also provide in improving portfolio performance. Clients are increasingly realizing that in a complex trading ecosystem that provides a myriad of choices for execution, there are greater risks when wrong execution decisions are made.”
Markit’s TCA product is the most mature of its suite of Trading Services products. “TCA is focused on enabling asset managers and sell-side firms, through unique analytics around execution, to reduce total transaction costs and ultimately deliver greater value to clients in the execution process,” Conigliaro said.
Markit TCA is currently focused on equities and FX “and we have an active product development roadmap that will deliver a full multi-asset class capability that will include futures, options and fixed income,” he added.
TCA has grown in one sense as a performance attribution tool, “but it has really come of age with respect to decision support,” said Ian Domowitz, managing director and head of analytics at Investment Technology Group.
Decision support requires the melding of the current state of the market with historical performance information. “This will come in the form not only of comparisons against standard benchmarks, but also in terms of the context surrounding an order,” Domowitz said. “So that the buy side, especially with respect to their self-directed trading, has more information as the order is being worked through the system.”
For any given order, tools now allow the buy side to judge, in real-time, what the relative performance of brokers happens to be. “It comes down to the various pieces of information that are probably most useful in providing decision support for self-directed trading, and communicating with the broker with respect to what they are doing concerning the handling of their orders,” Domowitz said.
The same is true for strategy choice, as in choice of an algorithmic trading strategy. A relatively new development is the use of TCA by the buy side in judging whether brokers are routing orders appropriately, called venue analysis.
“There, TCA has something special to offer,” said Domowitz. “The actual strategy that is being used, or strategies, independent of the routing decision, has a quantifiable effect on venue performance.”
In other words, the question is not only whether “brokers are routing in some sense correctly, based on just characteristics of lit versus dark markets, but also whether or not the routing is tuned to the trading strategy, which is really where the results come from,” said Domowitz.
To accurately measure broker performance in actual market conditions, it’s necessary to combine information about the current state of the market with performance history based on the stock, the size of the order, and market conditions.
“Based on that information, you can actually go back and ask the question, Can you give me a ranking of brokers based on their transaction cost performance for that kind of order under these types of market conditions?” said Domowitz. “At that point, you at least have information as to what type of broker is performing best.”
Feature image via/vinogradovpv
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