Results of In-depth Interviews with 52 Investment Management and Hedge Fund
Traders at AUM $1.1 Trillion to Under $10 Billion Size Firms
Boston, MA, April 20, 2004 â Gone are the days of a simple broker network. Faced with a changing market structure, equal virtual access to the markets, aggregation technology decentralizing marketplaces and crossing networks facilitating size discovery, buy-side traders now enjoy direct access to advanced electronic trading strategy execution servers.
But are they better off with access to this advanced arsenal of model-based execution tools?
In a securities industry report, "Institutional Equity Trading in America: a Buy-side Perspective", released today, The Tabb Group provides answers to questions, such as "If the buy-side can trade thousands of shares at the touch of a button, are they doing it better, cheaper and with less effort? While it may seem apparent, do they even know how to use this technology? By taking a more active role in trading, are they doing it better than if they delegated trading to brokers? And if they bypass brokers, how will they get value-added services, such as research and market information?
The report summarizes interviews with 52 head and senior traders at investment management firms and hedge funds with assets under management (AUM) over $1.1 trillion to under $10 billion. "We discussed their views on equity trading," says Larry Tabb, founder and CEO, The Tabb Group and reportâs author, "from order management systems, to market structure, through transaction cost analysis, and segmented our findings into large, medium and small firms." The report is 56 pages long and includes 50 exhibits.
"The US equity markets are facing unparalleled change," adds Tabb. "The sheer amount of change stemming from the 1997 SEC Equity Order-Handling Rule, underpinned by massive technology improvements, has been mind boggling, earth shaking. These rules put in motion developments that have challenged the most major of our institutions, transforming the very value proposition of the industry and the underlying mechanics of how we invest (in America)."
Says Tabb, "The interviews we held over two months, during January and March of this year, supplied us with deep, rich levels of information. For one thing, we learned that advanced electronic equity execution, known also as algorithmic trading, is set to rise 144% within the next two years."
The report states that while change is coming itâs not a revolution but an evolution. Technology and platforms will become more robust, metrics and management will get tighter, traders will become more adept at using the new technologies and platforms and soon they will be crossing more, trading more, delegating more and adding more value.
However, the most important issue for the buy-side will be less about specific trading technologies and more about value. Adds Tabb, "We wanted to learn, when do you add value, when do you detract value, how do you measure value and how do you maximize value? Understanding the value equation, we believe, will help guide the trader toward an execution strategy, dictating the proper time to delegate, cross, trade and ask for capital."
Key findings include:
- Broker relationships: Buy-side traders continue to value their broker relationships, claiming that the broker services they most value are idea generation and research (26%) and execution quality (23%). While overall buy-side traders place great value on research and execution, it is larger-size firms (over $US 1.1 trillion) that place the most value on technology, connectivity and quantitative execution strategies.
- Soft dollars: While 73% continue to value broker research with nearly seven out of 10 of the firms paying for research with soft dollars, two-thirds said that they were not currently using soft dollars or planned to reduce their reliance on soft dollars in the future.
- ECN impact: Today, 88% of buy-side firms have connectivity to at least one ECN. A clear 40% of firms accessed ECNs through aggregation (DML) technology, which provides connectivity to most major ECNs and a consistent execution platform across heterogeneous trading venues. Most firms now use ECNs to reduce market impact (32%), gain greater control of their executions (22%) and lower trading costs (16%). Overall, most firms are using ECNs to reduce market impact and provide a more control execution environment. Reducing fees was the major reason larger firms now use ECNs (42%).
- Crossing networks: The majority of buy-side firms are using crossing networks (70%), ranking finding liquidity (49%) and reduced market impact (40%) as the primary benefits. While the majority of firms ranked finding liquidity as the most important characteristic of crossing networks, larger firms overwhelming claim that reducing market impact was the primary benefit (74%).
- Algorithmic trading servers: One of the newest trading technologies embraced by the buy-side is algorithmic trading strategy servers, which splits larger order into smaller ones and automatically executes these orders in relation to a specific trading strategy. Overall, six out of 10 firms surveyed used these model-driven execution tools. However, eight out of 10 (or 82%) of larger firms reported using algorithmic models. While a majority is already using these tools, 57% responded that they were still in the experimentation phase of understanding how to effectively deploy these models on their trading desks.
- Market structure: While buy-side access to trading tools and trading markets has gained significantly, they still face trading challenges, the largest being the NYSE market structure, where 71% of firms aggressively voiced wide displeasure with the current market structure, followed by nearly 50% citing fragmentation as their second-highest rated challenge.
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