The bull market for U.S. stocks may be just a few months away from celebrating its sixth anniversary, with the S&P 500 index having more than tripled since its March 2009 lows, but investment managers and brokerages are anything but complacent when it comes to their equity trading costs.
Indeed, money managers say they are upgrading their efforts to conduct transaction cost analysis, or TCA, hiring staff skilled at dissecting massive amounts of trading data and bolstering order transparency for clients. They are also working to avoid additional costs amid growing concerns about the impact of dark pools and high frequency trading.
“Costs are becoming more and more important,” says David Griffin, director of research and technology at Elkins/McSherry, a subsidiary of State Street Corp., which assesses the effect of commissions, fees and market impact costs on institutions’ trade execution. “Every year there is a greater demand for transparency. People are looking in greater detail into their trading costs to uncover additional return. And there is regulatory pressure as well, both in the U.S. and Europe.”
Top Global Investment Managers
| Rank | Manager | Countries Traded | Cost Difference vs. Survey Universe1 |
| 1 | Boston Co. Asset Mgmt | 22 | –32.33 |
| 2 | Marathon Asset Mgmt | 26 | –31.16 |
| 3 | Aerion Fund Mgmt | 17 | –29.63 |
| 4 | Brandes Investment Partners | 31 | –25.45 |
| 5 | Nuveen | 38 | –24.77 |
| 6 | UBS Global Asset Mgmt | 31 | –24.44 |
| 7 | Harris Associates | 12 | –22.53 |
| 8 | Arrowstreet Capital | 35 | –20.43 |
| 9 | Capital Guardian Wealth Mgmt | 36 | –20.15 |
| 10 | Thornburg Investment Mgmt | 19 | –18.93 |
| 1 Transaction costs, in basis points, benchmarked against full-day volume-weighted average price, for 12 months ended June 30, 2014. | |||
Investment managers and brokers say they have had to become more cost-efficient since the 2008–’09 crisis, especially given the continuing drop in trading commissions. “Both buy-side traders and sell-side traders are totally focused on expenses, and that includes commissions and slippage,” says John Whitaker, president of Agency Trading Group in Wayzata, Minnesota. “Commissions have come down dramatically, so costs are a huge deal.”
Agency Trading Group ranks in tenth place among U.S. agency brokerages in terms of costs, according to Institutional Investor’s latest Transaction Cost Analysis survey, carried out by Elkins/McSherry. The survey measures firms’ trading costs compared with the average cost of about 1,400 investment firms, relative to the volume-weighted average price. Agency Trading Group’s costs came in 24.61 basis points below the average during the 12 months ended June 30, 2014, according to the survey.
Top U.S. Equity Brokerages
| Rank | Broker Type | Broker | Cost Difference vs. Survey Universe1 |
| 1 | Agency | ITG | –29.65 |
| 2 | Agency | Liquidnet | –27.57 |
| 3 | Full Service | Jefferies & Co. | –27.46 |
| 4 | Bulge Bracket | Citigroup | –26.76 |
| 5 | Agency | Bloomberg Tradebook | –26.17 |
| 6 | Bulge Bracket | Morgan Stanley | –26.09 |
| 7 | Agency | Garwood Securities | –25.89 |
| 8 | Full Service | Wells Fargo Prime Services | –25.08 |
| 9 | Bulge Bracket | J.P. Morgan | –24.72 |
| 10 | Agency | Agency Trading Group | –24.61 |
| 1 Transaction costs, in basis points, benchmarked against interval volume-weighted average price, for 12 months ended June 30, 2014. | |||
ITG ranks first, with costs of 29.65 basis points below the average. In global trading, Sanford C. Bernstein and Co. tops the list with costs of 40.55 basis points below the average. Among asset managers, New York–based Cohen & Steers Capital Management comes in at No. 1 in U.S. trading, with costs of 25.31 basis points below the survey average. In global trading, Boston Co. Asset Management tops the list with costs of 32.33 basis points below the average.
Firms say they have sharpened their in-house analytical tools and are increasingly using third-party research. Dimensional Fund Advisors, which manages $372 billion in assets, runs its own trade cost analysis and works with outside academics. “Trade quality can be measured in many different ways — we feel it is important to look for measures that are unbiased and give a true measure of market impact,” says Stephen Clark, head of global institutional services and senior portfolio manager at the Austin, Texas–based firm. “That is why we use internal and external trade cost analysis.” Dimensional ranks seventh in the asset managers’ survey, with costs of 20.41 basis points below the survey average.
Top Global Equity Brokerages
| Rank | Broker Type | Firm | Cost Difference vs. Survey Universe1 |
| 1 | Agency | Sanford C. Bernstein | –40.55 |
| 2 | Agency | Liquidnet | –30.94 |
| 3 | Full Service | BMO Capital Markets | –30.50 |
| 4 | Agency | Instinet | –29.11 |
| 5 | Bulge Bracket | UBS | –26.33 |
| 6 | Bulge Bracket | Bank of America Merrill Lynch | –26.08 |
| 7 | Full Service | Jefferies & Co. | –25.88 |
| 8 | Full Service | Scotia Capital | –25.41 |
| 9 | Bulge Bracket | Barclays Bank | –24.79 |
| 10 | Bulge Bracket | Morgan Stanley | –24.13 |
| 1 Transaction costs, in basis points, benchmarked against interval volume-weighted average price, for 12 months ended June 30, 2014. | |||
Weeden & Co., a Greenwich, Connecticut–based brokerage, says it has upgraded its internal TCA team in addition to using third-party vendors. “The type of people we hire now are different than the type of people we hired five years ago,” says Bill Foster, executive managing director at Weeden. “It’s not just programming skills; it’s people with high mathematical degrees and an ability to take large amounts of data and be able to boil it down to quantifiable results that can then be used in practical applications.”
The cost focus today often extends beyond equities. Some firms say they are seeking better ways of assessing expenses for fixed-income transactions. “We feel there is a need to continue to expand TCA in the fixed-income space, as it’s been historically underserviced,” says Jason Lenzo, director of equity and fixed-income trading at Seattle-based asset manager Russell Investments.
Investment firms are also confronting growing investor concerns about insufficient transparency in order execution in the stock market. Clients are seeking better data to measure the performance of their brokers as well as the venues in which their trades are executed.
Regulators have also latched onto the issue. In June chair Mary Jo White announced that the U.S. Securities and Exchange Commission was stepping up its review of market structure issues in a bid to improve transparency and fairness and promote market stability. The agency would strengthen its oversight of trading algorithms, look to minimize time discrepancies between direct and consolidated data feeds, and consider measures to increase disclosure requirements of dark pools. In addition, White said she had directed agency staff to draft proposals for tightening supervision of high frequency traders and banning disruptive trading strategies during periods of market stress and illiquidity.
Top U.S. Investment Managers
| Rank | Manager | Cost Difference vs. Survey Universe1 |
| 1 | Cohen & Steers Capital Mgmt | –25.31 |
| 2 | UBS Global Asset Mgmt | –25.12 |
| 3 | Blackrock | –23.00 |
| 4 | Deutsche Asset & Wealth Mgmt | –22.45 |
| 5 | Times Square Capital Mgmt | –22.08 |
| 6 | Jennison Associates | –20.60 |
| 7 | Dimensional Fund Advisors | –20.41 |
| 8 | Pzena Investment Mgmt | –20.40 |
| 9 | Harris Associates | –19.94 |
| 10 | GMO | –19.51 |
| 1 Transaction costs, in basis points, benchmarked against full-day volume-weighted average price, for 12 months ended June 30, 2014. | ||
“With all the pressure from the regulators and all the pressure from the marketplace for the costs to come down, brokers have to provide value in many different ways,” says Jake Elkins, business development executive at Elkins/McSherry. “One of the ways to provide value is transparency from counterparties.”
Weeden’s Foster says more clients are seeking real-time dialogue with traders on transactions. “In real time we’ll be speaking to clients as to what fills are getting done in electronic market-making venues as opposed to dark pools or lit exchanges,” he says. “In the past it used to be a quarterly or annual review, and now it’s in real time, which we welcome because we can have active, intelligent dialogue with our customers and make changes on the fly.”
Investment managers and brokers say the fragmentation of the U.S. stock market, where buying and selling shares is spread across 11 exchanges and more than 40 alternative platforms, adds to the analytical challenge and levies a burden in terms of costs and time.
The existence of multiple trading venues with very small market shares “imposes a tax” on the whole financial system, Foster contends. “For example, a broker needs to subscribe to data feeds to many of those venues to help ensure best execution, even though those venues’ market shares are below 1 percent,” he says. “When routing decisions are made, those venues have to be considered even though the likelihood of getting minimum fills is de minimis.”
Investment firms are also becoming more concerned about the impact of high-speed trading on their execution costs, thanks in no small part to the attention generated by Michael Lewis’s best seller Flash Boys: A Wall Street Revolt .
“Recent media attention has increased awareness of predatory trading in various venues, and there is strong demand to specifically identify and quantify its potential impact on the market,” says Griffin of Elkins/McSherry. “Market participants want to know exactly what their costs are and what they are absorbing due to various trading techniques.”
Matthew Karcic, senior vice president and head trader at Cohen & Steers, points to the risks posed by latency arbitrage, in which traders with direct data feeds from trading venues can take advantage of other market participants. “I believe HFT can lead to increased costs for investment firms if institutional traders do not dynamically vary their approach to executing orders in the market,” he says. Cohen & Steers tries to remain unpredictable to avoid losses in the face of HFT firms using speed and pattern-recognition software to gain an advantage over investors, Karcic says.
Griffin says the industry is still struggling to assess the impact of HFT. “While metrics exist at the trade level, the overall impact remains in dispute,” he says.
