Research drives the trading bus.
Now, research is fueling the bus, too-not just determining where an institution trades, but how brokers are getting paid, as well. In this new landscape, the buyside is adopting more sophisticated methods in how it decides which brokers it trades with and eventually how much they pay. For the brokers, the stakes are high. How much and how often a broker gets paid can mean the difference between life and death for a broker and their brokerage firm.
So what is the broker vote?
Nanette Buziak, managing director and head of trading at ING Investment Management in New York, told Traders the broker vote is basically a report card the buyside gives the sellside. In this process, the traders grade a broker’s research and the corporate-access content provided to the buyside.
Last January, John Caron, director of equity trading at Loomis, Sayles & Co., took Traders inside how his trading team rates their broker-dealers. The asset manager’s portfolio managers and analysts vote on the brokerage/research houses that help out the most on a daily, weekly, monthly and quarterly basis. “If we are going to add a broker-dealer to our approved trading list, they need to exhibit some types of advantage over brokers we already trade with. If they don’t meet that requirement and have received votes from our PMs and analysts, they would potentially be paid through a CCA,” said Caron.
“My traders only have to concern themselves with what broker to execute with, as all the research payments and client commission arrangements (CCA) allocations get done behind the scenes, which helps to eliminate any conflict of interest,” Caron added.
And the sellside-which is seeing incoming commission dollars shrink steadily-is taking notice. Big time.
GROWING IMPORTANCE
What is driving the importance of the broker vote process? Simply, it’s the economics of the current market environment of low volume and shrinking commissions. The buyside has fewer dollars to spread around the brokers for execution and research and wants to pay for the services it uses and places the highest value on.
Back in the heyday of the equity markets, in 2009 and 2010, very few firms conducted a formal broker vote as to how they allocated their commission dollars. As Doug Bantum, managing director of WallachBeth’s head of equity research sales and Trading and overseer of the firm’s broker vote ranking, told Traders, back when commissions were abundant, brokers could just insert a research analyst in every vertical and get paid.
“That was a good-time scenario back then,” Bantum said. “Now, you have to be really good, focused and differentiated to get on the vote and get paid. Back then, shops were built for good times, but when commissions shrunk, no one could support that structure anymore. Now, you have to be that much better these days to get a shrinking piece of the pie.
Market research firm Tabb Group reported that in 2013, U.S. equity commissions were approximately $12 billion, while in 2012 they were $12.1 billion. This compares with $13.8 billion in 2011. In 2010, U.S. equity commissions were $14.8 billion.
Adam Sussman, partner and director of research at Tabb Group, said that as a result of the shrinking commission environment, buyside institutions are “fine-tuning” their broker vote processes.
“The buyside wants to make sure that every dollar going out the door is being spent on something value-added that is helping generate alpha,” Sussman said. “There is a newer level of sophistication going into the vote process now versus five years ago-that’s a function of industry economics.”
Michael Levas, senior principal and chief investment officer at Olympian Group of Investment Management in Ft Lauderdale, Florida said that when he casts his broker vote he employs several measures.
“We rate brokers using various kinds of metrics. We look at economics, technical analysis, the macro point of view,” Levas said. “I have different criteria for different analysts and sellside brokerage firms.”
For example, Levas said he compares the brokers research offerings against one another. He gets research from most of the bulge-JPMorgan, Merrill Lynch, Deutsche Bank and others. Then, he looks at the quality of what the analysts are saying, the length of the reports, how in-depth they are, do they really understand the business, etc.
“I ask if they are able to give me information that is good, concise and convinces me what this company is trying to do and if I really want to be in this space and be long on them,” Levas said.
With limited commission dollars to spend, Levas and other buysiders now have to be more efficient in how it spends its scarce research dollars. The broker vote is the chief tool buysiders use to decide which broker gets paid.
Buyside commission spend has been divvied up between trade execution and research provision. Execution costs have come down with the growth of electronic trading and are relatively commoditized, industry observers said. The research portion of the spend has grown from simple quantitative analysis to more qualitative-the buyside is looking to the sellside to generate increased corporate access, conferences, more intimate and exclusive lunches and dinners that help the buyside generate alpha. It is here where the brokers can move up in the vote and hopefully get more execution business.
However, ING’s Buziak said brokers would need to gain a lot of traction in broker votes to really warrant garnering actual trading business through their trading desk. The reason, she added, is that if they are expected to receive a de minimis payment based on their broker vote rank, it is much easier for buyside firms to pay them via CSA check than to establish and maintain a trading relationship.
But for thiose who vote like Olympian’s Levas, where a firm places in the broker vote is where he sends his money regardless of size and location.
“I go to certain brokers for certain things. I go to a broker in Norway because they have excellent research team on shipping and this is worldwide,” Levas said. “There are certain firms that I will go to for a particular analyst, say Piper Jeffrey. They look at Apple, the internet and various technology firms and I go to certain analysts for their research that they excel at. And I use them.”
For the sellside brokers, the stakes are high as Levas piointed out. Where a broker firm places in the broker vote can mean life or death. Brokers are trying to place value on all the myriad services they supplies to the buyside, and they must cater to client needs more and more. This can mean a delicate balancing act of evaluating what services are important to each client and deciding which services and clients are economically viable to maintain. Brokers need to grab as much of the buyside’s commission spend as possible to maintain their business.
Staying at or near the top of the broker vote list is vital, as it determines which firms survive and which fade away.
HOW THE VOTE IS CONDUCTED
The broker vote process can be done within a buyside firm using proprietary systems or, as has been the case in the last few years, using systems supplied by outside vendors and brokers. Among the top vendor providers of broker vote software are Markit, Cogent (now part of Eze Software) , Instinet and State Street.
Regardless of who provides the software, the process of voting is relatively straightforward. At a buyside firm, portfolio managers, analysts, broker liaison officers, head traders and even back-office personnel can qualitatively evaluate the services provided by a broker and input their rankings into a program. Each person’s vote can be weighed among the participants-with some, such as the portfolio manager, having a greater weighting or say than a head trader.
According to Tabb Group research, traders participate almost 70 percent of the time in the vote process.
Also, different desks that trade different asset classes can have different sub-votes for a single broker that need to be aggregated and reconciled so a broker can be voted on wholly.
Then, once the individual votes are conducted, an overall vote is aggregated and completed. The results can be either distributed within the buyside firm or outside the firm to the actual broker.
According to one senior executive at a major bulge brokerage, the vote equates to a report card and is the single largest source of intelligence or feedback it gets on its service. The executive said some of his buyside clients share their vote results, while others do not.
Sarah Gadd, a director at Credit Suisse’s Client Intelligence Group, told Traders that there’s been tremendous growth of clients using a formal broker vote process. The bulge firm provides over 100 buysiders with data points that quantify the broker’s performance measuring research and corporate access interactions. Back in 2007, Credit Suisse provided data to only two firms.
“Larger firms tend to have a more formal voting process as some have hundreds of service providers they need to measure in a vote,” Gadd said. “Using a vendor or homegrown standardized platform makes a lot of sense for those dealing with a large volume of information.”
Buyside firms usually conduct their vote quarterly, bi-annually or annually. Credit Suisse provides data points that measure buyside/broker interactions, mostly along standard measures-26 percent of clients get data annually, 23 percent bi-annually and 30 percent quarterly, with the remainder of the requests coming in ad hoc. However, about 50 percent of vote results from the clients are received back bi-annually.
However, Gadd said the firm doesn’t always see the detailed results of how or where it ranks.
And that jibes with data from Tabb Group. In a 2011 report, Tabb reported that 30 percent of buysiders share their results of the vote with brokers, while 44 percent will share upon request. Seventeen percent of the buyside said they share data with only the top 10 brokers. Eight percent of the institutions surveyed said they do not share data at all.
THE BROKER VOTE OF THE FUTURE
Credit Suisse’s Gadd said that over time the broker vote process has evolved and continues to evolve, becoming more data driven and labor intensive.
“Requests are motivated by regulatory drivers-clients need to know what services they are receiving-as well as the institution’s need to manage its resources,” she said. “Clients need to have a handle on how these two factors affect their business.”
Brokers, keen to grab market share from each other or to maintain what share they have, continue to focus on their research offerings. Gadd noted that while there is normally a trading element in the broker vote process, the research portion is where the brokers can make strides and grow business with the clients who value research.
“With clients for whom corporate access and research are important, this is where brokers can influence a vote,” Gadd said. “But brokers have to strategically align services to clients. You have to understand what the client’s needs are in order to allocate resources properly.”
Also, the brokers are increasingly using the feedback they get from the vote to further tailor their offerings and manage their budgets. For those buyside firms that share color, WallachBeth’s Bantum said it helps the brokers who usually meet quarterly to audit themselves.
Also, the brokers are increasingly using the feedback they get from the broker vote to further tailor their offerings and manage their budgets. Both Gadd and Bantum said that for those buyside firms that share this coveted color, it helps the brokers to audit themselves.
“Where we get vote results with commentary and color, this helps our managers during the internal review process to assess the best strategy to service clients,” Gadd said.
As the relationship between the buyside and its brokers evolves, the buyside clearly holds the cards in the financial future of its brokers. And unlike at elementary school, the buyside is not grading on a curve.
“Being average is no longer acceptable for sellside shops, listening and remaining aligned with the buyside client by providing real value add is not only critical in achieving success as a broker, it is crucial to the success of the client,” Bantum said.
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