Execution Consulting: Quants Learn Handholding
November 23, 2011
Execution consulting. It’s the latest buzz phrase being tossed about between fund managers and broker-dealers. And it has nothing to do with getting advice on how to use the guillotine.
Instead, it refers to finding the best way for fund managers to receive low-touch (read: automated) trading with high-touch (read: personal) service from their broker -dealers
For broker-dealers, their ‘high-touch’ time is spent advising clients on how to execute their orders. This covers which trading venues to use, when to trade and how much to trade. They will also execute the order, if asked.
For fund managers, ‘low-touch’ means low-cost. Automating execution of trades on an exchange or alternative platform means lower transaction costs.
Based on estimates by research firm Tabb Group, more than 50 percent of equity trades are now down through the touch of a buttons, using algorithms, program trading or other computerized means. So clients shouldn’t need any handholding if computers do all their thinking right? Not exactly.
“At its core, execution consulting means helping clients improve their trading strategies to drive performance,” says Laurie Berke, a principal at Tabb Group who just wrote a report on the topic entitled “Execution Consulting: The Next Generation in Sales Trader Coverage.”
Berke didn’t highlight any firms in her report but often cited by fund managers in New York contacted by sister publication Money Management Executive were Bank of America Merrill Lynch and Bloomberg. Others were technology providers such as Tethys Technology and TradingScreen, which tout their independence from broker-dealer ownership as making them best positioned to providing execution advice.
Execution consulting really isn’t all that new. As Matt Samelson, managing principal at research firm Woodbine Associates in Stamford Conn., pointed out, fund managers have always wanted to work with broker-dealers who understood direct market access, algorithms and trading strategies.
The difference: It’s broker advice redefined for current market conditions. With Regulation National Market System in the U.S. and its European counterpart Markets in Financial Instruments Directive creating new alternative trading platforms and algorithmic trading, fund managers are a lot more demanding of their broker-dealers.
“In the current fragmented market where the buy-side trades much of its order flow through algorithms, the consultative process involves far more quantitative analysis of market structure, liquidity, trading performance and recommendations on how to use broker-provided tools to achieve desired results,” says Samelson.
Broker-dealers may be expert at trading but that expertise comes in two forms. Often called the “flow guys,” the high-touch traders can spout out plenty of advice on which stocks fund managers should buy based on their firm’s fundamental research. At best they might even know at what price to buy the stock.
Low-touch traders who work on an algo desk can explain in great detail how each algorithm works and when each should be used. There are dozens of broker algorithms and the wrong choice of trading strategy can result in costly leakage of trading information into the market, which can increase the costs of buying or selling shares.
Yet buy-side firms surprisingly think there is no notable difference between one broker’s algo and another’s. Roughly 52 percent of the fund managers who spoke with Berke say that algorithms are commoditized.
