Market Volatility is Forcing U.S. Equity Traders to Change Their Execution Strategies

NEW YORK--(BUSINESS WIRE)--Reaching unimaginable levels and showing no sign of settling back down to pre-crisis levels, market volatility is changing the way U.S. equity traders behave, including the way they use capital, transact trades in blocks, embrace algorithms and crossing networks and view their relationships with brokers. Based on new research from TABB Group, “U.S. Institutional Equity Trading: Crisis, Crossing and Competition,” an annual benchmark study, buy-side traders are altering their execution strategies, resulting in a realignment of market share and a reevaluation of broker relationships.

As a result, sell-side brokers’ sales traders have increased their share of order flow for the first time in years, capturing 44% of total buy-side flow, up from 37% in 2007. In the midst of extreme volatility, although the equity sales trader has enjoyed a comeback, the question remains, is it temporary?

TABB Group interviewed 61 head traders at traditional long-only institutional asset management firms representing an aggregate $12.9 trillion in assets under management (AuM), beginning in August, prior to Lehman Brothers’ downfall, finishing in September as the U.S. government announced the takeover of Fannie Mae and Freddie Mac.

Confirming that buy-side traders fear moving large blocks in highly volatile markets, 51% say their block executions have decreased year-over-year in 2008, and, says Laurie Berke, TABB Group senior consultant and the study’s author, “The percentage of volume executed on crossing networks has dropped for the first time since TABB began tracking it in 2004, in line with the overall drop in block-sized transactions.” Focusing further on the heightened affect of volatility on Wall Street, she adds that nearly 90% of the study’s participants increased or are maintaining the amount of their order flow executed using algorithms in 2008 over 2007.

As bulge-bracket firms undergo restructuring, the availability of risk capital has become scarce and, according to Berke, a majority of the buy-side firms say that the cost of capital has risen while the number of brokers willing to commit capital has dropped.

Asked what they need their brokers for most, over 30% said liquidity reigns supreme, and in 2008, only 13 core brokers are receiving 72% of the buy-side flow, versus 64% based on more than 15 core brokers in 2006. However, according to TABB Group, the trend toward ever-increasing broker consolidation has come to a halt. Buy-side firms will be diversifying their trading and commission sharing agreement (CSA) relationships, opening new opportunities for mid-tier and niche brokerage firms. “The next five brokers outside the core group of brokers will grow market share by as much as 20% by 2010,” says Berke.

Drawing from her analysis of 70-plus hours of interviews, Berke concludes, “The core broker list has stopped shrinking and while the loss of several bulge-bracket players required re-allocation of existing flow, the stage is set to encourage and reward that ‘next tier’ list of sell-side firms. If liquidity really is king, then buy-side traders will pay tribute with incremental commissions. Whether it comes over the phone, via IM, via IOI or in an electronic liquidity pool, brokers can build market share through coverage and persistence.”

“In some ways, just as the banks will have to go back to taking deposits to loan out money, brokers will have to go back to offering insight, expertise and a partnership to keep the orders flowing in,” adds Adam Sussman, director of research at TABB Group.

The 53-page study with 55 detailed exhibits, TABB’s fifth annual benchmark study on this subject, can be accessed by TABB Group Research Alliance clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. To request an executive summary or to purchase the report, please visit http://www.tabbgroup.com or write to info@tabbgroup.com.

About TABB Group

TABB Group is the financial markets industry’s only research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb, TABB Group analyzes and quantifies the investing value chain from the fiduciary, investment manager, broker, exchange and custodian, helping senior business leaders gain a truer understanding of financial markets issues. For more information, visit www.tabbgroup.com.