Download Monitoring trade data reduces the cost of asset

Vol. III, No 3
August 2006
Comments? Email: [email protected]
Monitoring Trade Data Reduces the Cost of Asset Management
Global equity trading costs have been on a steady decline over the last decade, especially for those large investors
who keep a watchful eye on their trading data. This statement can be quantified through the Elkins/McSherry
Universe. Since 1998, Elkins/McSherry clients have experienced a 25% reduction in overall global trading costs.
Commission
Basis Points
Fees
Basis Points
Market Impact
Basis Points
Total Cost
Basis Points
1998
32.93
8.13
18.55
59.61
1999
31.10
7.27
21.03
59.40
2000
31.18
7.20
22.80
61.18
2001
30.41
6.60
17.69
54.70
2002
27.24
6.85
20.16
54.25
2003
25.46
7.13
14.76
47.35
2004
25.84
7.42
13.69
46.95
2005
25.15
7.35
13.64
46.14
2Q06
24.53
7.25
12.67
44.44
1998 vs. 2Q06
-26%
-11%
-32%
-25%
Reductions in trading costs can be attributed to many factors but the most interesting advancement in equity
trading this decade has been in the area of analytics and buy-side empowerment. Today, equity traders are
constantly evaluating historical and situational averages to improve future decision making. Brokers are being
measured daily, monthly, quarterly, yearly by comparison to situational averages, including trading by stock,
country, speed, trade type and less quantifiable categories including service quality and research. The availability
of this data has allowed buy-side traders to become sophisticated managers of resources and “Alpha Creators.”
Analytics is one of the driving forces moving the physical “trading” function from the sell-side to the buy-side.
Brokers are slowly becoming technology and liquidity providers as buy-side desks are demonstrably adding greater
value to the investment process. For the typical $10 Billion dollar money manager with 100% turnover, a 5 basis
point reduction in trading costs is equal to $5,000,000 in increased returns to investors.
In the competitive world of money management a few basis points in returns can mean the difference between
expanding rapidly and staying idol. Coincidentally, in a scan through the most recent money management asset
rankings, as compiled by Pensions & Investments, it is evident that many of the fastest growing money managers
are groups that have embraced sophisticated analytical tools. This trend should continue as money managers
continue to find new and better ways to measure performance, not just overall performance but performance within
every area of the investment process.
© 2006 Elkins McSherry LLC. All rights reserved.
--
Vol. III, No 3
August 2006
Comments? Email: [email protected]
Despite Growth, Emerging Market Equity Trading Remains Costly
Equity trading within emerging markets remains considerably more expensive, then trading within the developed
markets as compared within the Elkins/McSherry 1Q06 Universe. Implementing investment ideas in emerging
market countries are costly as measured against VWAP and Implementation Shortfall. The following chart
compares broker commissions, price changes from broker receipt to execution and differences from VolumeWeighted Average Price within five emerging market countries.
Country
Commission
Market Impact
(Price to Price)
(Deviation from VWAP)
Brazil
24.99BP
59.05BP
19.16BP
Hungary
35.68BP
55.56BP
11.88BP
India
39.88BP
41.65BP
13.62BP
Malaysia
30.24BP
37.56BP
13.14BP
Philippines
43.71BP
39.43BP
14.21BP
Market Impact
As large money managers take positions in emerging market stocks the prices of those underlying stocks tend to
move away from the original price. Liquidity and information leakage are the primary causes of the large impact
of emerging market trading. Average stock price changes within the emerging markets are truly significant when
compared to price changes within large developed markets. For example within the 1Q06 average price changes
from broker receipt to execution on the NYSE was only 10.5 basis points as compared to 59.05 basis points in
Brazil.
Country
Commission
Market Impact
(Price to Price)
(Deviation from VWAP)
Market Impact
Canada
16.67BP
12.96BP
11.45BP
Italy
16.78BP
12.09BP
12.99BP
Japan
14.03BP
6.21BP
6.96BP
U.K
15.79BP
11.65BP
7.86BP
U.S.
13.38BP
11.57BP
6.13BP
Broker commissions within the emerging markets are equally costly as you can see from the above data, average
broker commissions in Hungary, India & Philippines are twice that of Japan, U.K. and U.S. Although, nowhere
is broker commissions more costly than in Columbia, as measured by 1Q06 Elkins/McSherry client data, the
average broker commission in Columbia is a whopping 60.41 BP.
Commission Sharing Agreements in the Spotlight
New SEC and FSA guidelines appear to be clearing the way for “Commission Sharing Agreements.” Commission
Sharing Agreements are arrangements set up between executing brokers and research providers to allow money
© 2006 Elkins McSherry LLC. All rights reserved.
--
Vol. III, No 3
August 2006
Comments? Email: [email protected]
managers to obtain broker research without being forced to direct trades to any particular research provider.
Within a commission sharing agreement, money managers build up credits which may be used by the executing
broker to pay for research from a third party provider. The arrangements allow money managers to balance their
“Best Execution” obligation and need for broker research.
Commission Sharing Agreements are already taking off in the United Kingdom where money managers
are required to provide commission transparency to clients. Both the FSA and SEC are moving to a more
transparent world of unbundling. Although the SEC still provides a “Safe Harbor” for bundled commissions,
SEC spokespeople are clearly in favor of commission transparency. SEC commissioner Roel C. Campos supports
the unbundling of commissions by US institutions on a voluntary basis, through public comments. In an SEC
Open Meeting on July 12th 2006, Commissioner Campos stated, that he was “glad to see that some industry
participants have taken a piece of the puzzle into their own hands with unbundling of commissions,” and
further noted that “the power of transparency and disclosure can be enormous.”
Even though the SEC seems to be taking a more liberal stance on unbundling than their U.K. counterparts, U.S.
commission sharing agreements may independently promote unbundling.
The New SEC Soft-Dollar Policy Takes Effect in January
January 24th will be the start date for the new tightened soft-dollar regulation to take effect. New regulations are
focused around tightening the “Safe Harbor” rules that have allowed money managers to pay research services
through client commissions. Services which will continue to be eligible for soft-dollars, include, those that
directly relate to executing trades and providing investment research. Mass marketed publications and computer
hardware are two items that are specifically mentioned as ineligible within the new “Safe Harbor.” As always
money managers must “determine in good faith that the commissions they pay are reasonable in relation to the
value of brokerage and research services they obtain.” 1
The SEC has suggested a three step process for money managers to decide if a service falls within the “Safe
Harbor” provision:
1) Identify the service and determine if the service falls within the SEC’s definition of investment
research.
2) Decide if the service provides managers with information that benefits investment decisions.
3) Confirm that the commissions being paid are reasonable based on the service being provided.
Although U.S. money managers are not required to officially breakout the costs commissions and research, they
will need to understand what average broker commissions are in order to properly evaluate the cost of research.
Step three of the above process, should keep downward pressure on commission costs, which have been on a
steady decline over the last decade.
1
July 12th 2006 SEC Press release. www.sec.gov/news
© 2006 Elkins McSherry LLC. All rights reserved.
--