Buy Side Does the Math - Adds Quants to Bolster E-Trading

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By Adam Sussman, TABB Group

Originally published on TABB Forum 

US buy-side equity trading desks are investing in automation and ramping up their quantitative skills to drive new efficiencies and enable execution capabilities on par with the sell side. 

TABB analysts Sayena Mostowfi and Valerie Bogard contributed to this commentary. 

The pace of change on the buy-side trading desk is accelerating. Technology, analytics and process are all undergoing transformations to adapt to competitive and structural shifts in the market at a time when commissions have declined 19% since 2010. But this is an industry known for being conservative in its embrace of change – electronic trading may have begun in the late 1990s with some early adopters, but it wasn’t until 2006 that the laggards of the industry finally capitulated, a full seven years later.

Nowadays, however, the adoption cycle has shortened significantly. Across 108 interviews with US-based asset managers, TABB Group has identified industry leaders who are using new technologies, analytics and trading processes to give their firms more of an edge. But there also is a middle majority of firms that recognize the threats of being behind and are actively engaged in bringing similar capabilities to their firms.

Technology is not only bringing more efficiency through automation; it also is seen as an area for cost savings. Firms are looking to consolidate the number of order and trading management systems within their organizations, particularly for more standardized and liquid instruments. The leading technology initiatives among asset managers offer a clear view of the various issues the industry is facing and how a cutting-edge firm approaches a problem, while a firm with limited means can achieve a close approximation (see Exhibit 1, below).

TABB 3 10 14 

Source: TABB Group 

Asset managers are also looking for efficiencies within their commission pools, some taking a more aggressive approach to funding Commission Sharing Agreements/soft dollar wallets. There has been a steady increase in the commission rate associated with funding a CSA, from 1.9¢ in 2012, to 2.3¢ this year. At the same time, the execution component of that commission fell from .9¢ to .8¢. This allows traders to route more flow electronically without having to worry about research budgets.

Thus, the use of electronic trading does not have as much of an impact on the total commission pool, since bellwether buy-side firms are more comfortable increasing the research component of a low-touch trade. TABB believes this trend will spread and that the rate differential between high-touch and low-touch will continue to narrow. As a result, it raises the ceiling on the low-touch market share that once existed.

Finally, leading buy-side trading desks are taking a thoughtful and measured approach to where and how their orders are routed to trading venues. While not everyone has the capability to do their own venue analysis, there is a group of analytically minded buy-side shops that work very closely with a couple of brokers to perform the same analysis once reserved for the largest firms.

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