The following article originally appeared in the October 2009 edition of Traders Magazine
As long as times keep changing, the idea of reinvention will always be in style. One has to adapt to stay competitive in a cutthroat world. This is true for pop stars, politicians and yes, even brokerages. The traders at 42-year-old Sanford C. Bernstein have grasped this. And as the securities industry has changed to remain competitive, so have they.
For decades, Bernstein’s trading division shared the stage with its more famous sibling, investment research. And the trading desk profited from a relationship that directed customer order flow its way as payment for research’s prized services.
But the trading environment for that model has changed. And the desk decided several years ago that it wanted to pull its weight and become an attractive destination in its own right. So Bernstein, a unit of the institutional firm AllianceBernstein, has since been making an effort to transform itself by adding an arsenal of new services for clients.
For one, it began committing capital for client facilitation. It has also recently introduced a derivatives group. And it’s in the process of building a desk to trade in Asia. These latest moves follow in the wake of other substantial changes–augmenting its electronic services and adding sector traders–it’s made over the past five years to broadcast its commitment to trading in the U.S., according to Tom Wright, Bernstein’s global head of trading.
“It’s this large investment and focus within the firm to make sure that trading is a key element of the value-add proposition overall of the firm,” he said. “It’s clearly paid off; we have been consistent share-gainers each of the last several years.”
The changes are well timed. The evolution of the markets–and subsequent shrinking of commissions and institutions’ broker lists–have forced sellside firms large and small to alter their business models for research and execution. And they’ve had to do so in the nuclear winter of a financial crisis that last year leveled competitors and customers alike.
In last year’s annual report, AllianceBernstein painted a grim picture for the brokerage’s business environment: more low-touch trading, more buyside-handled orders, lower subsequent transaction fees, lower commissions, continuing pricing pressure for traditional brokerage services and less overall volume expected from a battered customer base. A recent Greenwich Associates study piled on when it declared that U.S. institutional brokerage equity trading commissions could drop by as much as 25 percent from 2009 to 2010. That would put institutional commissions at $10.5 billion, roughly on par with 2007.
CCA Storm Clouds
Back in 2007, the industry braced for the potential impact of client-commission arrangements, a payment mechanism for buyside firms whereby monies are held by brokers for eventual payment to the money managers’ research providers. Industry pros predicted that CCAs would ultimately consolidate equities trading into the hands of the bulge bracket and a few others. In turn, research would increasingly get paid through CCAs, and few would trade with the research houses’ trading desks.
But it hasn’t really worked out that way.
CCAs did hurt the smaller brokers, Wright said. For those further out on buyside broker lists, CCAs consolidated the execution side of the business. But Bernstein wasn’t among those numbers, he added.
“Were we concerned about CCAs back when they came out? Yes,” Wright said. “But that has passed, at least for us. If you consider where we are, they did not disenfranchise our trading business. Given our size and scale–and importantly, given the timing of the investments we made–we’re winning business based on our trading expertise, not just our research.”
The firm’s 10-K reported that revenues for Bernstein’s execution and research services in the U.S. and Europe rose almost 13 percent from 2006 to 2007, and 11.4 percent from 2007 to 2008. Over the two-year stretch, revenues jumped to about $472 million, from about $375 million–almost a 26 percent increase.
Bernstein’s European research and trading averaged about 22 percent of the firm’s overall revenues for the period between 2006 and 2008. The overseas electronic business has been the primary driver of revenue in Europe, Wright said.
AllianceBernstein, though, does not separate the brokerage’s execution revenues from those it earned from research. And while Wright would not disclose trading revenues, he did say that the volatility the crisis unleashed increased the high-touch volume the firm’s traders saw by north of 50 percent during the second half of 2008. And he likes what he sees going forward.
“We think we’re positioned extremely well,” he said. “We feel like this is a very good time for us. Clients are responding very favorably to our trading platform.”
Others agree. Jay Bennett, managing director at Greenwich Associates said that Bernstein research gets great ratings from its clients and a significant share of the broker vote. Their new execution services should bring them more customer interest.
“Their opportunity, clearly in some of the moves [under discussion], is to make sure that they provide all avenues in order to get paid for that vote,” Bennett said. “The institutional community likes to deal with them. They just need to make sure they can facilitate the trading side as much as clients would like them to.”
The Five-Year Plan
Bernstein brought in Wright from Merrill Lynch back in the summer of 2004 to place the firm’s trading operations under direct management and guide its strategic changes. Out of the gate, the firm bulked up its electronic trading services–particularly in single-stock algos and program trading. Bernstein then closed down its New York Stock Exchange floor operation in that period and upgraded its platform to an upstairs, sector-focused desk. It currently has 11 sector traders, Wright said. The firm also stepped up its investment in London for the European program trading business.
Bernstein later added product specialists–sometimes called sector specialists or specialist salespeople. Each is expected to know names and sectors, and to amass information from Bernstein research and from around the Street to benefit trading clients.
“Given our strength in research,” Wright said, “those are people who pull research intelligence to the point of execution and use that information to try to impact our trading desk clients.”
About a year ago, Bernstein began committing small amounts of capital to facilitate clients’ orders. The firm does not trade proprietarily, and so doesn’t take positions for internal gain. It still employs an all-natural model, Wright said.
“For our key client partners, it’s something we wanted to be able to offer to them to make it easier for them to choose us for an order, to trust us with an order,” Wright said. “We’re in a position now where we can facilitate someone; they don’t have to take the risk of calling us and then we can’t protect them if something prints.”
The program has gone well, he added. Facilitating for a handful of clients has helped marginally with Bernstein’s market share. And the firm expects the activity will increase over the next year or two.
On the product side, Bernstein in August expanded its derivatives effort in single-stock options, exchange-traded funds and cash-based index trading. The business started roughly 18 months ago with a two-person desk. In August, it hired five senior-level pros, Wright said.
“It was a very sensible way to grow the firm, and to be more relevant to our clients,” he added. “We’ll use derivatives expertise to make us better at our other core competencies; sales traders and sector traders get smarter about what’s happening in names. A lot of times, the activity in the underlying options can tell you a lot.”
The derivatives team will commit capital, as well. And, as with equities, the team will have a specialist responsible for disseminating research and “pulling the Bernstein research brand into the derivatives space,” Wright said.
This is nothing new. In the past year, or so, many firms around the Street have been opening derivatives desks to supplement their cash businesses. Bernstein said it will carve out its niche in the space by leveraging its sizable research product with its new derivatives desk.
“We’ve already seen significant growth,” he said. “It will be many times larger than it previously was for us.”
For its next trick, the firm is moving into Asia. It can execute global programs there already through a third party, Wright said. But Bernstein is still determining where it will locate. And it plans to fill out its strategy with both sales and trading soon.
“We’re mapping that out now,” Wright said. “But we expect to have research coverage, as well as sales and trading capability, in the major markets over the next six to 12 months.”
The process begins with research, Wright said. Sometime in 2010, sales and trading will follow in tandem. Salespeople will support the research product. Traders will focus initially on the global program trading business, and ultimately provide cash trading.
And expect more change to come. Between the past 12 months and the next 12 months, Bernstein has changed more than it has in the previous 30 years, Wright said. At the same time, he added, the firm is careful to maintain its core culture of research excellence as the brand.
Every firm is bound to have its share of fans, as well as detractors. But Bernstein customers have largely applauded the moves.
Traders Magazine talked to one head trader who said his portfolio managers are in love with the research at Bernstein. This desk head doesn’t use Bernstein for either capital-intensive trades or for derivatives, but he believes that its trading ability is in the same league as its research. “I really like the program trading desk,” he said, adding that he thought that Bernstein is probably on most buyside shops’ lists of top 10 brokers.
Another Bernstein customer with a strong research relationship said he thinks that the use of capital for client facilitation can work to the broker’s advantage. This trader doesn’t look for capital from Bernstein now, but said he would consider it in certain situations down the road.
“They can only do themselves a favor by committing capital to attract additional business,” he said. “I think it’s a good thing.”
One head trader at a firm that specializes in small-cap stocks likened Bernstein’s expansion to a “coming of age.” To be sure, she said, not all boutiques can take the next step to expand their services into new areas. Then, comparing the evolution of a brokerage firm to the development of a child, she continued: “If the bulge bracket is an adult and the boutiques are children, then firms like Bernstein are teenagers,” she said. “They’ve grown up.”
