The reallocation of active to passive asset strategies, unbundling, streamlining funds execution infrastructure and increased volatility of US equities from 2018 into 2019 have significantly challenged buy-side head and senior traders. As a result, investment managers have told TABB Group they have significantly reduced their U.S. commission pool by 42% from 2015 peaks through 2019 and 27% from 2017.
Not only is the commission pool declining, says Larry Tabb, founder and research chair who co-wrote U.S. Institutional Equity Trading 2019 Trends: Is Active Management an Endangered Species? with Campbell Peters, research analyst, and Elyse Gerard, director of market outreach, but the unbundling of research and commissions has reduced the average buy-side research services allocation from 51% / 49% execution / services for the year ending 2017 to 55% / 45% in 2018. Peters adds, larger firms, however, have a more execution-focused mix, since they are allocating 36% of their commission dollars to research and services. This benefits larger firms over smaller ones.
The movement from active to passive management does not seem to be reversing, or even pausing, but accelerating, according to TABB, and while MiFID II does not directly impact the U.S., many larger firms say they are restructuring their research acquisition strategies to unbundle research from execution commissions, which has caused commissions to plummet as buy-side firms are rethinking their content strategies. All of these issues are top of mind with the 92 head and senior traders interviewed this year for TABBs six-part 2019 Institutional Equity Trading (IET) study. Trends is the second in the series, containing information on commissions, trends, rates, order flow, buy-side priorities, most widely used brokers and a host of other statistics. Part 1 covered liquidity.
Key findings in this 30-page study with 30 detailed exhibits include:
- A significant decline in blended rates pushed the average blended rates to 1.9 cents per share (CPS) from 2.3 cents per share in 2017.
- While low touch/algo flow rates held fairly steady, rates for high-touch, program and especially crossing network flow declined precipitously.
- Buy-side firms are increasingly prioritizing trading algos as their most critical factor in flow allocation, moving from high-touch coverage, historically the most important service.
- While algos are critical, the buy-side believes brokers need to improve their ability to provide high-touch coverage and liquidity.
- On average, research spending declined 9.9% from 2017 to 2018, as medium-sized firms cut research budgets by 15%.
- While broker research is the most important research service, market data terminals are second.
- Independent research budgets appear to be on the cutting block for 2019.
While it may appear to some that doom and gloom has taken over the industry, Tabb says its not the case, explaining that a new wave of innovation is upon us; brokers are reinventing their execution infrastructure; asset managers are rethinking their technology strategies; exchanges and trading venues are developing novel ways for buyers and sellers to meet; and the ecosystem is consolidating as it right-sizes capacity on all fronts, e.g., asset managers, brokers, venue and technology vendors.
While this will be a painful few years, says Peters, well transition into a leaner, more efficient equities industry. The buy- and sell-sides will be more automated. Well leverage new and more interesting data streams to find, quantify and capture alpha, There will be novel ways to trade, and the world of institutional investing will become less secretive and more open for the end investor.
As for who will emerge as a winner, Tabb says the buy-side believes that bulge-bracket, execution-only, mid-tier and algo brokers will all win. That said, larger buy-side institutions are flocking to larger brokers, while smaller buy-side firms are shifting to regional firms. The question is will smaller-size firms flow be enough to support this broker tier?
IET 2 is available now for immediate download by TABB US equities clients and pre-qualified media at https://research.tabbgroup.com/search/grid. For more information or to purchase Part 2, write to info@tabbgroup.com.
