Large Pension Funds Trimming Broker Lists to Bolster Service
May 4, 2009
The Teacher Retirement System of Texas (TRS) is taking steps to categorize its broker-dealers according to the level of service they provide, reflecting a growing emphasis among institutional investors on reevaluating--and paring--the brokers they work with.
Last fall, TRS, which had $70.6 billion in assets under management at the end of February, sent out a questionnaire to broker-dealers seeking details about the firms. It asked about trading histories, capitalization and compliance records, and requested copies of documents including their most recently audited financial statements, licenses, registrations and certifications.
The questionnaire is part of a process at TRS designed to identify brokers with which it wants to develop a stronger relationship. "To maximize trading performance, TRS will provide greater leverage of our key strategic partners," said Claudia Williams, senior director of trade management.
TRS is not alone among large pension funds in reexamining its executing brokers--coveted relationships in the broker-dealer community. The California Public Employees' Retirement System (Calpers) implemented a similar program earlier this year. In an April 20 presentation to the fund's investment committee, Calpers staff said that its number of active brokers has dropped from 78 to 30 since the program started.
Calpers, which has $175 billion in assets, has divided its active brokers into three categories: core brokers; firms whose capabilities and usefulness are currently being examined; and brokers that have been placed in a queue for inclusion in Calpers' biannual evaluations--the next is scheduled for July.
Improved Service
By reducing its broker relationships, Calpers gives the remaining firms more business, and in turn expects to receive a higher level of service. As a result, says Calpers, it has a "substantially smaller broker pool with counterparties who now recognize that continued order flow is directly dependent upon how they perform, rather than how well their sales force does." The pension fund expects that "this message will be equally compelling in more normal markets."
TRS, meanwhile, has developed six categories of brokers, according to Williams. Premier firms "deliver focused and high-capacity relationships globally and across all asset classes," she said. "They are highly integrated with TRS trading, risk management and administrative systems." TRS's core firms are well-established brokers with a global reach that provide best-of-breed products and services, as well as information about regulatory issues and market access rules. "Basically the entire trading process in every country," Williams said.
Firms that TRS considers "execution-only" must facilitate lower trading costs for securities that are hard to find or trade and provide increased access to liquidity in alternative trading venues. Niche firms help the fund gain expertise in specialized markets, while electronic trading firms provide access to the latest trading tools and algorithms. TRS's pilot firms are evaluated using the same criteria as its active brokers.
"If a brokerage firm does not place above the 'threshold' for trading with TRS on a regular basis, that does not mean they can't do business with TRS," said Williams. "But they will have to work very hard to earn a trade."
Paring Relationships
Historically, large institutional investors such as pension funds have used 200 to 300 brokers, said James Morrow, COO of Capital Institutional Services, a Dallas-based agency brokerage that caters to institutions. Over the past few years they've tried to reduce that number, he added. While the collapse of Bear Stearns and disappearance of Lehman Brothers put a brake on consolidation, which concentrates counterparty risk, Morrow noted that institutions have not responded by adding brokers.
